Precious metals under renewed pressure

It had been pointed out several times in this blog that the status as a safe haven does not imply that precious metals were immune against stronger downside moves. This past week is another proof for this statement. Precious metals were under renewed pressure and only a rebound last Friday prevented even bigger losses. Gold ended the week down by 6.6% and platinum lost only slightly less at -6.4%. Silver and palladium are the more volatile precious metals dropping by 7.9 and 9.0% respectively.

The traditional fundamental factors for the precious metals were all negative again. The US dollar firmed not only against the euro but also against the other major currencies. The stock markets in Europe and the US headed all south and crude oil prices came under pressure. However, also the flow of funds data indicates that investors reduce holdings of precious metals. According to the latest CFTC report on the “Commitment of Traders”, large speculators have reduced their long positions in gold and slightly increased the short positions. Thus, the net long position has dropped by 9,208 to 150,503 contracts, the lowest value since the beginning of November. Also holdings in the biggest ETF, the SPDR Gold Trust, have been reduced last week by 15.4 tons to 1,280.0 tons.

The major factor weighing on precious metals remains the debt crisis in the eurozone. The rating agencies are not satisfied with the result of the EU summit on December 9. Standard & Poor’s already warned that all member states of the eurozone might be downgraded before the summit took place. Now also Moody’s has reduced the outlook for the eurozone to negative and Fitch also warns that six member states might face a lower rating. All three agencies refer to the outlook for GDP growth. However, the rating agencies became a part of the problem and are an obstacle for a solution. When the crisis broke out, the agencies demanded that austerity measures had to be taken to restore confidence. However, as soon as those measures had been taken, they lowered the rating of various states and referred to the lower growth prospects due to the austerity measures. This is now going on for various cycles and more and more countries face a downgrade. As long as the agencies threaten to cut the ratings of eurozone member countries, the market for government bonds in the eurozone has difficulties to calm down. This has also a negative impact on the euro exchange rate. Furthermore, fears of a global recession will not subside. Quite the opposite, they are more likely to get stronger like the warning of the IMF last Friday showed by comparing the current situation in the eurozone with the early 1930^th, the beginning of the global depression.

Have you ever wondered that there is only one German among the Noble laureates in economics? Just take a look at the German economic orthodoxy and it is no longer a wonder. The German government and the Bundesbank believe that a fiscal austerity policy would be sufficient to solve the debt crisis in the eurozone. However, they completely ignore the German past when the austerity policy of Chancellor Bruenning steered Germany right into the depression of the 1930^th. Furthermore, they are obsessed with the experience of the hyperinflation of the early 1920^th. This obsession leads to the refusal to accept any involvement of the ECB and national central banks in solving the debt crisis. Germany blocks the proposal to grant the EFSF or EMS a banking license, which would allow these institutions to buy government bonds in the secondary market and to obtain credit from the ECB, while the state owned Landesbanks in Germany and state owned savings institutions in other eurozone countries could also hold government bonds refinanced by loans from the ECB. Economically, this differentiation does not make any sense because the ECB is also indirectly involved in state financing if state owned commercial banks buy government paper.

At the EU summit on December 9, there was an agreement that central banks of the eurozone should lend 200bn euro to the IMF, which then could leverage the funds of the EFSF and the EMS. However, the Bundesbank is blocking this solution by demanding that the German parliament would have to approve such a loan and by insisting that further leading countries outside the eurozone also participate in providing loans to the IMF. However, the US already announced that they would not grant a loan to the IMF. The Fed can not participate due to legal reasons as chairman Bernanke explained. The president of the Bundesbank argues that providing a loan to the IMF, which then lends to eurozone governments, would be circumventing forbidden lending of the ECB system. However, the Maastricht treaty only rules out direct lending to governments. Without any involvement of central banks, the market for government bonds could not be stabilized in the short-run. As Lord Keynes ones said, “in the long run we all are dead”. Waiting for the austerity measures to restore investors’ confidence might take too long.

As long as Germany refuses that central banks play a direct or indirect role in stabilizing the government bond market in the eurozone, fears of a global recession will prevail. The markets already ignored positive economic data last week. The implications for the precious metals remain negative in this case. The rebound seen last Friday might just been some short covering.

This was the last article in this blog for 2011. The next article will be published on January 7, 2012. We wish all readers of this blog a merry holiday season as well as a happy and successful New Year 2012.

Precious metals down again on eurozone debt crisis

Most precious metals posted losses again the past week. Only palladium bucked the trend and gained 6.4% on the week. Palladium is driven by the outlook for a supply deficit in 2012 due to declining stocks and production in Russia. The usual drivers for the price of gold were mixed last week. The US dollar index firmed slightly, which was a bit negative. The price of crude oil declined and thus weighed on gold. The rise of the S&P 500 index was a supportive factor, but could not compensate the negative factors. However, one has to take into account, that the strong rise of the S&P index on Friday pushed the index back into the black. Gold followed the stock markets most of the week, but not on the last trading day of the week.

The S&P 500 has also been influenced by the developments in Europe. However, also US economic data had an influence. While a few month ago, most US economists were convinced that the US economy would head towards a double dip recession, the macro-economic data is by and large better than economists predicted. We pointed out several times in August and early September that we don’t expect a recession in the US. Also the labor market shows signs of improvement. Therefore, from our point of view, the S&P 500 index has further upside potential, especially in the case that the debt crisis in the eurozone gets solved. However, one caveat has to be made. The winter season could lead to slower economic activity as it had been the case in Q1 this year. Thus, our medium-term assessment of the price development in precious metal markets remains positive.

It could not be repeated often enough; the key for rising precious metal prices is a convincing solution of the debt crisis in the eurozone. This past week brought a major improvement, but also a major set-back. At the beginning of the week, France and Germany agreed on a proposal to change the EU treaty. According to this plan, national states would have to include the requirement of balancing the budget in their constitutions. Individual states violating the 3% deficit criterion of the Maastricht treaty would face an automatic procedure to get penalized. The EU commission would have to send the case to the EU court. At the EU summit, 26 of the 27 member states approved this proposal, only the UK opposed it. However, the 26 supporting states will go ahead without the UK in implementing the proposals. These proposals that eurozone member countries follow a responsible fiscal policy might be important in the medium-term, but they unlikely solve the problem in the short-run. As one of the five economic advisers to German chancellor Merkel put it, the German chancellor sees the problem of the debt crisis as one-dimensional while it is multi-dimensional in reality.

