Questionable safe haven status of gold

While all the spot base metals posted gains on balance last week, gold ended almost unchanged and the other precious metals ended the week lower compared to the preceding Friday. This leads to the question whether gold is really a safe haven in times of increased risk.

The major concern during last week was the development in Japan after a major earthquake and a tsunami have hit the northern part of the Honshu Island. Both triggered a major incident at the Fukushima nuclear power station. The developments at this power station and the risk of a nuclear meltdown were the dominating factors in many markets and eclipsed the unrest in the MENA region.

Normally, this is a situation, where many expect that gold and the other precious metal would perform well and provide protection. However, gold was not the safe haven and was in a roller coaster. We have pointed out several times that gold is also a risky asset. A rise of volatility indices like the VIX is often accompanied by falling gold prices. The same applies for the other precious metals. Falling stock markets are often negative for the precious metals. This has been especially obvious last Tuesday, when stock markets tanked after a statement of the Japanese PM. And it was also the case after comments from EU commissioner Oettinger on the situation in Japan hit the wires. One possible reason for this link could be that stock investors might have to sell other assets to cover the losses suffered in stock markets. This could not be ruled out as some stock markets traded more than 10% below recent highs.

However, with plummeting equity markets, the risk inversion of investors increases and investors not only sell stocks but also other risky assets. And gold is one of those risky assets. This is underlined by the latest CFTC report on the “Commitment of Traders”. During the week ending March 15, the day gold hit the low of the week at 1385$/oz, large speculators reduced long positions by 12,773 to 240,661 contracts and increased short positions by 3,596 to 66,090 contracts. Thus, their net long positions dropped by 16,369 to 174,571 contracts. Also the gold holdings of the SPDR Gold Trust ETF declined further until Tuesday, but rebounded during the second half of the week.

 The stabilization of stock markets was very helpful also for gold. A further recovery of equity markets could lift gold further up. A rebound of automotive company share prices would also be positive for the PGMs as their price development is correlated with the price trend of car manufacturers. The latest news concerning the situation in Japan indicates that stock and precious metals markets might recover further. However, set-backs can not be ruled out.

Another geo-political risk factor is back in the spotlight. After the UN passed a resolution concerning a no-flight zone over Libya, France started military strikes against Libya and the UK and US forces joint them later. Last Friday, crude oil prices declined after Gaddafi announced a cease-fire. The military strikes against Gaddafi’s troops could lead to further decline of oil prices, which would be positive for stock markets. However, the impact on gold might be ambiguous as rising crude oil prices tend to increase the demand for gold as a hedge against inflation. However, in the current environment, the impact from rising stock markets might be the dominating force. 

The impact of the earthquake on metal markets

After a devastating earthquake and a tsunami hit Japan, the thoughts are first with the victims of these natural disasters. This will especially be the case for those readers who have friends and family or colleagues in Japan. The author of this blog was also several times on business trips in Tokyo and had many colleagues in the Tokyo branch of his former employer. The hopes are that they all are well.

Nevertheless, as financial and commodity markets only pause over the weekend, it is also legitimate to ask what the impact of the catastrophe will be, which hit Japan so strongly last Friday. Against the background that the situation in Fukushima nuclear power station is very dangerous and could result in another disaster, it is rather difficult to assess the damage caused by the earthquake.

According to press reports, the Bank of Japan is ready to provide as much liquidity as needed to the financial system, when markets open on Monday morning local time. This should prevent a run on banks. A situation comparable to the collapse of Lehman Brothers is most likely to be avoided, at least, as long as no panic sets in.

Japan’s GDP growth in the final quarter of 2010 was 2.2% yoy, with a trend towards slower growth. It could not be ruled out that GDP growth will come closer to zero or even that GDP will contract in the second quarter of this year. As the earthquake hit Japan towards the end of the current quarter, the impact of the current quarter GDP growth is probably smaller, in particular as industrial production and retail sales pointed upwards in Q1. However, it is currently not obvious, how strongly industrial plants in Northern Japan are affected by the earthquake and the catastrophe at the Fukushima nuclear power station.

Nevertheless, history shows that the impact of a natural disaster on economic activity is very often only temporarily. It is quite obvious that the earthquake and the following tsunami have caused damages on infrastructure and housing facilities. Reconstruction work will be positive for GDP growth going forward. Also cars have been destructed and need to be replaced. It is currently unclear, if the domestic automotive companies have the facilities to replace them quickly, but purchases of new cars are also likely to increase, which would be positive for the demand for PGMs (catalytic converters) and aluminum as well as copper.

