Silence is golden, Mrs. Merkel

Sir Isaac Newton once said he would be able to calculate the orbit of planets, but not the movements of stock markets. While many investment banks employ physicists nowadays, some graduates of this science still have difficulties to understand how financial markets work. One of them is the German chancellor, Mrs. Merkel. And what is even worse, she is stubborn to learn from past mistakes and to draw the right conclusions. However, commodity consumers outside the eurozone profited from her comments last week, which sent commodity prices lower. Among the metals, precious metals held well, but base metals ended the week lower as measured by the LME metals index.

At the start of the new trading week, markets welcomed that Ireland asked the IMF and the European Financial Stability Facility (EFSF) for a bailout, in particular to increase the capital of its nationalized banks. However, this request came at a high price for the Irish prime minister. His junior coalition partner only approve calling the IMF for help if snap election will be held. But the initial market reaction was as we expected in the blog article published on November 21. Also many fixed income strategists of investment banks pointed out that Portugal and Spain might be next to be bailed out. Nevertheless, even the Credit Default Swaps of these countries came down on Monday. Thus, precious metal prices rose at the start of last week but base metals pared earlier gains as stock markets came under pressure as contagion fear send jitters especially among US investors.

Geopolitical risk factors also played a role on Tuesday, as North Korean troops fired at a South Korean island. But this had only a temporary impact as prices recovered after an initial drop in Asian trading. But then came Mrs. Merkel into the spotlight and send the euro sharply lower against the US dollar by stating that the current crisis could lead to the end of the Eurozone and the EU. The firmer US dollar had a negative impact on base metals, but gold profited from its safe haven status. The German chancellor should have known what the impact of this statement on financial markets would be. The next day, at a meeting of the German association of industry (BDI), she bashed banks and repeated the demand that in future, private investors would have to contribute to bailouts of sovereign debtors in the eurozone. Of course, this has been another knock for the euro, sending the single currency further down against the US dollar.

 Mrs. Merkel lacks the skills of political leadership. She is not able to convince law-makers of her own party, the political commentators in the media and the population by sound arguments. Only by populist arguments like bashing the banks and by painting a bleak outlook if her policy would not be approved, she can get the support of law-makers being members of the government parties in Berlin. The results in markets are a catastrophe. The EFSF was intended to calm investors by demonstrating that there would be support for eurozone member countries. EU leaders even expressed the view that there would be no need for a eurozone country to ask for a bailout. However, by her populist policy, the German chancellor triggered a flight out of Irish government bonds. She even ignored the warning from ECB president Trichet. The strongest economy of the eurozone is expected to play the role of a political leader. The biggest problem of the euro is currently that Germany lacks a political leadership and a sound knowledge of economics.

As long as the crisis in the eurozone prevails, the euro is at the peril of weakening further against the US dollar, despite QE2. As gold is regarded as a safe haven, it might perform best among the metals. Industrial metals are likely to suffer, especially silver and palladium might correct stronger as it has already been the case last Friday. Among the base metals, the biggest losers are expected to be those metals with rising inventories and the highest speculative interest. This might also be negative for copper. However, as the market had been already in a 360K tons supply deficit in the period from January to August according to the latest report by the ICSG, which also expects a high deficit in 2011, such a correction of the copper price would present a good opportunity for consumers to hedge their exposure.

Bailout of Ireland should be positive for commodities, but…

Pressured by other eurozone countries including Portugal, Spain and Greece, which feared that a continued sell-off would also lead to higher funding costs for their own debt, Ireland’s finance minister declared this weekend that the country would ask the European Financial Stability Fund (EFSF) and the IMF for a bailout. In a radio interview, he stated that the volume of a credit would be less than 100bn euro, but some several 10bn euro. Earlier last week, the euro was still under pressure against the US dollar, however, after the meeting of EU finance ministers the euro stabilized as signs emerged the country might as for help to bailout its banking system. Thus, the official confirmation that Ireland seeks to get a credit facility from the EFSF and the IMF should lead to a further recovery of the Euro against the US Dollar.

