Precious metals prices on the rise

With only 3 trading days left, it looks like precious metal prices could advance higher for the second consecutive month. However, it appears that among the major fundamental drivers, the stock market is no longer at centre stage. The US dollar and the price of crude oil are currently dominating.

The finance ministers of the eurozone approved on early Tuesday morning, after 12 hours of negotiations, the 130bn euro bailout package for Greece. While this had a positive impact on precious metal prices, the reaction in stock markets was rather muted. Stock market indices initially reacted positive but reversed direction and closed the day lower. Especially fixed-income strategists voiced skepticism that Greece would be able to implement the necessary measures for a bailout and recommended to buy further the safe haven government bonds, which capped the upside for stock markets. The S&P index failed to surpass a major technical resistance level but ended the week slightly higher. However, it could not provide a stronger impulse for precious metals.

Another negative factor for stock markets had been the release of flash estimates of purchasing manager indices. In China, the unofficial PMI compiled by Markit for HSBC rose from 48.8 to 49.7 in February. The financial and commodity markets were disappointed that this index remained below the 50 mark. However, what is more important is the direction of the PMI and it points in the right direction. Furthermore, regressing industrial production on purchasing manager indices shows that the 50 mark is not set in stone as the sharp distinction between contraction and expansion. Even at readings slightly below 50 of the manufacturing PMI, industrial production could nevertheless increase. In the eurozone, the flash estimate also showed an increase of the manufacturing PMI; however, it remained below consensus forecasts. The service sector PMI surprised by a drop while the consensus of economists was looking for an increase.

The German ifo index posted a surprisingly strong increase exceeding market expectations. However, it could not provide a stronger impulse for stock markets. The reason had been the release of the GDP forecasts of the EU Commission, which took place only shortly after the ifo institute published its index. The EU now expects the eurozone to be in a recession this year with a slight contraction of GDP. However, this should not come as a surprise as the ECB already argued with a recession in the eurozone for the two rate cuts in November and December 2011. The reaction in stock markets just demonstrates that markets are not always information efficient.

Since late January, the price of crude oil is rising. The price of the nearby Brent future rose by more than 5$/bbl last week and closed above 125$/bbl. The reason for the rally in the oil market is the embargo of Western countries against Iran. Last weekend, the regime in Tehran announced to stop immediately oil deliveries to France and the UK. As Iran also threatens to close the Strait of Hormuz, crude oil prices could rise even further. The price development of crude oil adds to concerns about a slow-down of global economic activity. However, currently, the impact of crude oil prices on consumer and producer prices is a stronger factor for precious metal prices than the possible negative impact on economic activity, which would hit more the metals with a higher industrial use.

The second long-term repurchase operation (LTRO) of the ECB, which will take place next Wednesday, February 29, has lifted the euro versus the US dollar. The ECB will provide again funds for three years and the markets expect a strong demand from banks in the eurozone. The first LTRO already contributed to an easing of the debt crisis in the eurozone. Yields on Italian and Spanish debt came down and this development continued also last week. With the injection of further liquidity, banks are expected to purchase further government bonds in the eurozone. If further progress will be made with respect to the bailout of Greece, the euro might firm further against the US dollar, which would be another positive factor for precious and base metal prices.

As gold consolidated and traded sideways during most time this month, the recent rise has not led to an overbought market. Therefore, the advance starting this week could continue into the next month. Nevertheless, the stock markets could spoil the party for gold bulls. Therefore, we would stay long but keep tight trailing stops to protect positions.  

Diverging price moves among precious metals

The major fundamental factors for the development of the precious metals had been positive. The S&P 500 index and the price of crude oil posted stronger gains in the weekly comparison. The US dollar index increased only slightly, which indicates a marginally firmer US dollar. However, this would normally been overcompensated by the gains of the stock market and the oil price. Nevertheless, only gold could profit from the positive fundamentals while the other precious metals ended the week with a loss compared to the previous weekly close. The precious metals with a stronger industrial use had been dragged lower by falling prices of base metals. The LME metals index plunged by 4.1% last week.

