John Maynard Keynes once stated that markets could stay longer irrational than one could remain liquid. Currently, it seems we are in such a situation. Gold continued its rise after founding support at around 1,160$/oz three weeks ago. Silver traded further sideways, but ended the week lower, while the PGMs suffered again stronger losses. Base metals also had a negative week on balance with the exception of tin, but trading was rather volatile with larger swings up and down. The driving forces behind these moves in the metals markets were the Fed policy and fears that not only the US might head towards a double dip recession but also a stronger slow-down in China would lead to global economic weakness.
The correlation between gold and the US T-Note future became positive recently. And again last week, one could observe that gold rallied in line with the US Treasury market after the announcement of the Fed following the FOMC meeting. Furthermore, the behavior of the markets demonstrated that they are not information efficient, contrary to academic theories. After the semi-annual testimony of Fed chairman Bernanke and the Beige Book, it should have been already priced in that the Fed is unlikely to embark on tightening monetary policy. Some bond investors even betted the Fed would start another round of quantitative easing at the FOMC meeting last week. However, all the Fed is doing is just not to drain liquidity from maturing bond holdings. All proceeds will be reinvested, thus, the balance sheet will not be expanded but the Fed is just putting a floor on its balance sheet. Furthermore, the Fed clearly stated that “inflation is likely to be subdued for some time” (see FOMC statement). With no inflation on the horizon as far as the eye could see; there is also no reason to buy gold as a hedge against inflation. Some gold bugs argue that the metal would also be a perfect hedge against deflation. During periods of deflation, fixed income bearing assets perform better than real tangible assets like gold. Thus, this statement of the gold bugs makes as much sense as pretending that gasoline would be perfect for lightning and extinguishing fire.
In the case that the positive correlation between the gold price and the 10yr US T-Note future should prevail, the question arises, how far could both rise further. Usually, there is a close correlation between the 10yr T-Note future and the 3mth Eurodollar future, which matures one year later. This implies that the bond market rallies if also falling short-term interest rates are expected. The Fed is likely to keep the Fed Funds target rate at the current level for an extended period. With the Dec 2011 3mth Eurodollar future already trading above 99.0, the potential for further rise appears to be rather limited. Therefore, also the upside potential for the 10yr US T-Note future seems to be capped, but this does not exclude new all-time highs could be reached. In the current environment, this might also be supportive for gold.
The US economy is loosing steam compared to Q1 this year, there is no doubt. However, will this lead also to a double dip recession as more and more economists predict and markets fear? We remain skeptical or more positive formulated; we stay more optimistic for the US economy than the market consensus. The US consumer is not the driving force of the economic recovery. Given the balance sheet repair work of the private consumers, i.e. reducing indebtedness and increasing savings, the high unemployment rate and slow creation of new jobs, the private consumption will grew, but not at the rates seen in the past. However, inventories are still low relative to sales, thus, building up stockpiles is probably remaining a supportive factor and business investments are also likely to contribute to GDP growth in coming quarters. This also argues against strong gains of US Treasury futures and gold. And a continued growing US economy, even at a slower pace, should remain a positive factor for the PGMs and the base metals.
Asian investors already reacted disappointed on the FOMC statement, but their reaction in the markets for base metals and the PGMs was even more severe after the release of the Chinese trade data. While the trade surplus increased from $20.0bn to $28.7bn and the consensus expected a slight decline, the markets reacted negative on imports, which were only up 19% in July, far below economists’ predictions. This has been regarded as another signal for a sharp slow-down of the Chinese economy and weighed on metals markets. However, the rising trade surplus still indicates that the Chinese as well as the global economy is growing. Markets also reacted negatively on the German GDP, which grew by 2.2% qoq in Q2, the strongest growth rate after the unification in 1990. The pundits fear that this would not be sustainable. As construction spending made a bigger contribution to the German GDP growth, this expectation is probably right. Nevertheless, the ifo business climate and the PMI indices all indicate that the biggest economy of the eurozone will expand further at an elevated level. Thus, the negative reaction on surprisingly strong growth is not justified. It underlines the bearish sentiment in global equity and metals markets. This sentiment is currently the major thread for further market trends and could have a self-fulfilling impact on the global economy.
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