And it was this one-dimensional position of Germany, which prevented a solution convincing financial markets also in the short-term. However, Germany also had to make some concessions. The national central banks will lend 200bn US dollar to the IMF, which then can provide funds for leveraging the EFSF. In addition, the EMS, the stabilization mechanism, which should be a permanent institution, will start working already in July 2012 instead of January 2013. The major task is to restore confidence in the market for government bonds in the eurozone. These measures are probably insufficient to fulfill this task. Given the volume of bonds, which have to be refunded in 2012 by the countries being under attack in bond markets, the funds of the EFSF could be exhausted already in H1 next year in the worst case. Bond market strategists pointed this out already in their research papers.

Further measures to stabilize the government bond markets in the eurozone would be either to provide the EFSF or EMS with a banking license or that the ECB acts as lender of last resort. However, both measures have been blocked by Germany. It appears that Germany follows a new kind of beggar my neighbor policy as it is profiting from absurdly low interest rates on government bonds and notes, while other countries with similar or even better fiscal positions (Spain has a far lower debt/GDP-ratio than Germany) have to pay far higher interest rates to sell their bonds.

The ECB demonstrated again that a few words could do more harm than the benefits of some right measures taken. At the monthly rate setting meeting, the ECB Council decided to cut the refinancing rate by 25bp to 1.0%. Furthermore, the ECB extends credits to banks to up to 3years and accepts collateral with lower credit quality. The intention of these measures is to increase bank lending to the real economy. However, these measures are likely less effective as long as the tensions in the government bond markets persist. At the speech given to the EU parliament, ECB president Draghi created the impression that the ECB would be ready to buy government bonds in the secondary market more aggressively, if the EU agrees on stricter rules for fiscal policy in the eurozone. At the press conference following the council meeting, Mr. Draghi stated he was surprised by the interpretation of his remarks. He turned a cold shoulder to buying government bonds to reduce yields on bonds of pressured countries like Spain and Italy. That was not super, Mario!

As long as the ECB is not acting as a lender of last resort and uses its unlimited power to restore confidence in the market for eurozone government bonds, there is no lasting and convincing solution of the debt crisis in the eurozone. Furthermore, it is likely that the measures taken by the ECB fail to stimulate bank lending to the private sector sufficiently. The risk of stagnation of even recession in the eurozone is increasing. In this environment, also downside risks for the precious metals prevail. However, once the market for government bonds are stabilized and yields on Spanish and Italian government bonds come down to more sustainable levels, the precious metals might be in for another strong move upwards.         

Precious metals rebound, but not yet out of the woods

A report in an Italian paper last Sunday, that the IMF would lend 800bn US dollars to Italy, led to a rebound of precious metals in Asian trading on Monday. The amount stated in this report is above the lending limit of the IMF, thus, financial and commodity markets should have spotted this report easily as false. Also the IMF later denied being in talks with Italy about a bail-out loan. Nevertheless, precious metals rose and closed the day near the high of the respective trading ranges. On Wednesday, precious metals got another push higher by two measures from central banks. First, the Chinese central bank, the People’s Bank of China, reduced the reserve requirements by 0.5 percentage points. Second, the Fed and five other central banks agreed on mutual unlimited swap lines to provide sufficient US dollar liquidity to the banking system. This measure was targeted primarily for European banks after US investors withdraw funds from European banks and money market funds.

Among the precious metals, palladium posted the strongest weekly gain, soaring by almost 14.0%, the biggest weekly rise in 3 years. The cut of reserve requirements by the PBoC is probably positive for car sales and China and thus, for the palladium demand by the automotive industry. Furthermore, Norilsk Nickel, the world biggest palladium producer, expects the palladium market to be in a supply deficit next year.

After the rebound last week, also the technical situation for most precious metals has improved. However, does this imply that the assessment made last week in this blog was wrong? We still stick to our view that lasting and sustained rises of the precious metal prices require a convincing solution of the debt crisis in Europe. The rise last Monday was based at best on hopes that European politicians finally come to get their act together. However, there are many stumbling blocks on the road to a solution of the debt crisis in the eurozone.

On Thursday, the ECB will hold its rate setting meeting. After the swap agreement announced last Wednesday, some economists expect that the ECB might cut the refinancing rate again by 25bp. This would be helpful but would not eliminate the risk of a credit crunch in the eurozone with negative implications for activity in the real economy. At the hearing in the European parliament, ECB president Draghi repeated the stance that bond purchases would be limited and only temporary. However, one remark has been interpreted as keeping the door open for more active bond buying. Thus, the markets will also pay close attention to his statements at the ECB press conference.

At the EU economic summit on Friday, December 9, France and Germany want to push ahead to the formation of a fiscal union and want to present changes of EU treaties. German Chancellor Merkel insists on automatic punishments of countries violating the fiscal discipline and rules set in treaties. Also balanced budgets should be anchored in the constitutions of the eurozone member countries. While the creation of a fiscal union would repair at least to some extent the errors in the construction of the single European currency, the German demands do not provide a quick solution of the crisis. They might lead to a rebuild of confidence in the medium-term at best. Furthermore, Germany is only demanding what other countries should do but refuses to make any offer.

As we pointed out already earlier, the failure of politicians to act quickly and in a decisive manner contributed to the destruction of the government bond market in the eurozone. Government bonds are no longer a risk free asset. Investors have to fear that haircuts will not be only limited to Greece as a special case. Furthermore, the demand from Merkel and Sarkozy that a referendum considered in Greece should be about staying or leaving the euro, has opened the Pandora’s Box. Now, investors have to factor in the risk that they will get the redemption of a bond in a currency other than the euro. Furthermore, the European Banking Authority also contributed to the destruction of the government bond market in the eurozone by counterproductive regulations. The requirement, to value all government bond holdings at market values, not only those in trading books but also bonds intended to be held to maturity, has eroded the capital ratios of banks. In addition, they had to sell government bonds to reduce risk, which made the situation in the market only worse. In the short-run, the ECB is the only institution being able to act as a lender of last resort and to restore confidence. However, as long as German economic religion opposes such a step, the crisis will probably not be solved.

Thus, the second half of this new week will be very crucial for the further outlook for the precious metal markets. Currently, we regard the risks as more biased to the downside. We would not rule out that the announcement of an agreement would lead to a relief rally the following trading day. However, this relief faded more and more quickly after each EU summit. We remain skeptical that it will be different this time. But the next blog article provides an opportunity to comment on the EU summit. For those who went long precious metals, we recommend to keep tight stops.

Madame NO weighs on precious metals

The precious metals suffered during the course of the week and all metals ended in the red. Gold held best with a loss of only 2.5%, while silver and platinum were down by 4.0% each and palladium was the worst performer with a loss of 6.4% over the week. The three major fundamental factors of our quantitative fair value models all had a negative impact on the precious metals. The US dollar index strengthened while the S&P 500 index and crude oil fell and thus signal slower future economic activity and a declining inflation risk.

