Precious metals and the Fed

The major driving factor for precious metals, which all ended the week lower with gold and silver suffering most, was the FOMC meeting. Thus, we look closer at the impact of the Fed policy on precious metals. We conclude that the risk is more biased to the downside.

The flight into safe haven assets was not only driven by the development in Greece, but also by the monetary policy of the Federal Reserve System in the US. On the one hand, the current “Operation Twist” has pushed yields on longer dated US Treasuries lower as private investors also bought US Treasury paper ahead of the Fed purchases. On the other hand, the market speculated that the Fed would implement another round of quantitative easing, called QE3. This has kept the price fluctuations of the 10yr US T-Note future in a narrow trading range for several months and yields on 10yr T-Notes hovered slightly below the 2% level.

The precious metals profited from this development via three channels. The first one is the link between the price of precious metals and the US Treasury yields. The ultra-low yield level had reduced the opportunity costs of holding precious metals, which don’t yield any direct returns. The second link was via the foreign exchange rate. The expansionary monetary policy has lead to a weaker US Dollar against some major currencies. For the EUR/USD exchange rate, also the debt crisis in the euro zone played a role. Nevertheless, the stronger precious metal markets in the first two months of this year were accompanied by a weaker US dollar.

The third channel is via the stock markets. After the plunge in August, the expansionary monetary policy of the Fed was supportive for the stock markets. The tensions in the eurozone debt crisis caused some set-backs. However, after also the ECB took unconventional measures to flood the banking system with liquidity, the tensions eased. Of course, it was also helpful that economic data in the US surprised to the upside.

The FOMC provides an improved outlook for the US economy compared with the preceding statement. The committee has not provided any hint that QE3 would be implemented. While the FOMC continues “Operation Twist”, it also does not give any indication that this program would be extended beyond the scheduled end in June this year.

After the release of the FOMC statement, the US dollar came under pressure and a sell-off in the US Treasury market set in. However, the S&P 500 index still ended the week with a gain of 2.4%. This development explains that the PGMs declined far less in percentage terms than gold and silver.

Recent economic data indicates that the US economy is likely to expand further. The surveys of the Federal Reserve Banks in New York and Philadelphia rose stronger than the consensus of Wall Street economists predicted. The University of Michigan consumer sentiment index declined according to the preliminary data for March. However, the link between consumer sentiment and spending is not a very close one. Spending has increased also in the past despite falling sentiment. Therefore, we expect the US economy to expand further at around the pace seen in the final quarter of last year. But at a GDP growth of 3%, the Fed is unlikely to change its current policy stance. This implies even the risk that the current program of extending the maturity of its US Treasury holdings might not be extended.

Thus, the yield on 10yr US Treasuries might climb higher towards the 2.5% mark. Furthermore, the US dollar is probably going to hold fairly stable against major currencies or even to appreciate. Both factors would be negative for precious metal prices. However, an expanding US economy is likely positive for the stock market, which should also profit from shifting funds out of bonds into equities. This would be a supportive factor for precious metals and especially for the PGMs, which might perform better than gold and silver in the short-term horizon. But all in all, it has to be expected that the correction in precious metals markets is probably not over yet.

Also the flow of funds data points to a further correction. According to the latest CFTC report on the “Commitment of Traders”, large speculators have reduced their net long positions again. In the week ending March 13, they reduced the long positions in gold futures by almost 8,000 contracts to 190,477 contracts but increased the short positions by almost 5,000 to 39,571 contracts. Thus, the net long position fell by 12,359 to 150,906 contracts.

Some weeks ago, we argued that from a technical perspective gold should find support around 1,640$/oz. Gold has found indeed support at this level. However, also from a technical perspective, gold is not yet out of the woods. Some indicators point to an oversold market, which would argue for buying at support. However, the downward trend is still strengthening as the rising ADX indicates. This indicator is furthermore not yet at a level, which would indicate that the downward move is overdone. Also the MACD is still declining faster than its signal line. Thus, the knife appears to be still falling. Currently, we would stick to the old advice of never catching a falling knife.