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.