However, there remains one common factor behind the fundamental variables of our fair value models, the never ending debt crisis in the eurozone. Spain was now the fifth country in the eurozone, in which the debt crisis led to a change of the government. The conservative people’s party gained a broad majority of the seats in parliament and its leader Mr. Rajoy will become the next prime minister. Already during the election campaign, he indicated that more austerity measures and economic reforms would be needed to regain confidence of investors in Spanish government bonds. But investors gave Spain the cold shoulder. At an auction of short-term bills, Spain had to pay interest rates at a record high since the introduction of the single currency in 1999. The lackluster auction also led to rising yields on longer dated government bonds. The ECB bought Spanish paper, but the amount was not sufficient to prevent yields to rise.

At the beginning of last week, French government bond yields rose after a report from Moody’s was understood as an indication that France could loose the AAA rating soon. An economist at this rating agency warned that "Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications". This demonstrates how dangerous it is, when an economist chooses the wrong reference. Elevated could refer to the average of historical yields, but even at around 3.7%, yields on 10yr French OATs are relatively low by historical standards. The spread of almost 170bp over 10yr Bunds is rather high. However, is the 10yr yield spread the appropriate benchmark to judge the creditworthiness of France? The answer is absolutely no, from our point of view. The right comparison would be either nominal bond yields with nominal GDP growth or real yields with real GDP growth. At the current eurozone inflation rate of 3.0%, the real yield on 10yr French OATs is just 0.7%. The projected real GDP growth for 2012 is currently at 0.5%. As France is also implementing measures to reduce the budget deficit further, the difference between the real yield and real GDP growth rate should hardly give any concern about the creditworthiness of France. It appears again that rating agencies, which were a major culprit of the debt crisis in 2008, attack those who came to the rescue, namely the governments.

Many investors, but also politicians, thought that Germany would be the safe haven. Even when other core countries with a triple A-rating came under pressure, yields on 10yr German Bunds declined to a recorded low of 1.65%. Germany appeared to be the only solid rock. But last week, also Germany came under pressure. The auction of 10yr Bunds was a disaster and shows that investors are no longer willing to fund the budget deficit of the federal government, which will increase next year according to the 2012 budget. The German debt management agency planed to sell 6bn euro of 10yr paper, but investors bid for only 4bn euro. Thus, the remaining 2bn euro of 10yr Bunds will now be sold by the Deutsche Bundesbank in the open market. The Wall Street Journal accused Germany that it would accept the Bundesbank buying Bunds but would resist that the ECB buys bonds of other eurozone member countries. However, the WSJ did not understand the procedure. The Bundesbank only acts as a fiscal agent for the government. It is not buying the Bunds from the German government. The federal government will only receive the funds after the Bundesbank has sold the paper in the secondary market.

Nevertheless, the WSJ is right in pointing out that Madame NO is the major problem for solving the debt crisis. German chancellor Merkel is not only opposing the introduction of Eurobonds but even wants to oppress any discussion about this instrument, as her attacks on the head of the EU Commission, Mr. Baroso, showed last week. She also opposes that the ECB acts as the lender of last resort. As the debt crisis turned into a wide spread crisis of confidence, the ECB is the only institution, which has sufficient funds available to bring yields down to a sustainable level and to prevent further escalation of the debt crisis. The EFSF will fail miserable to reach the target level as press reports revealed over this weekend. Mrs. Merkel and her consultants are obsessed that solving the debt crisis would lead to a transfer union or rising inflation. In her naivety, Madame NO believes that a change of EU treaties would be sufficient to restore confidence.

The market for government bonds in the eurozone has been destroyed. The root cause is the ballooning Greece budget deficit during the Karamanlis government. However, the German chancellor played a major role that the initial problem could not be contained and the contagion now reached even the core countries of the eurozone. The demand that private investors would have to pay for the bailout of Greece while sovereign creditors get fully repaid was a major blow for holding government bonds. But also the European Banking Authority eba contributed to the destruction of the government bond market by several changes of regulations, which all lead to banks selling government bonds in a market, which is not ready to absorb them. It is a major construction failure of the euro that the ECB is not officially the lender of last resort. As long as Madame NO rejects all proposals which would involve a determined buying of eurozone government bonds by the ECB in the secondary market, the debt crisis will still prevail. For precious metals, this is a negative development. The current correction is likely to continue this week, unless there will be a convincing breakthrough to solve the eurozone debt crisis.

Precious metals dragged down by eurozone debt crisis

At the start of last week, gold approached the 1,800$/oz mark again, but reversed direction and closed lower. During the course of the week, gold headed further down and ended the week at 1,723$/oz, a loss of 3.6% over the week. Also other precious metals ended the week lower.

It might sound like a broken record, but the reason for the weak performance of the precious metals has been the never ending story of the debt crisis in the eurozone. After Mr. Berlusconi resigned and Italian President Napolitani asked former EU commissioner Mario Monti to form a new government, the financial markets got concerned that technocrat led governments in Italy and Greece would lack the skills of politicians. The week before, a major concern of financial markets was that politicians would not be able to solve the problems. This demonstrates how much financial markets are in panic. One week they are spooked by one factor and the next week just by the opposite. In Greece and Italy, technocrats now lead the new governments and in both countries, the new leaders have won confidence votes. Nevertheless, the debt crisis in the eurozone worsened further.

Yields on 10 year Italian BTP rose again above the 7% mark temporarily. After an auction of Spanish paper, where the yield was higher than at a comparable auction in October, also the yield on 10 year Spanish government bonds rose to the 7% level, which the markets regards as crucial because other eurozone countries asked for a bail-out once yields rose above this level. However, purchases by the ECB helped to push yields lower again. But the crisis is not contained to these two countries. Instead it has now also reached the core countries. France and Austria have both a triple A-rating, nevertheless, the spreads of 10 year bonds of both countries widened last week considerably over the benchmark German Bunds and reached almost 200bp.

The only institution, which could stop the panic in financial markets, is the ECB. During a conference last Friday in Frankfurt, Germany, the ECP president Draghi as well as the head of the Bundesbank Weidmann made it clear that they oppose to be the lender of last resort. Mr. Weidmann is even opposing the current purchases of government bonds in the secondary market. Also German chancellor Merkel still rejects calls that the ECB should be the lender of last resort and should assure the markets by setting a line in the sand for the yields on government bonds and defending this line by unlimited interventions. The common fear is that such a defense would lead to inflation.

