Don’t bet that the Fed will come to the rescue

It was another week that precious metals traded mixed and the next week might show the same behavior – at least ahead of the US labor market report. Unlike in March, the FOMC statement had no negative impact on precious metals, in particular on gold. However, gold bulls should not be too sure that the Fed would come to their rescue.

The hope dies last. This is not only the message of Pandora’s Box, but also describes the behavior of the bulls in the US Treasury and other financial markets. The FOMC members have revised up their forecasts for US GDP growth and core PCE inflation in this year and for 2013. The majority still expects that the first rate hike would not take place before 2014. However, the range of forecasts for the Fed Funds target rate has also moved up. This should already be a warning signal that the majority of the FOMC voting members are not inclined to implement a more expansionary monetary policy.

But this had been faded out in the cognition of traders and investors in financial markets. They just focused on the standard phrase of the FOMC, which had been repeated by Fed chairman Bernanke at the press conference. This standard sentence is “the FOMC is ready to act if needed”. However, what traders and investors overlook completely is the if-clause in this statement. It is conditional on a situation that further monetary stimulus would be required. Against the backdrop of forecasts for US GDP growth and inflation being revised upwards, this is currently not at the horizon as far as the eye could see.

The initial jobless claims remained at an elevated level. However, the seasonal unadjusted data – the raw figures – showed a decline of jobless claims. We have pointed out already that moving holidays like Easter could have a significant impact. Seasonal adjustment procedures could even distort the underlying trend instead of reducing the noise. Thus, the current labor market data is not providing a clear signal for the majority of the FOMC voting members to embark on QE3.

The advanced estimate of US GDP growth in the first quarter of 2012 came in lower than expected. However, private consumption grew stronger than total GDP. Even as it was at the expense of a decline in the saving ratio of the private sector, this is a positive sign as the consumer is still spending despite the weaker consumer confidence. Fed chairman Bernanke often emphasized that the pick-up in headline inflation rates would be transitory due to the rise of crude oil prices. The discrepancy between the core and the headline inflation rate supported his view. However, now the Fed’s favorite inflation gauge, the core PCE deflator, has risen above 2.1% yoy. It is widely assumed that the Fed has an implicit inflation target for the PCE deflator of 2.0%. We do not expect that one quarter of core inflation about this level would induce the FOMC to shift the direction of monetary policy. However, the hawks within the FOMC would stress that inflation risks have increased. Therefore, the core PCE deflator provides another reason for the FOMC to adopt a wait-and-see attitude. Furthermore, the standard phrase of being ready to act when needed is open for both directions. Further increases of the core PCE could also induce the FOMC to increase the Fed Funds target rate earlier than currently indicated. Nevertheless, this appears currently as a remote possibility only.

For the time being, it appears that financial markets have a clear preference for the safe haven of government notes and bonds issued by the US Treasury and Germany. As long as the risk appetite of investors remains low, it seems that precious metals would have difficulties to enter a new upward trend. Therefore, we expect the precious metals to remain in a trading range. However, this all could change very rapidly next Friday with the release of the US labor market report. 

FOMC might be negative for precious metals again

Precious metals are still consolidating. However, given the reaction of financial and commodity markets following the release of the FOMC statement in March, the risk appears to be biased on the downside the new week. The Fed might disappoint again expectations of providing hints for the implementation of QE3 at its two day meeting of the FOMC on April 24 and 25.

The major fundamental drivers had been positive on balance for precious metals this past week. Compared with the close of the preceding week, the US dollar weakened and the S&P 500 index as well as crude oil posted a gain. However, the moves during the week were rather mixed. Thus, it is not surprising that gold and platinum ended the week lower while silver and palladium managed to close higher, just the opposite of the previous week.

The debt crisis in the eurozone plays still an important role, but gold could not profit. The bond vigilantes expect the impossible that Spain should implement austerity measures to reduce the budget deficit and should prevent a further slow-down of economic activity. Some academic studies pretend to show that it would be possible to follow a restrictive fiscal policy and to have a growing economy. However, those empirical studies are based on cases were the fiscal austerity was pursuit to reduce inflation and not to cut the budget deficit. Nevertheless, fixed income strategists complain that either Spain would not cut spending enough to reach the target for the deficit/GDP ratio or Spain would shrink stronger than expected. Therefore, whatever measure the Spanish government is taking, there appears always a reason for a negative comment from fixed income strategists in the City of London.

