Madame NO weighs on precious metals

The precious metals suffered during the course of the week and all metals ended in the red. Gold held best with a loss of only 2.5%, while silver and platinum were down by 4.0% each and palladium was the worst performer with a loss of 6.4% over the week. The three major fundamental factors of our quantitative fair value models all had a negative impact on the precious metals. The US dollar index strengthened while the S&P 500 index and crude oil fell and thus signal slower future economic activity and a declining inflation risk.

However, there remains one common factor behind the fundamental variables of our fair value models, the never ending debt crisis in the eurozone. Spain was now the fifth country in the eurozone, in which the debt crisis led to a change of the government. The conservative people’s party gained a broad majority of the seats in parliament and its leader Mr. Rajoy will become the next prime minister. Already during the election campaign, he indicated that more austerity measures and economic reforms would be needed to regain confidence of investors in Spanish government bonds. But investors gave Spain the cold shoulder. At an auction of short-term bills, Spain had to pay interest rates at a record high since the introduction of the single currency in 1999. The lackluster auction also led to rising yields on longer dated government bonds. The ECB bought Spanish paper, but the amount was not sufficient to prevent yields to rise.

At the beginning of last week, French government bond yields rose after a report from Moody’s was understood as an indication that France could loose the AAA rating soon. An economist at this rating agency warned that "Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications". This demonstrates how dangerous it is, when an economist chooses the wrong reference. Elevated could refer to the average of historical yields, but even at around 3.7%, yields on 10yr French OATs are relatively low by historical standards. The spread of almost 170bp over 10yr Bunds is rather high. However, is the 10yr yield spread the appropriate benchmark to judge the creditworthiness of France? The answer is absolutely no, from our point of view. The right comparison would be either nominal bond yields with nominal GDP growth or real yields with real GDP growth. At the current eurozone inflation rate of 3.0%, the real yield on 10yr French OATs is just 0.7%. The projected real GDP growth for 2012 is currently at 0.5%. As France is also implementing measures to reduce the budget deficit further, the difference between the real yield and real GDP growth rate should hardly give any concern about the creditworthiness of France. It appears again that rating agencies, which were a major culprit of the debt crisis in 2008, attack those who came to the rescue, namely the governments.

Many investors, but also politicians, thought that Germany would be the safe haven. Even when other core countries with a triple A-rating came under pressure, yields on 10yr German Bunds declined to a recorded low of 1.65%. Germany appeared to be the only solid rock. But last week, also Germany came under pressure. The auction of 10yr Bunds was a disaster and shows that investors are no longer willing to fund the budget deficit of the federal government, which will increase next year according to the 2012 budget. The German debt management agency planed to sell 6bn euro of 10yr paper, but investors bid for only 4bn euro. Thus, the remaining 2bn euro of 10yr Bunds will now be sold by the Deutsche Bundesbank in the open market. The Wall Street Journal accused Germany that it would accept the Bundesbank buying Bunds but would resist that the ECB buys bonds of other eurozone member countries. However, the WSJ did not understand the procedure. The Bundesbank only acts as a fiscal agent for the government. It is not buying the Bunds from the German government. The federal government will only receive the funds after the Bundesbank has sold the paper in the secondary market.

Nevertheless, the WSJ is right in pointing out that Madame NO is the major problem for solving the debt crisis. German chancellor Merkel is not only opposing the introduction of Eurobonds but even wants to oppress any discussion about this instrument, as her attacks on the head of the EU Commission, Mr. Baroso, showed last week. She also opposes that the ECB acts as the lender of last resort. As the debt crisis turned into a wide spread crisis of confidence, the ECB is the only institution, which has sufficient funds available to bring yields down to a sustainable level and to prevent further escalation of the debt crisis. The EFSF will fail miserable to reach the target level as press reports revealed over this weekend. Mrs. Merkel and her consultants are obsessed that solving the debt crisis would lead to a transfer union or rising inflation. In her naivety, Madame NO believes that a change of EU treaties would be sufficient to restore confidence.

The market for government bonds in the eurozone has been destroyed. The root cause is the ballooning Greece budget deficit during the Karamanlis government. However, the German chancellor played a major role that the initial problem could not be contained and the contagion now reached even the core countries of the eurozone. The demand that private investors would have to pay for the bailout of Greece while sovereign creditors get fully repaid was a major blow for holding government bonds. But also the European Banking Authority eba contributed to the destruction of the government bond market by several changes of regulations, which all lead to banks selling government bonds in a market, which is not ready to absorb them. It is a major construction failure of the euro that the ECB is not officially the lender of last resort. As long as Madame NO rejects all proposals which would involve a determined buying of eurozone government bonds by the ECB in the secondary market, the debt crisis will still prevail. For precious metals, this is a negative development. The current correction is likely to continue this week, unless there will be a convincing breakthrough to solve the eurozone debt crisis.