Those fears appear to be overdone for several reasons. First, buying government bonds is not just printing new money. It is a traditional instrument of monetary policy to provide liquidity for the banking system by open market policy operations. Thus, the ECB could absorb the liquidity provided by open market operation by reducing the allotments in the weekly repurchase agreements. Second, even the announcement to buy unlimited amounts of government bonds to keep yields at a certain level does not necessarily lead to an increase of central bank money. Often the markets adjust to the target level and only smaller amounts are required to convince financial markets. A recent example has been the peg of the Swiss franc to the euro by the Swiss National Bank. Third, even in the case that the central bank money stock increases, the monetary impulse has to be transmitted to the real economy. The banking system has to increase the lending activities to governments and the private sector. However, banks in the eurozone reduce the holdings of government debt. The requirements to increase core capital ratios have also a dampening effect on lending to the private sector. Therefore, from our point of view, the risk of accelerating inflation rates as a result of acting as lender of last resort is overemphasized by the ECB.

As long as the debt crisis in the eurozone remains unsolved, it has to be expected that weaker stock markets, declining crude oil prices and a firmer US dollar will weigh on precious metals. In addition, also a technical indicator, the MACD, points to a trend reversal in gold. Thus, the correction in precious metals, which started last week is likely to continue.

Safe haven buying versus the fundamentals

In calls from journalists, the author of this blog is often asked lately, why precious metals declined during days the debt crisis in the eurozone worsened. This crisis has two effects. On the one hand, as politicians are unable to find a quick and convincing solution, there is an incentive to buy precious metals as a safe haven. However, one should not forget that this crisis now lasts for already two years. Thus, there was ample opportunity to buy precious metals and new buyers would have to enter the markets to push prices higher. On the other hand, the debt crisis also has an impact on the fundamentals of the precious metals. An escalation of the debt crisis normally has a negative impact on these fundamentals. Therefore, selling of precious metals driven by the fundamentals could have a stronger impact on the price development than the safe haven buying. But prices could also rise on days of slight improvements in the eurozone as buying driven by the fundamental factors outweighs the possible profit taking by safe haven investors.

Last week, all precious metals posted gains compared to the preceding weekly close. However, it was an up and down trading, where on one day safe haven buying dominated and fundamentals were the stronger influence during the other days. But on all days, political developments rather than economic data were at centre stage.

In the preceding week, Greece was in the spotlight. But after Mr. Papandreou won the confidence vote late Friday night, some movement came into the political landscape. After the publication of the previous blog article, also the conservative New Democracy party agreed to the formation of a national unity government. While it took some time to form a new government, there was finally an agreement that Mr. Papademos, the former ECB vice president, should lead the new government. Last Friday, he was sworn in.

However, last week, Greece was more on the sidelines and Italy was on centre stage. After protests over the preceding weekend and declining support from his own coalition parties, financial markets expected Mr. Berlusconi to loose a vote in parliament in Monday and to resign immediately. From various comments in the media, we got the impression that many market participants did not fully understand what the subject of the vote was. In Italy, the parliament has to approve the report of the PM about the preceding fiscal year’s budget. The parliament voted last Monday on the report for the 2010 budget, but many commentators were under the impression it would be a vote on a budget for a future fiscal year. The opposition parties abstained from voting, there was no risk for some former supporters of Mr. Berlusconi to demonstrate their dissatisfaction by not voting with a yes. Thus, the report was approved by parliament but not with the absolute majority.

But in financial markets, there was widespread disappointment. Some commentators were disappointed that the report was approved while other commentators were emphasizing that Mr. Berlusconi failed the absolute majority was the reason for the negative market reaction. However, gold and other precious metals profited from their safe haven status. Late Monday, after consultations with the president of the Republic of Italy, Mr. Berlusconi announced to resign after a reform package promised to the EU leaders has passed both houses of parliament. On Saturday, Mr. Berlusconi resigned and at the time of publishing this article, President Napolitano was still in consultations before announcing who should form a new government. Markets expect that former EU commissioner Mario Monti would be the next PM in Italy.

In the bond markets, the 2010 budget report had a devastating impact on Tuesday. The yields of Italian government bonds soared over all maturities. The yield on 10yr BTPs reached 7.5% in the peak. This massive sell off weakened the euro and stock markets. Thus, negative fundamentals weighed on precious metals. While the ECB was reported to buy Italian bonds, the purchases intensified towards the end of the week. This brought yields significantly down. Stock markets and the euro recovered. Thus, on Friday, precious metals rose also significantly driven by positive fundamental factors.

The panic in financial markets can only be stopped if the ECB accepts the role of the lender of last resort for government bonds in the eurozone, despite resistance from Germans. Well conducted, it is by no means inflationary. However, it would be far more effective to prevent a recession than another 25bp rate cut. For precious metals, it would also be positive. Unfounded fears of inflation accelerating might be a reason for some buyers. But the main factor would be improving fundamentals for the demand for precious metals by recovering stock markets and a firmer euro.

The Greek Tragedy and Precious Metals

Last week, we argued that the comments from German finance minister Schaeuble concerning the markets initial reaction on the EU summit could lead to declining prices in precious metals markets. While this remarks also played a role, two other actors entered the stage on Monday and one of them moved even to centre stage for the whole week and is likely the dominating figure this week.

The first actor was the Bank of Japan, which intervened in foreign exchange markets to weaken the Japanese yen against the US dollar. The BoJ already intervened on several occasions before. Thus, it should not have come as a total surprise that the BoJ would try to prevent a further strengthening of the yen. The yen was regarded as one of the safe havens. This is very strange with respect to two factors. First, the earthquake and the Fukushima disaster have hurt the Japanese economy, which is in a recession. GDP dropped in Q2 by 1.1% compared to the same quarter of the preceding year. Industrial production in September was down 4.0% yoy and the trend is still further down. Currencies of an economy being in recession usually tend to depreciate but this is not the case for the Japanese Yen.

Second, government debt in relation to GDP in the US and in Europe appears to be a major concern for investors. However, the debt/GDP ratio in Japan is exceeding those ratios in the other industrialized regions by far, being around 200%. According to the criteria presented by Professors Kenneth Rogoff and Carmen Reinhard, Japan should already be beyond the point of no return and bankrupt. However, as the example of Japan shows, some critical ratios are not set in stone. The level of interest rates on government debt is also a crucial variable in the calculation at which debt/GDP ratio the interest payments are unbearable. With a yield on 10yr JGBs of just 1.0%, Japan is in a far more comfortable position.

Especially former and current German members of the ECB council should have a look at Japan. The quantitative easing of the BoJ contributed significantly to the decline of yields on 10yr government bonds. Despite the extension of the balance sheet by the BoJ, inflation has not emerged in Japan. Of course, one could not transfer the situation and monetary policy response in Japan on a 1:1 basis to the eurozone. Nevertheless, buying of government bonds of those countries in the eurozone, which came under attack from financial markets, is not a sure way to inflation.

