Further range trading of precious metals despite tapering being delayed

The positive week for precious metals does not change our forecast that gold and silver are likely to remain in a broad sideways trading range. Only the PGMs might break out to the upside, but this depends on the supply from South Africa, as there is always the risk that labor unrest could lead to production shortfalls.

One factor contributing to the positive performance was the flash estimate of the HSBC manufacturing PMI for China. While the consensus forecast predicted an increase from 50.2 to 50.5, the index rose to 50.9, which points to a far stronger expansion of the manufacturing sector. However, this is not only a positive indication that the GDP growth of the Chinese economy is probably accelerating further in the final quarter of 2013. Given the strong dependence of China on exports, it is also a positive sign for the global economy after the recent forecast downgrades by the IMF and World Bank.

Just a few weeks ago, Eugene Fama was rewarded with the Noble laureate in economics. However, his theory rational expectations in financial markets, which leads to information efficiency, has been proven wrong again. Several members of the FOMC already stated that a decision to taper would be delayed into next year given the uncertainty about the economic situation caused by the government shutdown. Thus, it should be already priced in that the FOMC will not decide to reduce bond purchases at the last two meetings in this year. However, only after the release of the September US labor market report this week the financial and the precious metals markets reacted strongly.

Instead of creating 182K new jobs outside of the agricultural sector, the US economy added only 148K persons to the payrolls. The July figure was revised down to 89K (from 104K) while the August figure was revised up to 193K from 169K previously reported. However, for the FOMC, the unemployment rate is more important than the number of non-farm payroll additions. The unemployment rate edged further down to 7.2%. But there was only a slight decline of the number of unemployed persons. The negative aspect is that the number of persons not being in the work force increased further to 90,609K. The number of persons leaving the work force exceeded the decline of the persons being unemployed.

The FOMC already pointed out in the statement following the September meeting that the labor market has not developed as expected. However, the markets did not understand the message and only complained that the FOMC did not decide as the majority of Wall Street economists predicted. But as the recent labor market report shows, the majority of the FOMC voting members was smarter than most Wall Street economists despite also not having the September labor market report.

All information was not reflected in the prices. It took the market more than one month to recognize that the FOMC took the right decision and that tapering will be delayed into 2014. Thus, it has been demonstrated again that rational expectations and market efficiency does not always prevail in financial and commodity markets.

The yield on 10yr US Treasury notes came down to 2.5% again. In its statement released after the September FOMC meeting, the committee also mentioned the increase of financing rates as a reason to postpone tapering. We argued that the FOMC would probably feel more comfortable to reduce the amount of monthly bond purchases at a rate of around 2.5% on the 10yr US T-note. However, given outlook that tapering is likely to be delayed for several reasons into 2014 and that the debt ceiling has also been lifted, there is still some downside potential for yields on US Government paper. Thus, we would currently remain overweight duration on a US Treasury portfolio. But as the yield on 10yr US Treasuries approaches the level of 2.25%, we would start switching out of long-term into short-term US Treasury paper and thus, reduce the duration of a portfolio to neutral. Yields on 10yr US T-notes below 2.25% would be a reason to be duration underweight.

Gold and silver should profit from the outlook for tapering being delayed into 2014 and for further declining yields on US Treasuries. Thus, also the precious metals have still some upside potential. However, many analysts are still bearish for the precious metals in the final weeks of this year and for 2014. Some bank analysts have even reduced their forecast for gold and silver prices next year. Also the development of gold holdings in the SPDT Gold Trust ETF sends a warning signal. Thus, the most likely scenario is that gold and silver remain caught in the trading range of the third quarter this year. The chances for a breakout to the upside are higher for the PGMs, but this depends crucially on the supply from South Africa.