Risk for precious metals more biased to the down-side

Just when some gold bulls revised their forecast higher, the market turned around. Initially, it was regarded as a consolidation only. But this week was negative for precious metals. Gold lost 60$/oz or 4.3% and ended at 1330$/oz, the worst weekly loss since the sell-off in June. As usual, the price swing was even stronger in percentage terms for silver, which lost 6.8% or 1.62$/oz to close at 22.2$/oz. Only palladium managed to remain on balance almost unchanged, but it suffered a stronger loss the week before.

The drop of gold could be attributed to technical trading, but this is only one factor and does not describe the whole picture. After gold did not manage to stay above the 1,400$/oz mark, which was regarded first as an important resistance that should also provide strong support then, some traders not only took profits but also reversed positions. This is reflected in the renewed decline of gold holdings by the SPDR Gold Trust ETF too, which fell again to 911 tons. Furthermore, large speculators reduced their net long position in COMEX gold futures by almost 10,000 contracts to 68,724 contracts in the week ending September 10, 2013 according to the recent CFTC report on the commitment of traders.

The development in the precious metals market over the last couple of weeks also demonstrates that Gold is not the safe haven as many gold bugs pretend it to be. A safe haven should provide a wealth protection also when the storm calms down, which the precious metals did not. The UN inspectors are providing evidence that poison gas had been used on August 21 this year near Damascus. However, the military strike, which in particular US Secretary of State, Mr. Kerry, but also the French president and the British prime minister demanded, became unlikely due to political developments during the course of this week. But even with the Syrian regime handing over chemical weapons to the UN for destruction over the next few months, the civil war in this Middle-East country is far from being over.

That gold and silver reacted so strongly on these political developments took some commentators by surprise. However, they completely overlooked that it is not only the safe haven risk premium, which had been priced out, but also a fundamental factor played a crucial role in this context: the price of crude oil. Syria is not a major oil producer, however, it is an import transit country for transporting crude oil through pipelines to the Mediterranean Sea. Furthermore, a military strike by Western forces bears the risk that the conflict escalates by involving directly or indirectly other states like Russia or Iran. This could have serious implications for the supply of crude oil. Thus, the price of crude oil initially rose, but also declined as a military intervention got less and less likely. The oil price is a major factor for headline CPI inflation, which explains why it is also a major fundamental factor explaining the price development of gold and silver in many quantitative models. Thus, the recent developments concerning Syria had two negative impacts on precious metals, first by reducing the appeal as a safe haven and second by lowering the oil price.

In this blog, it had been pointed out, that the economic data does not indicate any urge for the Fed to taper at the FOMC meeting next week. The committee would be well advised to wait a bit longer and not to repeat the policy mistake made by the Bank of Japan some years ago when they reduced monetary stimulus too early. Nevertheless, the consensus of economists expect the FOMC to make the decision to reduce the volume of bond purchases on September 18. Thus, it cannot be ruled out that the FOMC will indeed vote for tapering in order to avoid disappointing the markets. While this possible decision should have been priced in already, the precious metals reacted again negatively on this outlook.

Another Fed related event also had a negative impact on gold and silver this week, the appointment of a successor for Fed chairman Bernanke. The announcement of President Obama’s decision is still pending. This week, the Japanese daily business newspaper Nikkei reported that former Treasury Secretary Summers would be appointed as next Fed chairman. While it is rather unlikely that not one of the leading US papers like the Washington Post or the New York Times receives such information first, markets reacted nevertheless. The US dollar appreciated against the euro and the yen on speculation that an FOMC led by Mr. Summers would reduce monetary stimulus faster. A firmer US dollar is another negative factor for gold.

Which decision US President Obama will take is hard to predict. However, Mrs. Yellen would be clearly preferred by the markets. But it could not be ruled out that Mr. Summers will be the favorite candidate of President Obama. Furthermore, without renewed geo-political tensions, it appears as less likely that the price of crude oil will rise again. A further easing seems to be currently the more likely scenario. Thus, the risk for the precious metals are expected to be more biased to the down- than to the up-side.