There appears to be a competition among fixed income strategists and traders to have the most negative comment on Spain in media reports – in some cases, it could also be the most stupid one. An example has been the comments on the Spanish auction last week. Spain managed to sell short-term paper which met good demand. This had calmed the tensions and the yield on 10yr Spanish Bonos declined again below 6%. Two days later, an auction of those 10yr Spanish bonds went also well as Spain could sell slightly more than the maximum target of 2.5bn euro. Also the bid/cover ratio pointed to strong demand for the 10yr paper. The yield accepted was 5.74%. However, immediately after the auction, Spanish bonds had been sold heavily. Traders and strategist were not satisfied that the yield was higher than at the preceding auction. This is a rather stupid comment given that the yield of 10yr Spanish government bonds was at 6.14% at the beginning of last week. If traders regard the accepted yield as too high, why did they push yields up so much?

The favorite trade among hedge funds is currently long 10yr German bunds and short eurozone periphery. John Paulson appears to be the lonely wolf among hedge fund managers being short in German government paper. Thus, it is not surprising that many comments from traders and strategists have a negative bias on the eurozone periphery and Spain in particular. However, some traders even manipulate the financial markets by spreading false rumors. Obviously, the gains of the German Bund following the Spanish auction on Thursday were not enough. Thus, the rumor was spread around that Moody’s would downgrade immediately France. This rumor had a negative impact on the euro and on stock markets. Thus, also precious metals were pulled lower by this market manipulation by some criminals. The shame is that no market supervising authority is taking any action against those gangsters despite the fact that market manipulation is a crime in most jurisdictions.

US economic data has been mixed lately, at least compared with the consensus forecast of Wall Street economists. We pointed out that economists’ forecasts get too bullish after they have underestimated monthly economic data for some time. We are currently in that phase that economists adjust their forecasts upwards. Furthermore, moveable holidays like Easter could have a significant impact on monthly figures, which could not be eliminated by the usual seasonal adjustment procedures. Quite the opposite, the seasonal adjustment could even exacerbate the distortions. The economic data indicates that US GDP growth might have slowed down somewhat towards the end of the first quarter. However, there is not yet a clear picture. And one month of a disappointing number of new jobs created is not enough evidence that the economic situation worsened considerably, in particular as the unemployment rate declined. The ISM purchasing manager indices still point to economic expansion. Thus, we expect the FOMC to keep the powder dry and to provide no hint of embarking on QE3.

The US Treasury market has rallied on hopes of QE3. Thus, we expect a stronger negative reaction after the release of the FOMC statement. This alone would be a positive factor for precious metals. However, at the same time, the US dollar might strengthen and stock markets might react negatively. This could lead to falling prices of precious metals after the FOMC meeting.

Therefore, the ongoing eurozone debt crisis and the FOMC meeting are factors that bias the risk for precious metals to the downside. Gold might test again the support around the 1,600$/oz level. 

Still consolidating

Precious metals are still in a consolidation and the outlook does not point to a short-term breakout to the upside. The past week was mixed for precious metals, after moving higher at the start of the week, prices came down again. Gold and palladium manage to end higher than the week before, while silver and platinum closed lower than the preceding Friday.

The positive start into the trading week was caused by the US labor market report released the Friday before. Some buyers of precious metals speculated that the lower than expected number of new jobs would induce the Fed to embark on the third round of quantitative easing. A look at the yield on 10yr US Treasury notes indicates also that bond investors are still convinced that the Fed would implement QE3 as yields declined further this week. However, those buyers overlook an important fact. The unemployment rate has declined further to 8.2%. And comments of some FOMC members indicate that the Fed is currently not considering any additional monetary stimulus. The indication to be ready to act when needed should not be misunderstood as this would be currently the case. Thus, the FOMC is likely to disappoint the expectations of Wall Street at the next FOMC meeting on April 24/25.

In the case that the FOMC does not indicate to prolong “operation twist” beyond the scheduled expiration by the end of June or to take any other measures of QE3 – as we expect - then the markets are likely to react as they did in March. The US dollar might strengthen against the major currencies and stock market indices and bond prices are likely to come down. This would also have a negative impact on the prices of precious metals.

We pointed out several times that it is a typical behavior of economists to become too optimistic after they have underestimated economic data for some month. This is currently the case. US economic data is coming in mixed. The PMI surveys for the manufacturing and service sector point to still robust growth. However, after some data came in lower than expected, the financial markets already fear a significant slow-down of US GDP growth. The risk-aversion of investors has risen and falling stock markets have also a negative impact on precious metals.

