Gold at risk of falling below 1600$/oz

Falling stock markets and a stronger US dollar might lead to further losses in precious metal markets. Gold bounced back at the upper end of a support zone last week. However, a renewed attack at the support zone and a fall below 1600$/oz can not be ruled out. In this case, gold would be at risk to visit the low from December last year again.

Two factors were responsible that weak stock markets and an appreciation of the US dollar pulled precious metal prices down last week. First, the FOMC minutes did not contain any hint that the Fed would embark soon on implementing another round of quantitative easing, called QE3. This should not come as a surprise. Even as the CPI is not the favorite inflation gauge of the Fed, but with core CPI inflation at 2.3% and headline inflation at 2.9% in February, some FOMC members are reluctant to increase the balance sheet of the Fed further. In addition, the recent GDP growth of 3.0% in the final quarter of 2011 does not indicate that another stimulus would be needed currently. However, the reaction in the stock and the foreign exchange markets was not rational at all. The Fed policy is expansionary as interest rates will be kept at extremely low levels into late 2014. The strong growth of the US economy should be positive for the stock market. Thus, there is no reason to liquidate stock positions because the Fed is currently not willing to get even more expansionary. However, there is also no reason to buy now US dollars because the Fed Funds rate is extremely low. There is still an incentive to borrow funds in US dollars and to invest abroad or in precious metals given the development of the US CPI inflation and the low opportunity costs for holding gold.

After the release of the US labor market report on Good Friday, the S&P 500 futures plunged further and the 10yr US T-Note future jumped by more than 1.25 percentage points. Instead of 202 thousand, as the consensus of Wall Street economists expected, only 120 thousand new jobs were created in March. However, the unemployment rate declined to 8.2% while the consensus was looking for an unchanged reading of 8.3%. Also the number of jobs created in the previous month had been revised up. The ADP estimate of private sector employment released only a few days earlier pointed to a robust new job creation around 200 thousand. True, the ADP report has not a good track record. Nevertheless, we are also skeptical that the labor market report for March paints the real picture. The numbers of new jobs created are revised up even two months after the first release. Furthermore, seasonal adjustment procedures could lead to distortions as the impact of the weather can not be eliminated completely. Normally, some confirmation for a worsening of the labor market situation would be needed. However, the labor market report could weigh further on the stock market as investors might fear a slow-down of the US economy. Also some hope for QE3 at the next FOMC meeting might revive. Thus, the risk appetite of investors could decline further, which would also be negative for the precious metals.

The second factor is the debt crisis in the eurozone, where the focus has now shifted to Spain. Initially, Spain planed to reduce the budget deficit, which ballooned after the financial crisis of 2007/08, to 4.4% of GDP in this year. However, this intention was based on higher GDP growth forecasts. But due to the Franco-German mismanagement of the debt crisis by Merkel and Sarkozy, GDP growth is not only lower, but Southern European economies face the risk of a recession. The new elected government of Mr, Rajoy took the right measures to reduce the budget deficit, but to the extent necessary to reach the original target for the deficit/GDP ratio. He was warned by the vicious circle of budget cuts and GDP slump in Greece. But bond vigilantes and traders at major investment banks were too dumb to understand this. If a recession is looming, sound macroeconomic policy would not increase the recession risk by implementing more austerity measures. The bond market had doubt that Spain would reduce the deficit/GDP ratio. As Spain sold notes only at the lower end of the target range last week, the bond market panicked and a new flight into safe haven Bunds set in. The case of Spain illustrates perfectly, that what might be sound microeconomic behavior could have devastating impacts on the macroeconomic level. However, also the euro got under pressure against the US dollar and stock markets plunged, which were additional negative factors for precious metals.

Fears of a slow-down of global economic growth and Spain getting into the centre of the debt crisis in the eurozone could be the main factors also for the new trading week. Thus, it could not be ruled out that precious metals remain under some pressure.