In addition, the US dollar gained last week as some politicians of the Republican Party as well as some economists close to this party wrote open letters demanding the Fed to abandon QE2. However, at a speech given last Friday in Frankfurt, Germany, on invitation by the ECB, Ben Bernanke left no doubt that the Fed is going to implement QE2 as announced after the recent FOMC meeting. This should also contribute to a weaker US dollar, which would be helpful for commodities.

 The latest CFTC report on the “Commitment of Traders” showed that the large speculators reduced net long positions in metal futures traded on US exchanges. In addition, the total open interest declined considerably. The rumor, which was spread around at the end of the second week in November, that the Chinese central bank would hike interest rates has lead to a flight of investors out of commodities. Also the open interest of base metals traded at the LME declined according to data from the exchange. The development of metal prices, only silver and palladium gained in a weekly comparison, indicates that investors remained cautious and have not increased their risk appetite again. The statement of the Irish finance minister could lead to a strengthening of the euro, which would be positive. However, whether investors increase their risk appetite and buy metals again is probably also dependent on the developments in China. On Friday afternoon GMT, China announced another increase of the reserve requirements for banks. This is probably negative for base metals in the short term. In the medium-term, we remain positive for base metals, as we don’t expect a hard landing of the Chinese economy. Furthermore, we expect in line with the ICSG a supply deficit of copper next year. The launch of ETFs on base metals, in particular copper and aluminum are also supportive factors in the medium-term horizon.

In the short run, easing tensions at the periphery of the eurozone are likely to be positive for the euro and could lead to a rebound against the US dollar. This would be positive for metals. However, fears of a further tightening of monetary and credit policy in China could be negative. But China’s monetary policy should have a stronger impact on base than on precious metals. Therefore, precious metals might perform better than base metals and the outperformer of last week could also be the outperformer of the coming trading week.

China and the Eurozone – repeating mistakes weigh on metals

New highs during the course of last week, but then all metals plunged heavily last Friday. Precious and base metals both posted gains while also the US dollar index rebounded. This combination is not common as a stronger US dollar normally leads to profit taking by financial investors. However, the G20 summit in South Korea might have induced them to hold positions. But after the end of the meeting, commodity markets in general came under pressure, while the reasons for the sell-off were not the results of the G20 summit. Again developments in China and the eurozone were the driving factors.

It is not a shame to make a mistake, but it is a shame to make the same mistake twice. While China is expected to repeat a mistake, the German government and in particular the Chancellor Angela Merkel and her staff already made the same stupid mistakes they did in spring during the Greek debt crisis. Mrs. Merkel insisted that private investors would also have to make some sacrifices in the case the government debt of a eurozone member country would have to be restructured. She won approval at the recent EU summit, which took place at the end of October. Investors holding Irish government bonds feared a haircut and dumped the holdings. The fear that Ireland might fail on its government debt did not only lead to rising spreads of Bunds and soaring CDS rates, but also sent the euro again lower versus the US dollar. However, this was not a burden for gold as investors bought the metal as a safe haven. The German government made the situation even worse by spreading rumors about getting prepared for Ireland seeking funds from the EU stabilization funds and the IMF. The warnings Mr. Trichet made at the EU summit came true. Last Friday, the EU declared at the end of the G20 summit, that private investors would not have to make any depreciation on Irish government bonds. The euro rebounded against the US dollar, but gold could not profit from this move as investors also left the safe haven. Thus, gold plunged despite a firmer euro.

