Trend remains up for precious metals

It was a positive week for precious metals on balance. The PGMs performed especially well while silver, which rose strongly in the weeks before, just managed to post a small gain. However, all four precious metals ended down on Friday. This already led to questions whether the upward trend in precious metals would be over. From our point of view, it is not and precious metals have further upside potential in the weeks and months to come.

Last week, the focus had been again on Spain and the question when the government will ask for a full rescue by the EFSF/ESM. Reports Spain could already apply for a bail-out as early as this weekend had been rejected by the prime minister and later also by the finance minister. But the statements by ECB president Draghi during the press conference led to a recovery of the euro, which was also positive for the precious metals.

The first Friday of a new month is usually the day where US labor market data will be released. Trading activity in many financial and commodity markets remains often range-bound ahead of the data release. But it was the reaction of precious metals after the numbers of new jobs created and the unemployment rate had been published, which was rather strange. The non-farm payroll figure came in just as expected by the consensus of Wall Street economists, but the previous months had been revised up. The surprise was the development of the unemployment rate. The consensus among economists predicted an increase from 8.0 to 8.2%. However, the unemployment rate declined 7.8%, the lowest rate since January 2009 when president Obama took office.

One reaction in commodity markets, especially in the crude oil pits, was that traders stated they do not believe the numbers were true. Also the comment by former CEO of GE, Jack Welch, on twitter that the numbers were manipulated by the administration to help the re-election of incumbent president Obama increased the disbelief in financial and commodity markets. The decline of the unemployment rate had been the result of people leaving the workforce. We pointed out some weeks before, that this is the normal behavior if jobs are hard to get. However, when the conditions in the labor market improve again, some workers return to the workforce and apply again for jobs. Thus, there is no rational reason to believe the allegations that the labor market report was faked.

Reuters wrote in a market report, that gold had been sold as the labor market report dimmed the safe haven demand. This statement does not make much sense as an increase of the unemployment rate is usually not a reason to buy gold. One factor behind the recent rally of precious metals had been the third round of quantitative easing by the Fed. The FOMC decided in mid-September to buy $40bn of mortgage backed securities per month until the unemployment rate had reached the target of the FOMC. Some fund managers voiced at TV stations like Bloomberg that this would be QE indefinite. As also the consensus forecast indicates, markets had priced in that the Fed would buy MBS for quite some time. However, if the unemployment rate continues to decline at the pace of the last two months, the target of the FOMC might be reached far quicker than assumed. Thus, some traders might fear that the Fed would provide much less liquidity through QE3 than assumed and therefore also less capital would flow into precious metals.

From our point of view, it is rather unlikely that the unemployment rate in the US will decline to full employment level only due to workers leaving the workforce. Also an increase of the pace of new job creation per month would be required. This will only be the case, if also economic activity accelerates stronger. At the recent GDP growth, the Fed is not expected to end the expansionary monetary policy anytime soon. Thus, the reaction in precious metals markets on the labor market report is overdone. A pick-up of economic activity would also be positive for precious metals. Stronger GDP growth should be positive for stock markets and should lead to higher equity prices. An increase of investors’ risk appetite is normally also positive for the demand for precious metals. Furthermore, stronger growth would also be supportive for crude oil prices, which are another fundamental factor for the price development for precious metals.

In our base line scenario, we expect the situation in the eurozone to stabilize. Furthermore, we expect that there will be a last minute compromise to prevent the US economy falling from a fiscal cliff. Thus, US GDP growth is assumed to increase again, which would be positive for stock markets and the oil price. Also in China, we expect further stimulus measures. This all should contribute to a decline of risk aversion by investors, which would be positive for precious metals. The rally is just taking a breather and is far from being over already.