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.