Japan is a country with a big export surplus. Short-term production short-falls might not necessarily be negative for global GDP growth as long as they could be substituted by products from other countries. Furthermore, the reconstruction work in Japan might lead to increasing imports to Japan, which would also be positive for the global economy. However, given the opaque situation about potential losses of industrial production, there is the risk that some products might not be easily replaced by other suppliers and that this could have a negative impact on industrial production in other countries in the short run.

Japan is an importer of commodities. Production losses over the next couple of weeks will have an impact on the demand for commodities by the world’s third biggest economy. This might especially be the case on Japanese imports of crude oil. Already on Friday, crude oil prices edged lower. This would also reduce the inflation fear triggered by the recent rise of oil prices after unrest in North Africa broke out.

Fears, the Bank of Japan might sell US Treasury holdings and repatriate the proceeds, led to a stronger yen versus the US dollar last Friday. However, those fears appear not to be well founded. Even if the BoJ would sell US Treasuries, it is unlikely that the Japanese central bank would intervene in FX markets to strengthen the yen. More likely would be that Japan uses the proceeds to pay for imports. Thus, the US dollar might rebound against the yen. Declining Japanese demand for commodities and a stronger US dollar against the yen would be negative factors for metal prices short-term. But reconstruction works are likely to lead to higher demand for commodities in the medium-term. Thus, metal markets might correct further down on fears of a global economic slow-down. However, we would regard this as an opportunity for consumers to hedge against the risk of medium-term price increases.

Gold at new record high

Last week, we forecasted that gold would reach a new record high in March. Already on the first day of the month, gold rallied above 1,430$/oz and surpassed the former record high at 1,430.95$/oz recorded on December 7, last year. On Wednesday, gold reached the next new record high at 1,439.5$/oz. However, on Thursday, gold plunged by more than 20$, but ended the week at 1,420.8$/oz. Especially the trading pattern of the last two trading days of the preceding week show that gold is currently driven by two opposite forces.

On the one hand, gold still profits from geo-political tensions in the Middle East and North Africa, the MENA region. As there is a wide spread fear that the tensions might not remain contained to Libya but could spark off unrest in other oil producing countries, in particular in Saudi Arabia, the price of crude oil rose further. The energy complex has not only a high weighting in commodity price indices, but also in consumer price indices. Therefore, the surge of oil prices will have an impact on CPI inflation. As gold has the reputation to serve as a hedge against inflation, the fear of rising inflation rates is another factor supporting gold and other precious metals.

But on the other hand, many central banks are worried by the rise of headline inflation rates. After central banks in emerging economies already changed the stance of their monetary policy and lifted interest rates higher, central banks in Western industrialized countries were hesitant so far. The monetary policy committee of the Bank of England already discussed rate hikes, but the majority preferred to keep rates on hold fearing a dip back into recession as the fiscal austerity policy of the Cameron government is already a drag on the economy. While the consensus was looking for a strong increase, the GDP in the final quarter of last year already surprised by an unexpected fall. And this decline of GDP was not only due to snow falls in December. However, the biggest surprise came from the ECB last Thursday. At the monthly press conference following the council meeting, ECB president Trichet announced that the repo rate might be increased as early as next month. A rate hike in the eurozone could also tip the balance within the MPC of the BoE. Thus, interest rates in Europe are likely to increase rather sooner than later.

A rate hike by the two major central banks in Europe would be negative for gold for two reasons. First, the opportunity costs for holding gold would rise. This would be especially negative, if the ECB and the BoE embark on a series of rate hikes. Second, tightening monetary policy would have an impact on inflation expectations. If investors expect that inflation will remain well anchored close to the target rates, they might liquidate gold holdings.

However, there might also be another opposite effect. Fed chairman Bernanke is not concerned about the impact of rising oil prices on core PCE inflation. Thus, he provided no hint at the testimony last week that QE2 might be terminated earlier than scheduled. Many commentators, analysts and strategists expected the central banks to hike rates earlier than the Fed. Nevertheless, rate hikes in Europe are now probably implemented far earlier than expected. This is weighing on the US dollar and a weaker US dollar could be a supporting factor for gold.

Large speculators have increased their net long position in gold futures last week again, according to the latest CoT report of the CFTC. The non-commercials added to long positions in the week ending March 1^st and reduced short positions. Thus, the net long position rose by 16,829 to 197,253 contracts. Gold holdings at the SPDR Gold Trust ETF continued to decline, but at a slower pace as only 0.9 tons were sold.

All in all, gold could still rise to fresh record highs in coming weeks. However, the headwinds are probably getting stronger.