After the Swiss National Bank pegged the Swiss franc to the euro, the appreciation of the yen increased. The yen fell to 75.5 at the last day of October. This induced the BoJ to intervene. The US dollar did not only firm against the yen, but also against other major currencies. This dollar strength send stock markets lower, which also pulled crude oil lower. As investors risk aversion increased, also yields on safe haven government bonds like the US Treasury paper or German Bunds dropped. In addition, the Schaeuble remarks contributed to a flight into Bunds as investors worried about the still open details of the EU summit package. As a result, also precious metals had been sold.

However, the centre stage was taken on late Monday by the Greek PM Papandreou, who announced to hold a confidence vote in parliament and later a referendum by the population. It was not clear, what would be the question for the referendum. However, given the polls on the rescue package decided at the EU summit, the markets feared that Greece would vote with a “no” in a referendum. This increased uncertainty send risky assets lower and safe haven Bunds and US Treasury notes higher. Precious metals initially fell further, but could already recover on Tuesday. The situation calmed somewhat after German Chancellor Merkel and French President Sarkozy called for a meeting with Greece’s PM Papandreou on Wednesday ahead of the 2day G20 summit. Both demanded that a referendum should be about Greece staying or leaving the eurozone. Furthermore, they announced that no funds would flow to Greece as long as the bailout package decided the week before will be fully implemented.

Holding a referendum on remaining a member of the euro would have been like playing with matches at a fill station. As soon as such a referendum had been called officially, the only rational behavior would be to withdraw all deposits with banks in Greece and transfer them to banks in other eurozone countries. If the result of a referendum would be to leave the euro, the new Greek currency would depreciate against the euro. Thus, one would make a profit. If the majority voted for staying in the eurozone, no currency gain would be made. However, there would be also no loss. Therefore, the financial system in Greece would have collapsed like a house of cards even before a referendum took place.

One Thursday, some movement came into the Greek political landscape. The finance minister opposed holding a referendum on staying in the eurozone. The PM Papandreou offered to give way to a coalition government of “national unity”, which should stay in power for some months to push all necessary legislation through parliament to implement the rescue package as agreed at the EU summit. Also opposition parties moved and showed some willingness to cooperate, but demands for snap elections in December remained on the table.

Friday night, PM Papandreou survived the confidence vote in the parliament. However, it is quite unclear how the political situation in Greece will develop. The major opposition party New Democracy insists on immediate snap elections. Some other parties in the centre appear to be willing to form a coalition government with currently ruling PASOK party. The main problem is that the party responsible for the mess torpedoes the clean-up work of the incumbent government to return back to power as soon as possible. Mrs. Merkel and Mr. Sarkozy should also make a strong call to Mr. Samaras, the leader of the New Democracy. All three are associated within the European Peoples Party, the conservative party in the EU parliament. But as long as Mr. Samaras puts his own interests above those of the Greece population, a solution appears hard to find. Thus, the political developments in particular in Greece, but also within the eurozone, are most likely the dominating factor for financial and metals markets. Investors should be on the defensive side as strong movements in both directions appear to be possible.  

A solution à la Cosa Nostra

One part of the business model of organizations belonging to the Cosa Nostra is to sell and to provide protection. However, what differentiates the mobsters from legal companies is that the mafia extorts protection money from unwilling customers by inflicting the damage, against which they are promised to get protected. Last Wednesday, Charles Dellara, the chief negotiator of the International Institute of Finance (IIF), a Washington DC based organization representing financial institutions, must have felt like a small shop owner in little Italy getting a visit from racketeers. Before the summit of EU head of states started on Wednesday, October 26, negotiations between the IIF and the EU on a higher voluntarily hair-cut for Greece debt reached a deadlock. At midnight, Mr. Dellara was asked to join the meeting of the eurozone head of states, where they faced him with the alternative either to accept a 50% hair-cut or Greece would default. Mr. Dellara accepted the lesser evil.

After the IIF agreed on a higher hair-cut, it took the eurozone head of states another four hours to reach a compromise on a package of measures. Banks will have to be recapitalized by a total amount of about 100bn euro. Also the EFSF, the European Financial Stability Facility, will be leveraged. Despite many details are still open, the financial markets welcomed the compromise.

However, it appears that the German finance minister Schaeuble is resistant against learning from past mistakes. Already after the EU summit in July, negative comments from Mr. Schaeuble increased the uncertainty among financial market participants and contributed to the rise of yields on peripheral government bonds and also a spill-over to the core countries. Now only two days after the summit ended, it is again Mr. Schaeuble warning against expecting too much from the summit. It would be a long way and many more summits would be required until the debt crisis in the eurozone is solved. Also outgoing ECB president Trichet sounded the same warnings in a newspaper interview.

Those warnings are counterproductive. Instead of giving the markets some hope that the crisis will be solved, those comments suggest that the worst might not yet be reached. Like Bill Clinton told former US president Bush senior in the presidential election campaign “It’s the economy, stupid” the German finance minister has to be told “It’s the market psychology, stupid”.

But the risk is not only that the financial markets might pare gains following the remarks from the German finance minister and the outgoing ECB president. The turmoil in financial markets during August and September had also an impact on business survey data. While real economic activity data remained resilient, the US GDP even grew stronger in Q3 than in Q2, expectations for future economic activity worsened, in particular in the eurozone. In the case that financial markets pare gains following the comments from the German finance minister, the already depressed business expectations could drop further. Then it would be only a question of time that falling business expectations also drag business activities down.

Gold posted the strongest daily gain last week on Tuesday after the press release that the summit of EU-27 finance ministers, originally scheduled to talk place a few hours before the summit of the EU head of states, was cancelled. Many market participants and commentators were confused by this headline. They did not realize that the decisive summit is the one of the head of states. Thus, even at Bloomberg TV, the commentator gave the initial impression that there would be another postponement of the EU summit and a failure to find a compromise for a solution. However, as it got clear that the summit would take place, gold defended the gains. Also stock markets pared losses. We interpret the recovery of stock markets on Wednesday and the rally on Thursday as the decisive factor that gold held the gains and even advanced further to close the week with a gain of more than 100$/oz compared to the preceding weekly close.

The outlook for gold and other precious metals will thus depend on the market reaction on the warnings from the German finance minister. If Mr. Schaeuble’s remarks lead again to turbulences in stock markets, precious metals are likely to be dragged lower. However, if the market will ignore him this time, then stock markets might recover further as economic data recently come in better than expected. This would also be supportive for the precious metals.  

