Ben Bernanke judged again by words instead of deeds

If anybody thinks that history is not repeating, he should have a look at the recent FOMC meetings and those in 2008. The similarities are striking. Last Wednesday, the FOMC decided to lengthen the duration of the holdings in US Treasuries but not to increase the volume of US government bonds on its balance sheet. This is called “operation twist” and has been widely expected by financial and commodity markets. However, the statement issued after the FOMC meeting caused more damage than operation twist is probably able to be beneficiary for US GDP growth. Also back in 2008 during the financial crisis, the Fed implemented many measures; even some innovative ones being appropriate to tackle with the crisis, however, the statements of the FOMC or from individual members of the FOMC were counterproductive.

It is probably both, the Fed and the markets, being to blame for the turmoil in markets following the FOMC statement last week. The Fed has not learnt the lessons from mistakes made in 2008 that words sometimes speak louder than actions and that monetary policy could be ineffective if statements of central bankers have a negative impact on the mass psychology in markets. The financial markets were already highly concerned that the US and the global economy might head towards a double dip recession. Changing the wording of the FOMC statement that “there are significant downside risks to the economic outlook“, made already hyper-jittery investors even more nervous.

However, also financial and commodity markets are to blame for overreacting. One could not expect that the FOMC decides on implementing further measures to prevent a recession of the US economy without providing a justification. This implies also that the FOMC would have to change the wording of its statement.

Increased fear of a global recession pushed stock markets lower. But also base metals got hammered. Copper, which is especially sensitive to business activity, lost more than 15% compared to the preceding week. Lead and tin lost even more as rising inventories contributed to pressure on prices.

Gold could not live up to its reputation of being a safe haven in times of turmoil in stock markets. Last Friday, gold suffered its worst one day plunge by falling more than 100$/oz. Compared to the previous week, gold lost 8.6%. Other precious metals with a higher share of industrial demand suffered stronger percentage losses and silver was again the most volatile among the precious metals. Also the situation in the precious metal markets is similar to fall 2008.

Two factors are at work, which push gold lower. First, investors sell assets across the board. To some extend this selling is driven by the intention to prevent capital and to keep losses from widening. However, some investors also sell assets to realize profits needed to compensate losses suffered with other investments. Gold is very likely being sold to a large extent for the second reason, i.e. to realize profits. The second factor is the US dollar. Investors not only sell assets in times of financial turmoil, like in 2008, however, they also repatriated funds invested abroad back into US dollars. Thus, the US dollar strengthened despite further Fed monetary easing measures. The US dollar index rose 2.5% over the week. The firmer US dollar is another reason for investors to sell also the precious metals.

Even before the FOMC statement was released, large investors have reduced their gold holdings further. According to the latest CFTC report on the Commitment of Traders, non-commercials have reduced the net long position in COMEX gold futures by another 18,318 contracts to 150,529 contracts in the week ending September 20. We would not be surprised to see another drop in the report for the week ending next Tuesday.

Whether gold will continue to trade lower probably depends to a large extend on the further movements in stocks and forex markets. A crucial role for these markets will be the developments of the eurozone debt crisis and the economic figures released during the week. Especially, if the situation in the eurozone gets worse, it could be a double whammy for gold and other precious metals. Therefore, it could not be ruled out that gold enters also bear market territory after falling already more than 15% from the record high. 

Time to say good-bye to gold?

It is a common wisdom that a bull market is over when the last bull has bought. One indication for a market reversal is according to an old market adage when a bull market does not longer rise on bullish news. This had been the case in the gold and other precious metals markets at the start of the week. The German economics minister and head of the junior coalition partner published an article in a Sunday paper where he talked about insolvency of Greece. As the German member of the ECB directorate resigned the Friday before and internal scenario analysis of the German finance minister had been leaked to the media the same day, the market got the impression that the German policy has changed and that the government want a Greek default instead. European bank shares got hammered and dragged the stock market indices lower. The German DAX index dropped below the 5,000 mark, a loss of more than 8% within two trading sessions. Both factors – the plunge of stock markets and the increased risk of Greece defaulting – are normally positive for gold but they could not push gold higher. Instead gold dropped to almost 1,800$/oz.

