Precious metals suffer under eurozone debt crisis

Only silver managed to close marginally higher than the week before. Without the news that Russia increased its gold reserve holdings in June, also gold would have posted a stronger decline in the week over week comparison. However, two of the major fundamental drivers had been positive for precious metals. Despite losses on last Friday, the S&P 500 index and crude oil prices ended the week higher compared with the previous week’s close. Only the US dollar strengthened and this pushed precious metal prices lower. For the week ahead, the risk for precious metals appears to remain still biased to the downside.

The reporting season of companies will continue. So far, they surprised more on the downside than companies beating market expectations. In addition, many companies got more cautious on the earnings outlook. This is probably not going to change. On Tuesday, the flash estimates of the PMI will be released again. Over the last couple of month, these flash estimates had a strong negative impact on stock markets. Thus, one has to take another negative market reaction into account. Therefore, stock markets might not be a supportive factor for precious metals next week.

For most of the last week, the euro exchange rate versus the US dollar showed some wider swings, but managed to close slightly up on the day. But on Friday, EUR/USD opened near the high of the day and closed about 120 pips lower at 1.2154 near the low of the day (according to data from ThomsonReuters).

The first push lower was triggered by a media report quoting a lawmaker from the German coalition government, a member of the Bavarian junior partner CSU, stating that Greece would have to stick to the agreements with the troika or would have to leave the eurozone. Later the day, the party secretary of the CSU, Mr. Dobrindt, made a comment along the same line. It is always astonishing that those who insist that others have to stick to treaties want to violate treaties. The EU treaties offer no legal way to push a country out of the euro. It is only up to the Greece government to decide staying in the eurozone or to leave not only the eurozone but also the EU. After the Greek elections in mid-June, markets had calmed down and a Greek exit was no longer on the radar screens of many investors. However, after this comment, markets fear again that Greece might have to leave the eurozone. This comment about Greece is also counterproductive as the debt crisis will be prolonged. As regional elections will be held in Bavaria next year, one has to expect that politicians from the ruling CSU will repeat those stupid comments. Therefore, the risk of further weakness of the euro against the US dollar remains at elevated levels.

Another negative factor had been the announcement of the ECB. At least during the review of the bailout program, it would stop accepting Greek bonds and other collateral used by Greek banks to tap ECB funding. However, Greek banks could turn to their Greece’s national bank for Emergency Liquidity Assistance (ELA) funds. Thus, Greek banks could still obtain liquidity, but the ECB and thus other national central banks are shielded from the risk of Greece not meeting its obligations.

The second negative factor had been Spain. Yields on Spanish government bonds had been rising already for six consecutive days before and rose above 7.3% for 10yr bonds on Friday. The Spanish government decided to take further measures to curb the budget deficit in a situation where the economy is already in a recession. Bond investors feared that the measures taken would only worsen the economic slump. Furthermore, the Spanish government revised the forecasts for GDP in this and the next year further down, expecting Spain to be in recession for two years. After protests on late Thursday in Madrid turned partly violent, many investors likened the situation in Spain with Greece. However, the situation is Spain is different from that in Greece. In Spain, the banking sector is the problem. After the German parliament approved the bailout program for Spanish banks, also the EU finance minister finalized the treaty with Spain to release the first 30bn out of the 100bn euro program. However, it did not calm down nervous investors, which sell Spanish government bonds on the fear that also the government would need a bailout. Franklin D. Roosevelt said in his inaugural speech “the only thing we have to fear is fear itself”. This also applies to the situation of Spain. The fear of investors that Spain might need a bailout could eventually turn out as a self-fulfilling prophecy. Last year, the ECB acted and bought Spanish government bonds. But after Mr. Trichet is no longer ECB president, the ECB under its new president Mr. Draghi behaves like spectators on the sideline. However, maintaining orderly conditions in financial markets is also the task of the ECB and not only of finance ministers.

It has been noted several times in this blog that declining yields of safe haven government bonds are not a positive environment for precious metals. Yields on 10yr German bunds dropped to new record low of 1.12% last Friday. Investors even paid more for 2yr German notes than they will get redeemed at maturity. The probability is rather high that the developments described above will continue during the coming trading week. A fight to safe haven government bonds like the German Bunds and weakness of the euro against major currencies might be accompanied with declining stock markets. As precious metals trade like risky assets and not as safe havens, one has to expect further weakness. For all four metals, a test of the lows recorded in June can not be ruled out.