Eurzone debt crisis still moves gold price

The situation in Greece gets more and more severe, despite the eurozone finance ministers decided to transfer the next tranche of the bailout funds. The Greek government pushes one austerity measure after the other through parliament while protests and strikes don’t come to an end. The fall of Greek GDP growth accelerates with each austerity measure passing legislation procedures. At the same time, gold and other precious metals trade far below their highs made this year. Therefore, some commentators ask the question whether gold still serves as a safe haven and whether the eurozone debt crisis still has an impact on the price of precious metals.

Of course, gold is still a safe haven. Otherwise, it would not have rallied to prices above 1,900$/oz in September. However, even prices of an asset serving as a safe haven could fluctuate. If there is a wave of save haven buying, as it was the case over the summer, demand has to increase permanently to absorb supply, which usually increases with rising prices. Once the rush to a safe haven subsides, also prices retrace. Or put it in other words, once the last seeker of a safe haven has bought, who is left to push prices still higher? If those investors who bought gold were no longer convinced that it is still a safe haven, they would sell gold and prices would be much lower.

Therefore, we can draw a first conclusion. Gold is still a safe haven but the eurozone debt crisis is no longer leading to sufficiently high safe haven buying to lift gold prices to new record highs. However, the question arises, how is this compatible with observations that negative news related to the eurozone debt crisis does not lead to short term price increases but to falling gold and other precious metal prices?

The answer is rather easy. Precious metal prices follow again more closely those fundamental drivers, which are highly significant in our quantitative fair value models. The three major fundamental factors are the stock markets, the price of crude oil and the US dollar, either versus the euro or versus the basket of the major currencies as measured by the US Dollar Index (USDX). And these factors are currently still heavily influenced by the development of the eurozone debt crisis. However, negative news with respect to a solution of the debt crisis has a negative impact on the fundamental factors, which finally also have a negative impact on the prices for precious metals.

We have now an approach to explain the price movements of the precious metals with respect to the debt crisis in the eurozone. However, this approach is not very helpful in predicting even the short-term direction of precious metal prices. The reason for this failure is the lack of reliability and credibility of European politicians. For example, last week at the G20 summit, the finance ministers of the eurozone promised to deliver a solution at the EU summit taking place today at October 23. But already the following Monday morning, the German finance minister paddled back and stated that a final solution to the debt crisis should not be expected at this summit. Thus, gold initially rose in line with stock markets and a firmer euro against the US dollar, but turned negative after the comments from Mr. Schaeuble. It is already hard to understand that investors buy bonds with a negative real return, but it is even harder to understand that they also buy bonds of a country, whose finance minister is no longer trustworthy.

It remains doubtful that the eurozone politicians will find a solution at the EU summits taking place on October 23 and 26. France and Germany are split in the crucial question how the EFSF could be leveraged. Many German commentators already get scary when they hear the word leverage. Furthermore, the German position is driving more by ideology and dogmas. Therefore, Germany favors a model of guarantying a part of the nominal value of government bonds against a default. The position of France is more pragmatic by favoring to provide the EFSF with a banking licence, which would open the EFSF the access to the repo facilities of the ECB, like for every other bank within the eurozone.

Thus, we can only come to the conclusion that gold would probably fall below the 1,600$/oz mark if the eurozone fails to deliver a convincing solution. However, if finally the eurozone delivers a package of measures that convince financial markets and therefore, also reduces the uncertainty within the real economy, then stock markets, the euro and also the precious metals are likely to rally. 

Recovery of the euro supports gold

One of the factors contributing to the fall of gold and other precious metals in late September was the weakness of the euro versus the US dollar. Beside the inability of politicians to solve the debt crisis in the eurozone and fears that the troika of IMF, EU and ECB would block the payment of the next tranche of bailout funds, the euro weakened also on speculation that the ECB would quickly reverse the direction of monetary policy. However, the ECB disappointed hopes to cut rates already at the October council meeting. The ECB repeated its stance in the monthly bulletin released last week. Inflation is expected to stay high during the final months of this year and is expected to decline next year. The risks for economic activity have increased due to the heightened uncertainty, especially in financial markets.

At least, the ECB forecast appears to be right for the trend of consumer price inflation. In the eurozone, the HICP inflation rate increased to 3.0% in September after 2.5% in August. Also the core inflation rate increased to 1.6% from 1.2% in August. Now also the underlying trend of inflation is getting closer to the crucial 2% mark. Thus, before cutting interest rates and embarking on a more expansionary monetary policy, the rate setting council might wait until the inflation data indicates that the peak has been reached. This would argue more for a rate cut at the end of this year or the beginning of 2012.

The fall of the manufacturing PMI for the eurozone to 49 in September and to 48.5 in October was probably a factor contributing to the warning of the ECB that downside risks for economic activity have increased. However, is seems that the turbulences in financial markets had an impact on the PMI, while actual economic activity is affected far less by the plunge of stock markets in August and September. The consensus of City economists expected that industrial production in the eurozone would decline by 0.8% in August. Instead industrial output increased by 1.2% on the month. While the fall of the PMI below the 50 threshold indicated a contraction in the manufacturing sector, industrial production expanded even faster than in July, which had been revised up to +1.1%. Despite increased risks, they have not yet materialized.

Thus, the ECB appears to be in a fix. Cutting rates early despite still robust economic activity data and inflation above the target by a full percentage point could prevent inflation to come down significantly next year. Waiting too long with a rate could bear the risk that economic activity eventually follows the PMI indicators down and that a possible downswing might be aggravated. This also indicates that the ECB would not be as quick in cutting interest rates as the market consensus had expected.

Keeping interest rates on hold will have an impact on gold and other precious metals via two channels. First, it has an impact on the exchange rate of the euro versus the US dollar. As long as money market rates remain higher in the eurozone compared to the US, there is an incentive to invest funds in the euro instead of the dollar. However, in this context also the eurozone debt crisis and the impact on the banking system play a crucial role. Plans to shield banks against the fallout of a possible default of Greece could reduce the risk of investing funds with European banks and thus could also contribute to a further appreciation of the euro versus the US dollar.

The second channel is via stock markets and risk appetite of investors. A delay of a rate cut due to firm economic data could reduce the fear that the global economy would head towards a recession. Value oriented investors already regard stock valuations as cheap after the drop in August and September. Thus, the risk appetite of investors could increase further and push stock market indices higher. A higher risk appetite would also be positive for gold and other precious metals.

Despite the better than expected economic data in the eurozone and also the US, the crucial factor remains the debt crisis in the eurozone. The G20 finance ministers urged the eurozone to present a solution to the debt crisis within one week at the next EU summit. Germany’s finance minister promised that the eurozone would deliver a solution. If it will be one convincing the markets, the euro might firm further and precious metals would probably be a beneficiary.