Tuesday was a reversal day for major European stock markets. Furthermore, the Fed and the major European central banks agreed on measures to provide banks with sufficient US dollar funds over the year-end, which pushed stock markets further up. The German DAX index closed 12.25% above the low of the week. This rise of stock markets did lead to a fall of gold to a low of 1,766$/oz but there was no plunge of gold or other precious metals.

On Friday, gold recovered after hitting the low of the week. Some market commentators attribute this recovery to US consumer expectations in the University of Michigan consumer sentiment index. However, the turnaround set in already during the European morning hours, far ahead of the release of the US consumer sentiment. From our point of view, this recovery is more related to market expectations and reactions on the appeal of US Treasury secretary Geithner at the conference of EU finance ministers. The European FinMins presented unanimity in rejecting the demands of Mr. Geithner. While one might not subscribe to all of his points made, the eurozone finance ministers did again fail to understand the main message. The eurozone has to demonstrate and convince financial markets that they are determined to take all measures necessary to solve the debt crisis. But as long as the eurozone finance ministers just react half-heartedly to new developments in the debt crisis instead of acting decisively, gold bulls could feel comfortably with their positions.

According to the latest CFTC report on the Commitment of Traders, the large speculators reduced their long positions in gold futures by 13,062 contracts and increased the short positions by 2,462 contracts in the week ending September 13. Thus, the net long position of the hedge funds and CTAs declined by 15,524 contracts to 168,847 contracts. This is the lowest reading after the net long position reached a peak at the start of turmoil in stock markets. Since August 2, the net long position dropped by 78,328 contracts or 31.7%. Also the gold holdings at the biggest ETF, the SPDR Gold Trust fell from the high in early August at 1,309.92 tons by 78.51 tons but recovered last week to 1,251.91 tons. Thus, while the debt crisis in the eurozone intensified and major stock markets declined, investors have reduced positions in gold.

Gold rose twice above the 1,900$/oz mark within the last few weeks. However, the flow of funds data shows that major investors have reduced their gold holdings. Also gold did not react to the major drivers as one would have supposed. This might be a warning signal. But it could also simply imply that no longer investment demand from Western countries is the main factor driving gold. Asian investors and the fear of inflation in the major economies of China and India might now be the dominating factor. 

Swiss National Bank and Germany moved Gold

The precious metals posted losses compared to the close of the week before. As the US dollar index rose by 3.2% to 77.19 one might be tempted to attribute the decline of all precious metals to the stronger US dollar, which is normally a negative factor. However, the US dollar index rose steadily, while the precious metals showed a completely different trading pattern over the course of the week. Therefore, other factors have obviously also played a role.

On Tuesday, gold hit a new record high, but ended the trading day significantly lower. The decision by the Swiss National Bank to peg the Swiss frank to the euro triggered a stronger liquidation of gold holdings. The SNB announced to defend a EUR/CHF exchange rate of 1.20 and would be ready to buy euro at this exchange rate for unlimited amounts. This decision limits the potential for movements in USD/CHF to the fluctuations of EUR/USD. Thus, a weakness of the euro against the US dollar also implies a weakening of the Swiss franc versus the US dollar. The price of gold showed recently a closer correlation with USD/CHF. As the upside potential for a stronger Swiss franc appears now to be limited by the determination of the SNB to defend the target rate, the attractiveness of precious metals has also been reduced.

Another negative factor for the precious metals as a safe haven had been the German Constitutional Court, which rejected two law suits against Germany’s participation in the bailout of Greece. The ruling has strengthened the position of the German Parliament, the Bundestag. Its budget sub-committee has to approve payments made within the framework of the European Financial Stability Facility. Some commentators have regarded the ruling of the highest German court as a stop for further financial assistance or also for common “euro-bonds”. However, this is not the case. It depends on the details of such arrangements. However, neither the government nor the parliament is allowed to issue a blank check and other national governments have the discretion to decide about spending the money. Germany still has the possibility for financial aid but an automatism must be avoided. Therefore, Germany could still participate on measures to solve the European debt crisis.