China released a series of economic data in the second half of the week. Initially, metals markets reacted positive on the data. LME 3mth Copper hit a new record high at 8966$/t, thus exceeding slightly the high made on July 2, 2008. The markets were also not much concerned about the rise of headline CPI inflation from 3.6% to 4.4% in October. However, on Friday, the markets were concerned that the central bank, the People’s Bank of China, might hike interest rates again. The major driver of the accelerated inflation rate was again the food component. We argued already earlier that one can not fight the weather with interest rates. A better way to reduce the impact of rising international agricultural commodity prices would be to allow a stronger appreciation of the yuan against the US dollar. However, Chinese politicians will not walk this way as their rhetoric ahead of the G20 meeting showed. It has to be feared that the PBoC will hike rates again, which would slow the economic growth. Nevertheless, in the case of copper, we still expect that the market would be in a deficit next year, in particular as launch of copper ETFs is looming, which would reduce the amount of available copper for consumption. Thus, any correction of copper is likely to be a good opportunity to for consumers to hedge against a further rise of copper prices.

Metals rise to fresh highs after FOMC

It has been well announced in advance that the FOMC would embark on a new round of quantitative easing at the November meeting. Normally, markets follow the rule of buy the rumor and sell the fact. However, metals rallied after the FOMC announced to buy more US Treasury paper. Gold reached a new all-time high on Friday and also base metals traded at a new high of the year as measured by the LME index. The outlook for the final few weeks of 2010 remains positive.

It was surprising that metals started to rally in the Asian trading hours on Thursday. The immediate reaction in markets following the announcement of the FOMC was negative. The total volume of QE2 at $600mn is slightly higher than consensus figures reported in the media, but the whisper number was higher and the markets priced in up to $1trn. Also the monthly purchases of US Treasury paper by $75mn is lagging behind market expectations. That the Fed would reinvest proceeds from maturing mortgage bonds has already been announce two meetings ago. It would just keep the balance sheet of the Fed unchanged and thus, it could not count as QE2.

The rise of gold to a new all-time high is also surprising against the background of latest available data on investors’ positioning. The reference date of the commitment of traders report compiled by the CFTC was the Tuesday and therefore before the release of the FOMC statement. Nevertheless, as gold rose on balance since the preceding reporting date, one would expect that large speculators have increased their net long position. However, the non-commercials have reduced their net long position again by 8,858 to 230,228 contracts. Within one month, the large speculators have reduced their long exposure from the recent peak at October 5 by 29,392 contracts or by 11.3%. The rise of small speculators net long position over the last four weeks by around 6,500 contracts in total does not compensate the liquidation by the large specs. Also the gold holdings of the biggest ETF, the SPDR Gold Trust, declined last week by 2.3 tons. The holdings declined further after the release of the FOMC statement on QE2. As gold rose against this backdrop, the sentiment remains positive.

In a Washington Post article, Fed chairman Bernanke pointed out that investors already bought more risky assets since the Fed pointed to the possibility of further quantitative easing in August. The US stock market has gained despite many pundits feared a drop in September as this month had on average the worst performance in the past. A rising stock market is one of the leading indicators of future economic activity. The German finance minister called QE2 as clueless. However, as investors’ risk appetite has already increased, the clueless politicians seem to be located in Germany. The period from November to March is very often positive for stock investments as the indices post their strongest gains during these months. This would be another positive indication for metal markets. In addition, the last quarter of the year is characterized by seasonal weakness of the US dollar – which also prevailed during the many years without quantitative easing. Thus, the perspectives for metal markets remain positive.

While the outlook for the precious and base metals is positive, nevertheless, investors should keep two factors in mind. First, the FOMC stated that the volume of US Treasury purchases would be spread over the period until the end of the Q2 2011. But the FOMC also stated that it would constantly monitor conditions and to decide about further measures. In the markets, this was understood that QE2 might be extended beyond June 2011. Second, the FOMC statement could also imply that the Fed would terminate purchasing US Treasury paper before the end of June 2011. The key would be the development of non-farm payroll figures and the unemployment rate. The labor market report released last Friday surprised on the positive side as more jobs were created and previous months’ figures were revised to the upside. Some more months with consecutive strong new job growth and the Fed might end QE2 already in Q1 next year.