US economy is not heading towards recession

At least for now, the US economy is not heading towards a recession despite forecasts from some Wall Street economists. The most bearish forecasts came again from Goldman-Sachs’ team. Some weeks ago, we argued that one important factor for a US recession has not emerged and would be very unlikely to emerge, an inverted yield curve of US Treasury paper. The flight to safe havens and the announcement of “Operation Twist” by the Fed has pushed the yield on 10yr US Treasury notes to record lows and thus, the yield curve flattened. However, as the Fed keeps the Fed Funds target rate at the current level of 0.0 – 0.25% until the middle of 2013, an inverted yield curve is rather unlikely.

A major factor for the fear of a US recession had been US statistics. The financial and commodity markets were already nervous due to the political wrangling over lifting the debt ceiling, when US statisticians revised four years of GDP statistics downward. However, the market participants completely overlooked that GDP growth in Q2 remained below expectations but was above the revised growth in the preceding quarter. There is a saying “there are lies, damned lies and statistics”. But even worse appear to be US statistics, especially for the labor market. In September, the markets got spooked by the non-farm pay roll figures, which came in flat and the two previous months had been revised down. Last Friday, the non-farm payroll figure surprised to the upside by creating 103K new jobs in September, while the consensus of economists was looking only for an increase by 55K. However, also the figures for July and August had been revised up. Instead of no new jobs, the revised figures show now that 57K jobs were added to the payrolls in August. The pace of creating new jobs is still too slow to reduce the unemployment rate. However, it is not pointing towards a recession of the US economy. Therefore, more monetary stimulus remains still on the agenda of the FOMC meetings.

The survey indices of some regional Federal Reserve Banks plunged over the summer months. This had also an impact on the index of purchasing managers. The ISM index for the manufacturing sector dropped from 55.3 in June to 50.9 in July and many economists already predicted a fall below the 50 threshold in August. However, the manufacturing PMI only declined to 50.6, which was already a positive indication. In September, the PMI reversed direction and rose again to 51.6, which indicates that economic activity in the manufacturing sector is increasing again after the summer vacations.

Nevertheless, the US economy is not yet out of the woods. A major threat is the debt crisis in the eurozone. After reaching a compromise in July, eurozone finance ministers now talk about a bigger participation of the private sector in a bailout of Greece. Also discussions of a Plan B, i.e. a default of Greece and shielding other eurozone countries and banks, move towards centre stage. The major problem in dealing with the debt crisis is that politicians rule out sound instruments for obscure ideological reasons. Thus, politicians will always be one step behind the markets and can only react instead of acting strongly and impressing the markets.

A positive development was also noticed in the recent CFTC report on the “Commitment of Traders”. After two months of declines, the net long position of large speculators in gold futures rose again. Compared with the week before, the non-commercials added 5,355 new contracts to there net long position in the week ending October 4. Thus, the net long position rose to 133,156 contracts. However, in silver, the large speculators reduced the net long position further to a mere 11,900 contracts.

The improved US economic data indicates that the risk aversion of investors might not increase further but is more likely to decline again. This would be positive for the precious and the base metals. However, the debt crisis in the eurozone is a factor that keeps uncertainty at a high level. Therefore, any decline of investors’ risk aversion is probably only gradually. Against this background, we expect that precious and base metals are likely to stabilize. The bias is likely to shift towards higher prices. However, as long as no convincing solution of the eurozone debt crisis is found, we do not expect a strong upward move of metal prices. In the worst case of a Greek default, gold might profit as a safe haven, but other metal prices might plunge again.  

The flight of hedge funds out of commodities

According to academic working papers, large speculators have no influence on commodity prices and the price fluctuations only reflect fundamentals. However, the recent developments in commodity markets show a different picture. Academic studies focus on the concept of Granger causality. The time series used in those studies are often the “commitment of traders” data and the price of the corresponding commodity future. Lagged values of the net positions of non-commercials would have to have a statistically significant impact on current commodity prices to assume that large speculators would Granger-cause commodity prices. If there is only a significant relationship between current values of the net position held by non-commercials and the current commodity prices, then the hypothesis of Granger causality is rejected and the academic researchers conclude that speculators have no impact on commodity prices.

This concept, however, is not appropriate to judge if speculators have a significant impact on commodity prices in efficient markets. An increase of the net position held by hedge funds is supposed to have an impact on commodity prices only in the next period. This would imply that increased demand for commodities driven by hedge funds would have no impact on prices now, but would lead to rising prices next week. This is an absurd assumption. Every student in microeconomics 101 learns that an increase of demand leads to an immediate increase in prices. The buying or selling of non-commercials has a significant influence on commodity prices. And the decisions of large speculators are not only driven by expectations how fundamentals will develop.

Commodity prices have declined over the board recently. In the case of energy and industrial metals, the fear of a global recession is one of the driving factors. For gold, the status as a safe haven also plays a crucial role. A global recession could have a negative impact on the demand for gold from the jewelry sector, but given the debt crisis in the eurozone and the troika of IMF, EU and ECB still having to decide whether Greece would receive the next tranche of bail-out funds, one would expect that gold would be relatively stable. Nevertheless, since early August, non-commercials have reduced the net long position in gold futures continuously. And gold could not escape the sell off, which drove gold to as low as 1,550$/oz last week.

For agricultural commodities, the development of supply caused by weather conditions should have a stronger impact on prices than demand changes due to slower GDP growth in the US and Europe. Nevertheless, also grain prices dropped due to position liquidations by hedge funds and other financial investors. The current harvest season as well as delays in planting of winter wheat in the US should have more a bullish impact on grain prices.

Therefore, we can conclude that changes in risk aversion or risk appetite of financial investors could have a stronger impact on commodity prices than the usual fundamentals. However, this does of course not imply that all commodities would fall by the same percentage change. While also gold could not escape the massive selling pressure, its price declined less compared to other precious metals, which have a higher share of total demand for industrial usage. In the case of platinum, a global recession would have an impact on platinum demand from the automotive industry for catalytic converters. Thus, gold traded above the price of platinum and the premium of gold widened to more than 100$/oz. There is no long-run equilibrium relationship between the prices of these two precious metals that would limit the price spread. Thus, the spread could even widen more, especially if stock markets fall further and economic data will be weaker than expected. However, a stabilization of stock markets and a stronger than expected US labor market report next Friday could also trigger a narrowing of the premium of gold over platinum.

