“In Gold We Trust”

This is the headline at the title page of a German business weekly this weekend. It is an old market adage that it is time to exit a market if magazines report about this market on its title page. Given the price development of gold over the last two trading days of the previous week, the old wisdom seems to get it right again.

However, it is certainly not the reason gold dropped by 3.7% from the high reached on Wednesday to the close on Friday that a German business magazine devoted the title page to gold. The two factors causing this decline had been the FOMC meeting and the second press conference by Fed chairman Bernanke as well as the debt crisis in Greece and how the eurozone handles it.

Greece’s PM Papandreou reshuffled his cabinet the week before and faced a confidence vote in parliament last week. He survived this confidence vote. This week, the Greek parliament will vote on his austerity package. If markets were forming expectations rationally, as academic theory postulates, then markets should price in that with expressing the confidence to PM Papandreou, the majority of the lawmakers would also vote for his austerity package. However, financial markets still fear that the austerity measures demanded by the EU to support Greece would fail to pass the approval of parliament in Athens. As a result, the credit default swaps for Greek government bonds are still surging and the spread over benchmark German bonds and notes are rising. However, also the yield on German government bonds are falling due to safe haven flows into Bunds. The yield of 10yr Bunds dropped to 2.83% and is only 13bp above the eurozone inflation rate. Institutional asset managers taking their fiduciary duties seriously should not invest in bonds yielding less than the inflation rate. Nevertheless, they buy German government bonds along the curve and thus, harm their clients by holding bonds with a negative real yield.

Therefore, the Greek debt crisis has a negative impact on the euro directly and indirectly. The direct impact is the flight of capital out of the eurozone based on the fear of a Greek default. The indirect negative impact is via the yield and interest rate spreads, despite the ECB is going to hike the refi rate at the rate setting council meeting in July.

However, also the FOMC meeting had a negative impact on gold. The Fed revised its forecast for GDP growth down to 2.7 – 2.9% compared with 3.1 – 3.3% in April. The unemployment rate is now expected slightly higher at 8.6 – 8.9%. But unlike some market commentators and bank economists predicted, the FOMC decided to terminate QE2 as scheduled by the end of this month. In addition, as Fed chairman Bernanke pointed out, the Fed does not consider the implementation of QE3. However, it will reinvest proceeds from interest payments as well as maturing notes. Thus, the Fed will remain its current stance, but will not become more expansionary. As the market priced in further easing measures to support the economy, the US dollar recovered and this is a negative factor for gold.

We were never convinced by the argument that QE2 would be inflationary. The rise of headline CPI is the result of the supply shocks in the agricultural and crude oil markets. Both shocks are not the result of the Fed monetary policy. Nevertheless, those investors believing that QE would be inflationary had to revise their expectations about inflation after the Fed announce that they are not considering QE3, which is also a negative factor for gold and other precious metals.

All in all, we still expect the precious metal markets to consolidate over the summer month. The low reached in early May at 1,463$/oz should be a stronger support level.  

Gold torn between euro weakness and the Greek debt crisis

The ECB prepared the markets for a rate hike in July at its monthly press conference and the euro lost about six cents versus the US dollar to 1.41 within a few days. If the sell-off were triggered by profit taking according to the old market adage to buy the rumors and to sell the facts, the impact of the stronger US dollar on Gold should have been negative. One would have expected that gold would give back a bigger part of the gains made before. However, this was not the case. The weakness of the euro against the US dollar was not triggered by profit taking, but by renewed fears of a Greek default on its national debt.

Partly, the drop of the euro could be blamed on the continuing protests in Greece against the austerity policy. The Greek government is trying to push the sixth saving package through parliament. However, the Greek government is in an uphill struggle like Sisyphus. The more they try to save, the more the GDP contracts and the debt to GDP ratio increases, which leads to further downgrades by the rating agencies. The agencies are part of the problem as they pour gasoline in the fire and prevent the fire-brigades from EU, ECB and IMF to extinguish the fire.