Various market reports cited one reason for the fall in base metal prices, the uncertainty about the bailout of Greece. Eurozone finance ministers already postponed a decision on the 130bn euro package the week before. Last week on Tuesday, the summit scheduled to take place on the following Wednesday was postponed again and should now be held on Monday, February 20. Nerves of already jittery investors had been strained further by reports that Germany and the Netherlands intend to hold back a final decision on the bailout package until after the Greek general election in April. Germany is playing with fire if it blocks a final approval of the package at the meeting of eurozone finance ministers at the meeting tomorrow.

We fully agree with George Soros that Germany’s crisis management is leading Europe to disaster. We also wrote about this subject several times in this blog and thus, there is no need to repeat the assessment again. However, the further development of precious metal prices will depend on solving the debt crisis. A final approval of the Greek bailout package would be positive for precious metals. Any further delay of the decision, in particular after the Greek elections in April, would be negative for the euro and stock markets, which would drag precious metals down. Unlike last week, gold would probably not escape a downward move in the case that eurozone finance ministers fail to fully approve the bailout package at their meeting tomorrow.

Flow of funds data provides a first warning signal that institutional investors might get more pessimistic on the short-term outlook for gold and take profits. Since the end of last year, large speculators have increased their net long positions in gold futures in every week according to the CFTC report on the “Commitment of Traders”. However, in the week ending February 14, they reduced the net long position for the first time. It declined from 177,507 by more than 10,000 contracts to 167,420 contracts. The decline of the net long position was not only the result of closing longs but also of adding to short positions. But on the other hand, holding in the biggest ETF, the SPDR Gold Trust, increased further last week by 2.6 tons to 1,281.3 tons.

After the release of SEC data, some commentators came to the conclusion that John Paulson would turn negative on gold. His hedge fund has reduced holdings in the SPDR Gold Trust also in the final quarter. However, we don’t share this view. It is well known, that John Paulson had to sell holdings in the gold ETF to raise cash in the third quarter of last year. This operation probably had continued into the fourth quarter of 2011. Nevertheless, one should always keep in mind that once a major market player is forced to liquidate his position or turns bearish, gold and other precious metals could drop despite fundamentals still look positive.

Uncertainty over Greek bail-out weighs on precious metals

Most precious metals ended the week lower. The only exception was platinum, which gained strongly at the start of the week and managed to defend a major part of the gains at the end of the week. The major factor moving precious metals prices had been the EUR/USD exchange rate, which was following largely the news flow over the Greek bail-out.

Financial markets started disappointed in the trading week after Greece could not announce an agreement with private creditors on the PSI, the hair-cut private bond holders would have to accept. Furthermore, the Greek government and the parties backing the technocratic PM Papademos had not reached an agreement with the troika of IMF, EU and ECB. However, as news pointed towards an agreement being in reach, the euro firmed against the US dollar and pulled also precious metals higher. On Thursday, an agreement within the government and with the troika had been reached a few hours before a meeting of eurozone finance ministers took place. However, led by Germany, the finance ministers rejected the agreement with the troika as insufficient. They demand that Greece would have to save another 345mn euro. Furthermore, all coalition parties would have to sign the agreement. Greece had been set a deadline by Wednesday, February 15, 2012. On Friday, the right-wing party left the coalition government. The Greek parliament will decide on Sunday evening, after this article had been released, on the measures of the bail-out package.

Germany’s stubbornly hard stance is again guided by domestic political considerations and economic stupidity. In speeches on public finances, German chancellor Merkel refers often to the metaphor of the Swabian housewife, which is known as being extremely thrifty. Micheal Lewis noted rightly in his latest book that saving appears to be a virtue in Germany and borrowing as being a deadly sin. Therefore, it comes not as a surprise that supporting the bail-out package for Greece is not popular in opinion polls. Furthermore, the support in Mrs. Merkel’s coalition parties appears to be declining.

Germany’s economic prescription for the healing the Greek debt crisis is like medieval medicals blood-letting. The worse the situation of the patient got, the more blood-letting was ordered by the medicals until the patient died. It is thus no wonder that it was a physician who compared the economy with the blood circulation in the human body (Francois Quesnay in Tableau Economique, published in 1758). The more austerity measures Greece has to implement the more severe the slump in economic activity gets. Measures to reduce the budget deficit by spending cuts and tax hikes have to be compensated by other expansionary measures. However, in the case of Greece, this is not the case.

