Vanishing hopes for QE-3 drag precious metals lower

Gold and silver ended the week with a loss, while the PGMs managed to defend some of the gains made during the week. But all precious metals were dragged down after the release of the US labor market report.

The US labor market report released last Friday was not the first one, which surprised the market consensus to the upside. For a couple of months, the non-farm payroll figure came in stronger than Wall Street economists predicted on average. Also figures for the preceding months were revised to the upside in a couple of consecutive reports. The unemployment rate dropped in the report for December already from 9.0 to 8.5% and declined now in January further to 8.3%. However, this time something was really different, the reaction in financial markets. The last few times, the US Treasury market reacted with losses and the S&P 500 index future rallied immediately after the release of the labor market report. However, only a few minutes later, markets reversed direction. US Treasury notes and bonds prices not only recovered losses but even ended in the plus. Stock markets gave back the gains. But, last Friday, the markets reacted as one would have expected it after a strong labor market report. US Treasury notes ended down and stock markets closed significantly higher.

From our point of view, two factors contributed to the normal market reaction. First, the talks about a debt restructuring of Greece are still not completed. But as the Greek administration stated, an agreement is almost reached. In addition, auctions of other eurozone countries went well and Italy and Spain could issue paper at considerably lower yields compared with previous auctions. Thus, the situation is the eurozone has at least stabilized. This reduces the appeal of US Treasury paper and of the US dollar as safe haven.

Second, Fed chairman Bernanke was more optimistic on the US economy during the testimony compared with the FOMC statement released the week before. Furthermore, markets realized that the recent FOMC statement did not provide a firm guarantee that exceptionally low interest rates would stay at that level until late 2014. If economic conditions change, the Fed would also be ready to end the phase of exceptionally low interest rates. In addition, some economists rightly argued that even a hike of the Fed Funds rate would be compatible with exceptionally low interest rates because the FOMC might regard also Fed Funds below 1% as exceptionally low.

But most important in this context appear to be expectations for another round of quantitative easing. The US Treasury market was well supported by speculation that the Fed would soon embark on QE-3 officially. Economic data released during the course of the week pointed to a further strengthening of the US economy. The further strong increase of non-farm payrolls and the surprising decline of the unemployment rate, which was not due to unemployed persons leaving the work-force, have triggered a change in market expectations. Hopes for QE-3 vanished and got priced out in the US Treasury market as well as in US dollar foreign exchange rates. The US dollar index declined and the euro firmed against the US dollar. This spilled over to the precious metals, which also traded lower in line with the falling US dollar index. The rise of stock market indices and the rebound of crude oil prices were not sufficient to compensate the negative impact from the US dollar and Treasury market.

After the strong rise in January, gold might now be in for a correction. We would not be surprised if gold pares all the gains made after the release of the recent FOMC statement. However, experience also tells that economists adapt their forecasts. After having underestimated economic data consistently for some months in a row, they get then too optimistic and overestimate economic data in their forecasts. Therefore, if economists get too optimistic and economic data disappoints markets, hopes for QE-3 could then be back on the agenda again. But even in the case that economic data remains strong, the usual fundamental drivers of precious metals are likely to prevent a sell-off. Thus, we expect only a correction but not a medium-term trend reversal.