The eurozone debt crisis is back in the focus after last week as Spain sold new paper at the lower end of the target range only. Italy could sell sufficient amounts at auctions this week. However, as yields have risen since the preceding auction in March, some fixed income strategists and traders were concerned about the higher yields Italy had to accept according to market comments. Yields and CDS rates on Spanish and Italian debt rose. The situation calmed down after the member of the ECB directorate responsible for the bond purchase program, Mr. Benoit Coeure, indicated that the ECB could buy bonds of the two countries in the secondary market again. However, on Friday, the president of Netherland’s central bank, Mr. Klaas Knot, send jitters again among market participants by stating that renewed bond buying would be a far way off.

Mr. Knot’s comment was rather stupid for several reasons. First, it is the ECB directorate to decide about the timing of any bond buying in the secondary market. ECB president Draghi just recently confirmed that the security market program is not terminated. Second, After Mr, Coeure calmed down the fears in the bond market somewhat without any bond purchase this week, Mr. Knot has done the speculators attacking Spain and Italy a big favor. While he and the German Bundesbank president Weidmann oppose the bond buying program, the comment of Mr. Knot is counterproductive. Further pressure on Spain and Italy could induce the majority of the ECB council to vote for renewed bond purchases. Keeping his mouth shut would have avoided this.

The comments from the head of the Dutch central bank had not only negative consequences on the government bond prices of Spain and Italy. Stock markets turned negative and plunged after his comments. The euro weakened against the US dollar. In this environment, the safe haven had been the German Bunds and the US Treasury notes and bonds, but not the precious metals. Being regarded currently as risky assets, precious metals turned also lower after the comments from Mr. Knot.

As the eurozone debt crisis is back at centre stage and investors fear a slow-down of global growth, especially after China’s GDP growth came in lower than expected, the markets for precious metals are likely to remain in a sideways trading range. Currently, we see the risk more biased towards the downside. However, should the ECB surprise the markets by buying Spanish and Italian bonds again, also precious metals might move higher again.

Gold at risk of falling below 1600$/oz

Falling stock markets and a stronger US dollar might lead to further losses in precious metal markets. Gold bounced back at the upper end of a support zone last week. However, a renewed attack at the support zone and a fall below 1600$/oz can not be ruled out. In this case, gold would be at risk to visit the low from December last year again.

Two factors were responsible that weak stock markets and an appreciation of the US dollar pulled precious metal prices down last week. First, the FOMC minutes did not contain any hint that the Fed would embark soon on implementing another round of quantitative easing, called QE3. This should not come as a surprise. Even as the CPI is not the favorite inflation gauge of the Fed, but with core CPI inflation at 2.3% and headline inflation at 2.9% in February, some FOMC members are reluctant to increase the balance sheet of the Fed further. In addition, the recent GDP growth of 3.0% in the final quarter of 2011 does not indicate that another stimulus would be needed currently. However, the reaction in the stock and the foreign exchange markets was not rational at all. The Fed policy is expansionary as interest rates will be kept at extremely low levels into late 2014. The strong growth of the US economy should be positive for the stock market. Thus, there is no reason to liquidate stock positions because the Fed is currently not willing to get even more expansionary. However, there is also no reason to buy now US dollars because the Fed Funds rate is extremely low. There is still an incentive to borrow funds in US dollars and to invest abroad or in precious metals given the development of the US CPI inflation and the low opportunity costs for holding gold.

After the release of the US labor market report on Good Friday, the S&P 500 futures plunged further and the 10yr US T-Note future jumped by more than 1.25 percentage points. Instead of 202 thousand, as the consensus of Wall Street economists expected, only 120 thousand new jobs were created in March. However, the unemployment rate declined to 8.2% while the consensus was looking for an unchanged reading of 8.3%. Also the number of jobs created in the previous month had been revised up. The ADP estimate of private sector employment released only a few days earlier pointed to a robust new job creation around 200 thousand. True, the ADP report has not a good track record. Nevertheless, we are also skeptical that the labor market report for March paints the real picture. The numbers of new jobs created are revised up even two months after the first release. Furthermore, seasonal adjustment procedures could lead to distortions as the impact of the weather can not be eliminated completely. Normally, some confirmation for a worsening of the labor market situation would be needed. However, the labor market report could weigh further on the stock market as investors might fear a slow-down of the US economy. Also some hope for QE3 at the next FOMC meeting might revive. Thus, the risk appetite of investors could decline further, which would also be negative for the precious metals.

