Continuing rally in gold and silver

Gold and silver reached new highs last week and the rally is probably not over yet. Gold surpassed the psychological resistance at 1,500$/oz. Silver rose above 46$/oz and is close to the record high reached when the Hunt brothers tried to corner the markets. However, the other precious metals, platinum and palladium, gained in the week over week comparison but remained clearly below recent highs.

One factor supporting the precious metals is the development of the US dollar. The rating agency Standard & Poor’s changed the outlook for US Treasury paper to negative and attributed the likelihood for a downgrade within the next two years at 3:1. This is reducing the attractiveness for foreigners to buy US Treasuries. Despite the negative surprise, the yield on 10yr US Treasuries declined and the spread over 10yr German Bunds narrowed. The spread convergence at the longer end of the yield curve is a factor weighing on the US dollar. However, once the Fed will have finished QE2, the yield movements in the 10yr segment might turn again positive for the US dollar. Nevertheless, it remains doubtful whether this would also lead to a stronger US Dollar.

The monetary policy of the Fed and the ECB are likely to diverge further after the ECB hiked rates earlier this month. As a member of the ECB council pointed out, markets are right in discounting further rate hikes. The open question is only when will the next move take place and at what level will the refinancing rate be at the end of the year. True, some members of the FOMC also sound hawkish and would favor an end of the ultra-low Fed Funds rate between 0.0 and 0.25%. But unlike in the ECB council, these members don’t have a voting right in the FOMC this year and the majority of the voting members still follow the guidance of Fed Chairman Bernanke. Therefore, it is likely that money market rates in the euorzone increase stronger than in the US, which is another negative factor for the US dollar.

The German politicians have not learned the lesson from last year and the various episodes of the debt crisis. But the Greek newspapers are not better. Both fueled by comments the speculation and fear in financial markets that a restructuring of Greece government debt would be inevitable within this quarter. Despite the denials of the Greek government and warnings by the central bank and the ECB, some German politicians and Greek journalist like to spread rumors and to spook investors. The yield on 2yr Greek government paper rose above 20% last week. Thus, a renewed wave of spread widening over Bunds and rising CDS on bonds from peripheral countries provides another reason for buying gold and silver as a safe haven. It could not be ruled out that the debt crisis will become the dominant factor for the EUR/USD exchange rate. Thus, despite a more restrictive ECB policy, the euro might weaken on debt concerns. Then, this could also be a negative factor for gold and silver.

Positive earnings surprises by US companies lead to an increased risk appetite of investors. Stock markets performed positive. Rising stock market indices are another positive factor in our quantitative models for gold and silver. However, the tightening of monetary policy in China prevented that the PGMs profited stronger from otherwise positive factors. Sell in May and go away is not necessarily the best advice for stock market investors. However, the yoy percentage gains of the S&P 500 index might be close to the peak in coming weeks and month. A turnaround would then also be a negative factor for the precious metals.

Also speculative money is flowing again into gold and silver. According to the latest CoT report, the net long position of large speculators rose in the week ending April 19 for gold and silver. In gold, the net longs have reached the highest level of this year and are close to the level at the end of last year. However in silver, the net long positions are considerably below the high of the year.

While the US dollar probably remains a supportive factor for some time, but the other factors in our quantitative models might get less supportive, especially as the typically weaker season is ahead. Thus, it could not be ruled out that investors take profits at some point, which could lead to a stronger correction. Therefore, we recommend to stay long in gold and silver as long as the current trend prevails, but also to tighten stops at the same time.