However, also the German government is more part of the problem then the solution. German academics have demanded to let Greece default and restructure its debt. The finance minister resisted this siren calls and rightly pointed out that it could lead to collapse of the financial system like the bankruptcy of Lehman Brothers. But suddenly, he changed his course and demanded that the private sector would have to make voluntarily a considerable contribution to a second bail-out package for Greece as it is rather unlikely that Greece would be able to obtain funding in the capital markets next year given the high interest rates in secondary markets and poor ratings by the agencies, which keep the outlook still on negative.

The ECB fears that the demand from Germany could trigger the credit event clause as the rating agencies already threatened. In this case, all Greek debt outstanding could be demanded to be redeemed immediately. In addition, the ECB would no longer be able to accept Greek government debt as collateral in the repo operations. This could trigger the default of banks in Greece. Fortunately, Germany has softened its stance after a meeting between German chancellor Merkel and French president Sarkozy in Berlin last Friday. This gave the euro a push higher and gold also profited from this move.

Also the politicians in Greece play a crucial role. The troika of IMF, EU and ECB demanded that also the opposition would back the agreement between Greece and the troika. However, the opposition party, which was responsible for the ballooning budget deficit between 2004 and 2009, is not willing to cooperate. They demand tax cuts, a measure the troika will not accept. Furthermore, the conservative opposition creates the illusion among the population that the austerity policy would not be necessary to avoid a default on the national debt and a collapse of the financial system. Thus, the support for the policy of the PM is decreasing. After a government reshuffle, the PM faces a confidence vote after this blog is published.

In the case that the PM of Greece will survive the confidence vote, the flight to the save haven of gold might ease somewhat. But in this case, the euro should strengthen versus the US dollar, which would be a positive factor for gold, especially as the diverging monetary policy in the eurozone and the US point to further dollar weakness. In the case that the development concerning Greece get worse, the euro might come under renewed pressure, but the impact on gold might be compensated by safe haven buying. In the short run, it looks like gold remains torn between these two opposing forces. 

Signs of slower growth mounting

Last week, metal markets were mixed but most metals ended the week slightly lower compared to the close of the preceding Friday. The dominating factor was the economic data released during the week, which had a direct negative impact. However, the indirect effect of the weaker than expected economic figures was supportive. We expected that metal markets would consolidate during Q2 and Q3. Thus, we are currently not much concerned that the weaker than expected economic data would trigger a bear market in metals.

Two types of important economic data are usually released at the beginning of the month, the surveys among purchasing managers in the manufacturing industries of various countries and the US labor market data. In China, the official PMI came in slightly above the consensus, but declined again in May. The HSBC PMI for China edged up to 51.6 after 51.1 in the month before. Nevertheless, the PMI in China is close to the crucial 50 mark. But as long as the PMI stays above this level, the index points to an expanding economy. However, it is understandable that the base metal markets remain concerned that the restrictive monetary policy of the PBoC could drag growth further down.

In the eurozone, the manufacturing PMI declined from 58 to 54.6 in May. While the decline is considerable, it is not a reason to worry as long as the PMI stabilizes around that level. We pointed out several times that readings close or even above 60 were not long lasting and that the PMIs often decline to readings in the mid-50 range. And the economy still could expand strongly with a PMI around 55. Thus, the eurozone PMI is still at a level, which would not prevent the ECB from increasing the rather low refinancing rate further towards 2% by the end of this year or early 2012. The ECB is likely to prepare the market for the next rate hike at the press conference following the council meeting this week.

In the US, the drop of the manufacturing ISM index was even steeper, from 60.4 to 53.5. Furthermore, the unemployment rate edged higher again to 9.1% and only 54 thousand new jobs were created in the non-farm sector. This indicates that the US economy has lost some pace. While it is rather unlikely that the Fed would embark on a new round of quantitative easing, the risk for a rate hike in H2 of this year has also diminished.

The indirect effect on commodity prices worked through a weaker US dollar. Despite the PMI feel in the eurozone and the US, the outlook for monetary policy remains dollar negative. Also the report of the IMF, EU and ECB on Greece with testify that Greek has made progress and the next tranche of the loans to be made in time have supported the euro. Thus, a weaker US dollar is like to partly compensate weaker economic data. Nevertheless, the consolidation is likely to last during the summer.

I will be at a conference this week and can not follow the commodity markets closely. Therefore, the next block article will be published on June 19.