The second factor is the debt crisis in the eurozone, where the focus has now shifted to Spain. Initially, Spain planed to reduce the budget deficit, which ballooned after the financial crisis of 2007/08, to 4.4% of GDP in this year. However, this intention was based on higher GDP growth forecasts. But due to the Franco-German mismanagement of the debt crisis by Merkel and Sarkozy, GDP growth is not only lower, but Southern European economies face the risk of a recession. The new elected government of Mr, Rajoy took the right measures to reduce the budget deficit, but to the extent necessary to reach the original target for the deficit/GDP ratio. He was warned by the vicious circle of budget cuts and GDP slump in Greece. But bond vigilantes and traders at major investment banks were too dumb to understand this. If a recession is looming, sound macroeconomic policy would not increase the recession risk by implementing more austerity measures. The bond market had doubt that Spain would reduce the deficit/GDP ratio. As Spain sold notes only at the lower end of the target range last week, the bond market panicked and a new flight into safe haven Bunds set in. The case of Spain illustrates perfectly, that what might be sound microeconomic behavior could have devastating impacts on the macroeconomic level. However, also the euro got under pressure against the US dollar and stock markets plunged, which were additional negative factors for precious metals.

Fears of a slow-down of global economic growth and Spain getting into the centre of the debt crisis in the eurozone could be the main factors also for the new trading week. Thus, it could not be ruled out that precious metals remain under some pressure.   

Up and down on Ben

Precious metals remain in a consolidation. Most precious metals managed to end the week slightly higher compared with the preceding weekly close, only palladium ended lower. But they could not defend the gains made at the beginning of the week and pared most of the earlier advance.

The major event for the precious metal markets had been a speech given by Fed chairman Bernanke at the National Association of Business Economists on “Recent Developments in the Labor Markets”. The main message of this speech is that the Fed chairman is not sure whether the improvement of economic growth is already self-sustainable. Therefore, he favors that the Fed will maintain its current course of expansionary monetary policy.

The initial reaction at the stock markets was positive as hopes for QE3 were revived. However, over the course of the week, the doubts of Bernanke turned into a burden for stock markets. We pointed out here that if economists are too pessimistic and economic data comes in better than expected for some time, then economists get more bullish and overestimate the economic figures. The data for the US economy released last week was mixed. However, after the Bernanke speech, the market focused only on the negative surprises. The best example is the durable goods orders data. While the new orders for core capital goods came in better than the consensus of Wall Street economists predicted, the overall new order figure was below consensus. The new orders for core capital goods provides a better picture of the underlying trend as it is not distorted by large ticket orders. Nevertheless, the financial markets focused on the overall figure and got concerned again about global growth.

Bernanke’s speech also gave the euro a lift against the US dollar, which rose again above 1.335. The US dollar index declined again towards 90.0. However unlike the stock markets, the euro and other major currencies defended the gains versus the US dollar and traded sideways. This gave the precious metals some support, but it was not sufficient to compensate the negative impact of stock markets paring gains.

The crucial question remains, what does the Bernanke speech imply for monetary policy? Expecting that the Fed would embark on implementing QE3 would be far too optimistic. As we already pointed out some weeks ago, the best one might expect is that the FOMC will extend “Operation Twist” beyond the scheduled deadline at the end of June. However, operation twist is not quantitative easing in the usual sense of extending the balance sheet of the Fed. With operation twist, the balance sheet of the Fed remains unchanged as short-term Treasuries are sold and longer-term Treasury notes and bonds are bought. Operation twist aims at flattening the yield curve and reducing the level of yields at the medium- to long-term part of the yield curve. After terminating operation twist, the risk is that yields on longer dated US Treasury notes and bonds increase again. Thus, the Fed might decide to extend operation twist with the intention to keep yields on Treasuries fairly stable and thus, that also yields on corporate and mortgage bonds remain stable.

Therefore, from our point of view, financial markets got too excited about US monetary policy getting more expansionary. A significant extension of the Fed balance sheet would require a slow-down of US GDP growth and slower creation of new jobs. However, in this case, also stock markets would head lower. But this scenario would also be negative for the precious metals.