In Germany, but also in some other so-called stability oriented countries, the belief that a default of Greece and an exit of the eurozone would be contained, is finding more and more supporters. However, also the US administration believed that the bankruptcy of Lehman Brothers would have little impact. As we know, they were completely wrong and it caused a major global financial and economic crisis. If Greece would default in March, the ESM is not ready to work and the EFSF might not have sufficient funds available to prevent a contagion. Financial market would immediately attack Portugal, Ireland, Spain and Italy again. And if the German economic orthodoxy leads to a depression in the eurozone, which would also lead to a global recession, where do they want to export all their goods?

Thus, the further development of precious metals prices depends crucially on avoiding a Greek default and on passing the 130bn euro bail-out package. A default is probably negative for precious metals due to a weaker euro against the US dollar and revived fears of a global recession. However, gold might profit from safe haven buying. However, as the development in 2008 showed, this might only set in after gold also weakened due to liquidations of positions to cover losses and to obtain liquidity.       

Vanishing hopes for QE-3 drag precious metals lower

Gold and silver ended the week with a loss, while the PGMs managed to defend some of the gains made during the week. But all precious metals were dragged down after the release of the US labor market report.

The US labor market report released last Friday was not the first one, which surprised the market consensus to the upside. For a couple of months, the non-farm payroll figure came in stronger than Wall Street economists predicted on average. Also figures for the preceding months were revised to the upside in a couple of consecutive reports. The unemployment rate dropped in the report for December already from 9.0 to 8.5% and declined now in January further to 8.3%. However, this time something was really different, the reaction in financial markets. The last few times, the US Treasury market reacted with losses and the S&P 500 index future rallied immediately after the release of the labor market report. However, only a few minutes later, markets reversed direction. US Treasury notes and bonds prices not only recovered losses but even ended in the plus. Stock markets gave back the gains. But, last Friday, the markets reacted as one would have expected it after a strong labor market report. US Treasury notes ended down and stock markets closed significantly higher.

From our point of view, two factors contributed to the normal market reaction. First, the talks about a debt restructuring of Greece are still not completed. But as the Greek administration stated, an agreement is almost reached. In addition, auctions of other eurozone countries went well and Italy and Spain could issue paper at considerably lower yields compared with previous auctions. Thus, the situation is the eurozone has at least stabilized. This reduces the appeal of US Treasury paper and of the US dollar as safe haven.

Second, Fed chairman Bernanke was more optimistic on the US economy during the testimony compared with the FOMC statement released the week before. Furthermore, markets realized that the recent FOMC statement did not provide a firm guarantee that exceptionally low interest rates would stay at that level until late 2014. If economic conditions change, the Fed would also be ready to end the phase of exceptionally low interest rates. In addition, some economists rightly argued that even a hike of the Fed Funds rate would be compatible with exceptionally low interest rates because the FOMC might regard also Fed Funds below 1% as exceptionally low.

But most important in this context appear to be expectations for another round of quantitative easing. The US Treasury market was well supported by speculation that the Fed would soon embark on QE-3 officially. Economic data released during the course of the week pointed to a further strengthening of the US economy. The further strong increase of non-farm payrolls and the surprising decline of the unemployment rate, which was not due to unemployed persons leaving the work-force, have triggered a change in market expectations. Hopes for QE-3 vanished and got priced out in the US Treasury market as well as in US dollar foreign exchange rates. The US dollar index declined and the euro firmed against the US dollar. This spilled over to the precious metals, which also traded lower in line with the falling US dollar index. The rise of stock market indices and the rebound of crude oil prices were not sufficient to compensate the negative impact from the US dollar and Treasury market.

After the strong rise in January, gold might now be in for a correction. We would not be surprised if gold pares all the gains made after the release of the recent FOMC statement. However, experience also tells that economists adapt their forecasts. After having underestimated economic data consistently for some months in a row, they get then too optimistic and overestimate economic data in their forecasts. Therefore, if economists get too optimistic and economic data disappoints markets, hopes for QE-3 could then be back on the agenda again. But even in the case that economic data remains strong, the usual fundamental drivers of precious metals are likely to prevent a sell-off. Thus, we expect only a correction but not a medium-term trend reversal.