Hope for QE3 versus eurozone debt crisis

Hope for QE3 versus eurozone debt crisis

Many traders and investors distrust technical analysis and regard it as reading tea leaves. However, from our point of view and many years of experience, we are convinced that it is an indispensable tool in the tool box of a market analyst. The fundamental analysis pointed to fall of gold and silver below the support of the lows made during the two weeks before. But with the technical analysis in mind, we also pointed out that support might hold and that this could lead to a significant rebound. Gold reached the low of the week already on Wednesday and technical buying drove gold higher. Silver reached the weekly low on Friday. But both metals rallied at the first trading day of the month. Gold rocketed 5.2% from the low of the day and reached the highest level in about four weeks. All precious metals managed to end the week higher.

If the rebound of precious metals were based only on a technical reaction triggered by short-covering of positions, the recent rally could peter out very soon. For a lasting recovery, the sentiment among market participants has to change. Unfortunately, the weekly CFTC data on the “Commitment of Traders” does not provide any useful hint. The data are for the week ending Tuesday, May 29. However, the rebound in gold and silver took place after this deadline. Thus, the decline of the net long positions in gold futures held by large speculators from 151,151 to 110,712 contracts can not be regarded as proof that large speculators are still negative on gold. We will have to wait for the next CFTC report to see whether the non-commercials have reduced the net long position further while gold rallied. The holdings at the SPDR Gold Trust ETF remained unchanged until Thursday, but increased by 3.6 tons on Friday. This provides an indication that the sentiment has changed.

Each week, Bloomberg is polling analysts about the outlook for some commodities during the coming week. The bullish and bearish replies declined both for gold. While the balance between bulls and bears is still positive, it has declined too. At a first glance, this would also argue for a still pessimistic sentiment for precious metals. However, again two reasons argue to treat this survey with caution. First, it is not public knowledge when the poll is taken. Thus, analysts participating in the poll might have already provided their answer before the jump in precious metals set in last Friday. Second, our quantitative research of the Bloomberg commodity sentiment polls showed that the balance between bullish and bearish replies follows the price move over the current week. Changes in the balance are not correlated with the price change over the next week. In some markets however, the Bloomberg sentiment indicator has turned out to be a reliable contrary opinion indicator. Unfortunately, gold is not among those markets.

The usual fundamental factors driving the prices of precious metals can not explain that all four metals closed the week higher than at the Friday before. Stock markets had a very negative week and also crude oil prices fell on worries over the outlook for the global economy. The US dollar strengthened further. Beside the weaker than expected economic data out of China, the unsolved debt crisis in the eurozone is weighing on stock and commodity markets as well as on the euro. Spain presented a smart plan to recapitalize its banks by an equity for government bond swap. Markets turned sour after the Financial Times reported that this plan had been rejected by the ECB. However, this report was denied by the Spanish government and the ECB, both stating that such a plan had not been officially presented. Criticism came also from German politicians and commentators. But Germans should not forget that they also recapitalized banks by government debt following the currency reform after World War II, which led to the introduction to their still adored Deutschmark. Germany is still blocking any proposal made by the EU Commission to solve the crisis quickly, as the federal government can borrow at record low levels and investors even pay for buying short-term notes. Furthermore, the export-driven German economy profits from the weakness of the euro. Germany benefits from the crisis in the rest of the eurozone currently. Thus, despite all the appeals, it is unlikely that Germany is giving up the beggar the neighbor policy and contributes to solving the crisis by accepting proposals presented by the EU. Therefore, the debt crisis could still weigh on financial markets and could remain a burden for precious metals.

What has changed is the outlook for the monetary policy of the Fed. While some voting members of the FOMC reject calls for further quantitative easing the majority was ready to act if needed. On various occasions, the US bond market already reacted as the if-clause was not included in the FOMC statement. However, US economic data released last Friday increase the odds for at least extending “operation twist” beyond the scheduled termination at the end of this month. The non-farm payroll figures for March and April had already been disappointing. But due to the moveable Easter Holiday and the possible distortion caused by seasonal adjustment procedures, these two reports were not sufficient for the FOMC to opt for QE3. Also the figures for previous months had been revised up and the unemployment rate declined. This all has changed with the May labor market report. The change of non-farm payrolls remained even below pessimistic forecasts and came in at only 61,000 new jobs being created. Furthermore, the numbers for the preceding two months had been revised down. In addition, the unemployment rate climbed back to 3.2%.  Also the ISM manufacturing index declined from 54.8 to 53.5 and the GDP growth in the first quarter had been revised down to 1.9% annualized. It appears that the eurozone debt crisis and its impact on stock markets has worsened the business sentiment globally and has led in the US to hesitation to hire more workers. Therefore, the probability for further quantitative easing by the Fed has risen. At the next FOMC meeting, a decision to prolong “operation twist” should not come as a surprise.

The plunge of safe haven government bond yields to record lows last week provides support for gold as opportunity costs declined. Thus, it is especially for central banks cheaper to hold gold instead of US Treasury paper as a hedge against US dollar exchange rate fluctuations. Also, gold got more attractive by the increased likelihood for further Fed monetary stimulus measures. However, the unsolved debt crisis in the eurozone is still a negative factor for the usual fundamental factors of precious metal prices. Thus, gold might be torn between the supportive outlook for QE3 and the burden of otherwise negative fundamentals. But after such a strong rise last Friday, it would be normal that gold pares a part of its gains, especially against the backdrop that one of the main trading centers is closed for two bank holidays to celebrate the Queen’s Diamond Jubilee.