On Thursday, the ECB decided to keep the interest rates unchanged, which was not a big surprise. However, the staff projections for GDP growth had been revised down. The ECB sees the inflation risks now balance, but those for economic expansion are to the downside. Thus, the ECB is no longer intending to hike interest further and even a rate cut during the final quarter of this year is possible. This had weakened the euro versus the US dollar, but the stronger US dollar did not lead to a further decline of gold.

Precious metals even recovered thanks to the stupidity of Wall Street. Fed Chairman Bernanke gave a speech to the Economic Club of Minnesota. Wall Street was disappointed that he did not announce new monetary stimulus measures but repeated more or less the positions outlined in August at the Jackson Hole seminar of the Fed. How insane are some traders and investors expecting the Fed chairman to announce new monetary policy measures at a luncheon? Decisions about monetary policy are not taken by the Fed chairman alone, but by all voting members of the FOMC. The FOMC could decide also via telephone conferences outside of the regular meetings. However, it is usually at those regular meetings that decisions about new measures are taken. Therefore, the Fed chairman can not announce new measures at a speech. He has to convince the council members to follow his proposals. Declaring that the Fed will implement new measures before the FOMC has decided would be an insult to other FOMC members, which could be counterproductive as the FOMC might vote against those new measures. However, as Ben Bernanke did not fulfill the unrealistic expectations of some Wall Street traders, the stock indices pared earlier gains and turned negative. This reversal supported the precious metals.

On Friday, gold rebounded from an earlier drop after stock markets sold off. It was again panic among traders and investors, which send stock markets south and thus, supported gold. The ECB chief economist Stark resigned. In the letter to ECB president Trichet, Mr. Stark wrote that he resigns for personal reasons and would stay in office until a successor had been appointed. This statement was supposed to be released after markets closed. However, two persons knowing about this resignation informed a new agency and stated the reason for this step would be the decision of the ECB council to buy Spanish and Italian bonds.

It appears that the source of this indiscretion was the German Government as the report on Reuters also named the under-secretary of the German finance ministry, Mr. Asmussen, as the potential successor for Mr. Stark. And indeed, FM Schaeuble proposed him to the Eurogroup at the G7 meeting. Also another leak from the German finance ministry increased the jittery among traders and investors. The German finance ministry is analyzing and evaluating the consequences of a possible Greek default. It would be careless not to do such a scenario analysis. And of course the question, whether the government would have to shield the German banks in such a scenario, has to be considered also. However, some sources again leaked to the media that Germany would shield its banks in the case of a Greek default. In financial markets, this was interpreted that Greece would already default over the weekend, some weeks before the report of the IMF, EU and ECB on Greece. Thus, German attacks on the ECB council and its independence as well as the attempt to aggravate the already poor economic situation in Greece have triggered a sell off in stock markets and a rally in safe haven Bunds, but also contributed to paring losses in precious metal markets.   

Metals close mostly higher, but mixed moves in markets

The precious metals and with the exception of lead and zinc also the base metals ended the week higher. However, it was a very mixed development for both segments of the markets for metals. While the industrial metals traded higher during the first half of the week, gold and silver only managed to close the week in the black due to a rally last Friday.

For the base metals, the development was similar to the movements of the stock markets. Also the S&P 500 index rose during the first half of the week and ended in the red due to the plunge following the release of the US labor market report. Earlier last week, the stock market even shrugged off the deteriorating consumer confidence index, which dropped from 59.2 to 44.5 - far stronger than the consensus of economists expected.

There is one striking point to notice among various economic data releases during the past two weeks in the US. The sentiment or expectation based date came in lower than the decline, which economists had already predicted. However, data based on hard figures tended to surprise on the upside. This was also the case with the Chicago PMI and the nationwide ISM manufacturing PMI, which remained above the crucial 50 level being regarded as the threshold between expansion and contraction of the economy. The factory orders increased 2.4% on the month, which was also far above the consensus forecast.

