Precious metals still have upside potential in Q2

Gold ended the first quarter of 2011 close to our forecast of 1,440$/oz. Also platinum was only 2% below our forecast of 1,800$/oz. While palladium missed our forecast by 4% due to a stronger correction after the earthquake in Japan and the nuclear catastrophe caused by the tsunami, silver overshoot our forecast considerably. For the current quarter, we still expect that precious metals have some upside potential before the summer lull is leading to the typical seasonal correction.

Despite there are some good reasons to buy gold as a safe haven, i.e. geo-political tensions in the MENA region, the leak of radioactivity at the Fukushimi nuclear power station in Japan, it is currently more the risk aversion or risk appetite of investors, which has a strong impact on the price movements of gold. The decline of volatility indices as an indicator of investors risk aversion and the rebound of global stock markets in the second half of March pushed also the precious metals higher. Despite the production shortfall of Japanese car manufacturers, platinum and palladium recovered as did the stock prices of other major automobile companies. We pointed out that the stock prices of car manufacturers are normally positively correlated with platinum and palladium prices. The recovery of stock markets might still continue. However, the recent decline of the ISM manufacturing index in the US or the German ifo business climate index point out that these indices probably don’t advance much further. This would also be an indication that the upside potential for stock indices appears to be limited.

Furthermore, global central bank policy is another argument that stock markets are probably not trending higher through the rest of this year. In China, the PBoC has just recently increased the minimum reserve requirements further. Another rate hike, the fourth one since October last year, is expected in the near future. Fears that the PBoC might slow down GDP growth to strongly are a negative factor for stock markets and also for base metals. In Europe, the ECB is very likely lifting the repo rate by 25bp on Thursday this week. The MPC of the Bank of England is currently split about the further direction of monetary policy. However, the balance could tip easily. In the US, some Fed governors already demand to end QE2 ahead of schedule and to lift interest rates. The markets already priced in a Fed Funds hike in H2 this year. Even as the majority of the FOMC voting members still favor to proceed as scheduled, an extension of QE2 beyond June seems to be unlikely too. However, the FOMC might change the wording of the statement referring to the Fed Funds rate. Dropping the part “exceptionally low levels for the federal funds rate for an extended period“ would be interpreted as an exit from ultra-expansionary monetary policy. This could be a dampening factor for the stock markets, and thus also for the metals markets.

The euro strengthened versus the US dollar despite the crisis in some peripheral countries widened, especially in Ireland and Portugal after a series of rating downgrades by the agencies. One reason for the recovery of the euro is the monetary policy divergence in the eurozone and the US. Ending QE2 by the end of June and continued hawkish comments from some Fed officials could also trigger a rebound of the US dollar. A firmer US dollar would not only be welcomed by some emerging market countries, but would also be negative for the metals markets.

Some flow data also sends some warning signals that the upside potential for gold might be limited. The latest report of the CFTC on the CoT shows a rise of net long positions held by the large speculators. In the week to March 29, the net long position in Comex Gold futures rose by 18,284 to 193,121 contracts and is back to the level prevailing before the earthquake hit Japan. The net long position in silver fluctuated far less. At 37,139 contracts, it rose only by 364 contracts and is still clearly below the level of March 8. The holdings at the SPDR Gold Trust ETF declined further last week by 2.7 tons to 1,211.2 tons. Partly, this might be compensated by switching into other gold ETF, which have lower management fees. Retail investors are also switching from gold into silver, and this might explain the outperformance of silver in Q1 this year.  However, the conclusion from these developments is that investors get more cautious. But to push the precious metals strongly higher, investors would have to allocate more funds to precious metals.

All in all, therefore, we still expect that precious metals have some upside potential in the current quarter. However, the fundamentals might get less favorable during the next 3 month. We would still hold long positions, but would be very careful with entering new long positions.