The correction of precious metals reached bear market territory last week, i.e. a decline of 20% or more from the previous high. Some technical analysts and former gold bulls now call the end of the long-run bull market in precious metals. We can not rule out such a scenario, especially not in the case that European politicians remain stubborn and react furthermore only slowly to the risks of the debt crisis. The warning calls from US President Obama and his Treasury secretary Geithner are fully justified. However, the main scenario is one of slow growth in the US and Europe with the risk of a technical recession. Asian emerging economies still grow at high single digit growth rates. Thus, a plunge of levels seen in the second half of 2008 and early 2009 for precious metals is currently not the main scenario. 

Ben Bernanke judged again by words instead of deeds

If anybody thinks that history is not repeating, he should have a look at the recent FOMC meetings and those in 2008. The similarities are striking. Last Wednesday, the FOMC decided to lengthen the duration of the holdings in US Treasuries but not to increase the volume of US government bonds on its balance sheet. This is called “operation twist” and has been widely expected by financial and commodity markets. However, the statement issued after the FOMC meeting caused more damage than operation twist is probably able to be beneficiary for US GDP growth. Also back in 2008 during the financial crisis, the Fed implemented many measures; even some innovative ones being appropriate to tackle with the crisis, however, the statements of the FOMC or from individual members of the FOMC were counterproductive.

It is probably both, the Fed and the markets, being to blame for the turmoil in markets following the FOMC statement last week. The Fed has not learnt the lessons from mistakes made in 2008 that words sometimes speak louder than actions and that monetary policy could be ineffective if statements of central bankers have a negative impact on the mass psychology in markets. The financial markets were already highly concerned that the US and the global economy might head towards a double dip recession. Changing the wording of the FOMC statement that “there are significant downside risks to the economic outlook“, made already hyper-jittery investors even more nervous.

However, also financial and commodity markets are to blame for overreacting. One could not expect that the FOMC decides on implementing further measures to prevent a recession of the US economy without providing a justification. This implies also that the FOMC would have to change the wording of its statement.

Increased fear of a global recession pushed stock markets lower. But also base metals got hammered. Copper, which is especially sensitive to business activity, lost more than 15% compared to the preceding week. Lead and tin lost even more as rising inventories contributed to pressure on prices.

Gold could not live up to its reputation of being a safe haven in times of turmoil in stock markets. Last Friday, gold suffered its worst one day plunge by falling more than 100$/oz. Compared to the previous week, gold lost 8.6%. Other precious metals with a higher share of industrial demand suffered stronger percentage losses and silver was again the most volatile among the precious metals. Also the situation in the precious metal markets is similar to fall 2008.

Two factors are at work, which push gold lower. First, investors sell assets across the board. To some extend this selling is driven by the intention to prevent capital and to keep losses from widening. However, some investors also sell assets to realize profits needed to compensate losses suffered with other investments. Gold is very likely being sold to a large extent for the second reason, i.e. to realize profits. The second factor is the US dollar. Investors not only sell assets in times of financial turmoil, like in 2008, however, they also repatriated funds invested abroad back into US dollars. Thus, the US dollar strengthened despite further Fed monetary easing measures. The US dollar index rose 2.5% over the week. The firmer US dollar is another reason for investors to sell also the precious metals.

Even before the FOMC statement was released, large investors have reduced their gold holdings further. According to the latest CFTC report on the Commitment of Traders, non-commercials have reduced the net long position in COMEX gold futures by another 18,318 contracts to 150,529 contracts in the week ending September 20. We would not be surprised to see another drop in the report for the week ending next Tuesday.

Whether gold will continue to trade lower probably depends to a large extend on the further movements in stocks and forex markets. A crucial role for these markets will be the developments of the eurozone debt crisis and the economic figures released during the week. Especially, if the situation in the eurozone gets worse, it could be a double whammy for gold and other precious metals. Therefore, it could not be ruled out that gold enters also bear market territory after falling already more than 15% from the record high. 

Time to say good-bye to gold?

It is a common wisdom that a bull market is over when the last bull has bought. One indication for a market reversal is according to an old market adage when a bull market does not longer rise on bullish news. This had been the case in the gold and other precious metals markets at the start of the week. The German economics minister and head of the junior coalition partner published an article in a Sunday paper where he talked about insolvency of Greece. As the German member of the ECB directorate resigned the Friday before and internal scenario analysis of the German finance minister had been leaked to the media the same day, the market got the impression that the German policy has changed and that the government want a Greek default instead. European bank shares got hammered and dragged the stock market indices lower. The German DAX index dropped below the 5,000 mark, a loss of more than 8% within two trading sessions. Both factors – the plunge of stock markets and the increased risk of Greece defaulting – are normally positive for gold but they could not push gold higher. Instead gold dropped to almost 1,800$/oz.

Tuesday was a reversal day for major European stock markets. Furthermore, the Fed and the major European central banks agreed on measures to provide banks with sufficient US dollar funds over the year-end, which pushed stock markets further up. The German DAX index closed 12.25% above the low of the week. This rise of stock markets did lead to a fall of gold to a low of 1,766$/oz but there was no plunge of gold or other precious metals.

On Friday, gold recovered after hitting the low of the week. Some market commentators attribute this recovery to US consumer expectations in the University of Michigan consumer sentiment index. However, the turnaround set in already during the European morning hours, far ahead of the release of the US consumer sentiment. From our point of view, this recovery is more related to market expectations and reactions on the appeal of US Treasury secretary Geithner at the conference of EU finance ministers. The European FinMins presented unanimity in rejecting the demands of Mr. Geithner. While one might not subscribe to all of his points made, the eurozone finance ministers did again fail to understand the main message. The eurozone has to demonstrate and convince financial markets that they are determined to take all measures necessary to solve the debt crisis. But as long as the eurozone finance ministers just react half-heartedly to new developments in the debt crisis instead of acting decisively, gold bulls could feel comfortably with their positions.

According to the latest CFTC report on the Commitment of Traders, the large speculators reduced their long positions in gold futures by 13,062 contracts and increased the short positions by 2,462 contracts in the week ending September 13. Thus, the net long position of the hedge funds and CTAs declined by 15,524 contracts to 168,847 contracts. This is the lowest reading after the net long position reached a peak at the start of turmoil in stock markets. Since August 2, the net long position dropped by 78,328 contracts or 31.7%. Also the gold holdings at the biggest ETF, the SPDR Gold Trust fell from the high in early August at 1,309.92 tons by 78.51 tons but recovered last week to 1,251.91 tons. Thus, while the debt crisis in the eurozone intensified and major stock markets declined, investors have reduced positions in gold.

Gold rose twice above the 1,900$/oz mark within the last few weeks. However, the flow of funds data shows that major investors have reduced their gold holdings. Also gold did not react to the major drivers as one would have supposed. This might be a warning signal. But it could also simply imply that no longer investment demand from Western countries is the main factor driving gold. Asian investors and the fear of inflation in the major economies of China and India might now be the dominating factor.