From this observation, we conclude that the plunge of international stock markets following the last minute compromise to lift the US debt ceiling and the politically motivated downgrade of US Treasury paper by Standard & Poor’s has massively damaged the economic sentiment. It has increased the fear that the world’s leading economy might head towards a recession. However, the activity data on order flow, industrial production and consumer spending has held far better and does not yet point to a recession in the US. But it still has to be seen, whether the plunge of stock markets had a negative impact on economic activity. While we still regard a modestly growing US economy as the most likely scenario, it can not be ruled out that the fear of a recession eventually leads to a recession. But in the case that real activity data continues to come in better than expected, the sentiment in stock markets could improve. This would be positive for the industrial metals and negative for gold and silver.

In China, the official manufacturing PMI also remained above the 50 mark and the HSBC manufacturing PMI increased to 49.9 and therefore also provided a positive indication. Thus, it appears as likely that the Chinese GDP will grow with a rate above 8% this year. The Chinese PMI data has also been supportive for the base metals. In Europe, however, the final PMI was revised further down to 49.0. The drop of the eurozone PMI was mainly a result of the strongest plunge of foreign orders in two years, with especially export orders in Germany posting the strongest drop. The German government has already damaged the GDP growth with the u-turn in the energy policy. Now, the hesitation to agree on measures to solve the eurozone debt crisis, which also impress the financial markets, is firing back. Germany needs expanding foreign economies to prosper from its export oriented industry.

The lift for gold and silver to a positive close on the week came from the US labor market report, which on the other hand reduced the plus of base metals. The US economy is not growing sufficiently to create enough jobs in order to reduce the unemployment rate. This is no news. However, the situation is not as bleak as the labor market report suggests on a first glance. Given the constraints on state budgets, the government sector is cutting jobs for some time now. The August labor market report now suggests that the private sector only created jobs just enough to compensate for the losses in the public sector. However, the August report is distorted by a strike at Verizon, which led to a loss of 45,000 jobs. Once this strike is over, those jobs will be added again to the payrolls. A neutral treatment of the Verizon strike would have shown a positive new jobs figure at this magnitude. Nevertheless, this is not enough that the Fed would not have to react on its second duty. Therefore, the Fed is likely to announce additional stimulus measures at the next FOMC meeting later this month. However, the Fed could not solve the problem of insufficient job creation alone. Also the fiscal policy has to contribute its share.

Additional measures by the Fed to stimulate the economy would be positive for the stock market. If the Fed decides to buy more long-term US Treasury notes and bonds, it would also the support the long end of the US bond market and the real yield on US T-Notes could fall even further. This would be positive for gold and silver. However, an improved outlook for the stock market could trigger a stronger shift in asset allocations out of the save havens into the more risky assets. In this case, the impact on gold and silver could be negative.

Another factor, which is crucial for the save haven flows into gold and silver is the development of the eurozone debt crisis. Italy’s PM Berlusconi appears to have only bunga bunga (a common name in Italy for wild sex parties of the PM with young girls) on his mind. His coalition partner from the Northern League is more interested in politics, but is also narrow minded and does not understand that the fate of Europe has also an impact on the regions in the north of Italy. After proposing a package of measures to balance the budget by 2013, which was the basis for the ECB to support Italy by buying its bonds in the secondary market and thus pushing yields from above 6% down by a full percentage point, the Italian government now announced to step back from implementing some of the measures announced. This has increased the fear in financial markets that the debt crisis is escalating again. Rumors were also swirling around after the members of inspection team from the IMF, EU and ECB left Greece and talks were suspended. As long as the media is interested in spreading around false rumors and politicians are unable to implement necessary measures, the financial markets will not calm down. Thus, concerns about the eurozone debt situation will remain alive for quite some time. This is not good for the economic outlook of the eurozone, but all the better for holders of gold and silver.