Precious metals rebound, but not yet out of the woods

A report in an Italian paper last Sunday, that the IMF would lend 800bn US dollars to Italy, led to a rebound of precious metals in Asian trading on Monday. The amount stated in this report is above the lending limit of the IMF, thus, financial and commodity markets should have spotted this report easily as false. Also the IMF later denied being in talks with Italy about a bail-out loan. Nevertheless, precious metals rose and closed the day near the high of the respective trading ranges. On Wednesday, precious metals got another push higher by two measures from central banks. First, the Chinese central bank, the People’s Bank of China, reduced the reserve requirements by 0.5 percentage points. Second, the Fed and five other central banks agreed on mutual unlimited swap lines to provide sufficient US dollar liquidity to the banking system. This measure was targeted primarily for European banks after US investors withdraw funds from European banks and money market funds.

Among the precious metals, palladium posted the strongest weekly gain, soaring by almost 14.0%, the biggest weekly rise in 3 years. The cut of reserve requirements by the PBoC is probably positive for car sales and China and thus, for the palladium demand by the automotive industry. Furthermore, Norilsk Nickel, the world biggest palladium producer, expects the palladium market to be in a supply deficit next year.

After the rebound last week, also the technical situation for most precious metals has improved. However, does this imply that the assessment made last week in this blog was wrong? We still stick to our view that lasting and sustained rises of the precious metal prices require a convincing solution of the debt crisis in Europe. The rise last Monday was based at best on hopes that European politicians finally come to get their act together. However, there are many stumbling blocks on the road to a solution of the debt crisis in the eurozone.

On Thursday, the ECB will hold its rate setting meeting. After the swap agreement announced last Wednesday, some economists expect that the ECB might cut the refinancing rate again by 25bp. This would be helpful but would not eliminate the risk of a credit crunch in the eurozone with negative implications for activity in the real economy. At the hearing in the European parliament, ECB president Draghi repeated the stance that bond purchases would be limited and only temporary. However, one remark has been interpreted as keeping the door open for more active bond buying. Thus, the markets will also pay close attention to his statements at the ECB press conference.

At the EU economic summit on Friday, December 9, France and Germany want to push ahead to the formation of a fiscal union and want to present changes of EU treaties. German Chancellor Merkel insists on automatic punishments of countries violating the fiscal discipline and rules set in treaties. Also balanced budgets should be anchored in the constitutions of the eurozone member countries. While the creation of a fiscal union would repair at least to some extent the errors in the construction of the single European currency, the German demands do not provide a quick solution of the crisis. They might lead to a rebuild of confidence in the medium-term at best. Furthermore, Germany is only demanding what other countries should do but refuses to make any offer.

As we pointed out already earlier, the failure of politicians to act quickly and in a decisive manner contributed to the destruction of the government bond market in the eurozone. Government bonds are no longer a risk free asset. Investors have to fear that haircuts will not be only limited to Greece as a special case. Furthermore, the demand from Merkel and Sarkozy that a referendum considered in Greece should be about staying or leaving the euro, has opened the Pandora’s Box. Now, investors have to factor in the risk that they will get the redemption of a bond in a currency other than the euro. Furthermore, the European Banking Authority also contributed to the destruction of the government bond market in the eurozone by counterproductive regulations. The requirement, to value all government bond holdings at market values, not only those in trading books but also bonds intended to be held to maturity, has eroded the capital ratios of banks. In addition, they had to sell government bonds to reduce risk, which made the situation in the market only worse. In the short-run, the ECB is the only institution being able to act as a lender of last resort and to restore confidence. However, as long as German economic religion opposes such a step, the crisis will probably not be solved.

Thus, the second half of this new week will be very crucial for the further outlook for the precious metal markets. Currently, we regard the risks as more biased to the downside. We would not rule out that the announcement of an agreement would lead to a relief rally the following trading day. However, this relief faded more and more quickly after each EU summit. We remain skeptical that it will be different this time. But the next blog article provides an opportunity to comment on the EU summit. For those who went long precious metals, we recommend to keep tight stops.