Mixed signals in the metals markets

All six base metals traded at the LME posted a gain last week compared to the close of the preceding Friday. Also gold and silver advanced and reversed the short-term downward trend. Only the PGMs pared earlier gains and ended the week with a loss. At a first glance, one might attribute the rise of base metals and gold to an improvement of economic sentiment, however, this is not the case. And in addition, it would not explain the reasons why the PGMs turned lower by the middle of the week and closed in the red. From our point of view, the various segments of the metals markets are dominated by different scenarios.

The driving force for the base metals was the manufacturing PMI indices. The market got already surprised by the official Chinese PMI which remained above the 50 threshold. Only the HSBC manufacturing PMI dropped from 50.4 to 49.4 but this decline was also less than the market consensus expected. In Europe, the final PMI had been revised up to 56.7 from an initial estimate of 56.5 after 55.6 in the previous month. Europe is driven particularly by the German economy. Also in the US, the ISM manufacturing PMI declined less than the consensus of Wall Street economists predicted and did decline only from 56.2 to 55.5 while the consensus expected a drop to 54.2. In addition, US construction spending increased in June by 0.1% whereas the consensus predicted a 0.4% decrease, which is another positive factor for copper.

All in all, the PMIs indicate that the Chinese economy is cooling down, but not sliding into a contraction. The eurozone economy is even gaining speed in the manufacturing sector and in the US, the slowing down slightly, but is still far above the critical 50 threshold. Thus, the demand for base metals is likely to increase further. Also the ADP estimate of private sector payrolls in the US surprised to the upside, which was another positive factor for base metals.

Gold and silver got some support from a weaker US dollar, which depreciated not only against the Japanese yen, but also against the euro. However, what appears to be more important for the development of these two metals is the US Treasury market. It has been quite obvious that gold and silver made stronger moves to the upside, when the 10year US T-Note future rallied on economic data which fueled speculation that the Fed would embark on a new round of quantitative easing. This has been the case after the release of the US personal income and consumption figures, which indicate that the consumer would not be the driving force of an economic upswing in the US. However, a much stronger impact had the labor market report released last Friday. While the unemployment rate remained unchanged and the hourly work week as well as average hourly earnings increased, the dominating figure was the stronger than expected fall of non-farm payrolls.

 The gold bugs and bond vigilantes expect that the Fed would pump more money into the economy after this labor market report. However, the Fed is likely to have a closer look at the details. Employment in the private sector increased as the ADP estimate indicated. The fall of non-farm payrolls is the result of the public sector. The job loss is not only the result that temporary workers had been laid off after the census poll, but also the states, which are not allowed to run a budget deficit, had to reduce their work force, in particular in the education sector. However, the Fed can do very little to improve the fiscal situation of the various states. Thus, it is not already a done deal that the FOMC will announce more quantitative easing at its meeting this week.

More and more commentators state that gold would be a perfect hedge for deflation. However, these persons are snake-oil salesman. There is no empirical evidence that the price of gold is rising with deflation. Quite the opposite is the case; falling inflation rates are negative for gold. And the best example to illustrate that quantitative monetary easing does not necessarily lead to surging inflation is Japan. For almost the whole decade, the BoJ tries to combat deflation by keeping the interest rate near zero and quantitative easing. However, a falling CPI still leads to positive returns of holding cash. Those, who follow now the siren calls of those snake-oil salesmen that buying gold as a hedge against deflation risks, might be the last fools buying gold according to the bigger fool theory.