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.