Testing support – gold and silver likely to follow the PGMs

All precious metals test support at the lows of the preceding week. While gold and silver managed to rebound, the platinum group metals made new lows on the current downward move. On Friday, all four metals recovered but closed lower in the weekly comparison. This recovery is probably more the result of position squaring ahead of the longer weekend with a holiday on Monday in the US and some European countries. The main factors, which pulled precious metals and other commodities lower, are still in place. Therefore, also gold and silver might break through technical support.

The US stock market was a supporting factor this week for precious metals. Several times, the S&P 500 index managed to pare losses in the afternoon. Furthermore, the S&P 500 index ended the week higher. Nevertheless, this was not sufficient to push precious metals higher. The negative impact of a stronger US dollar more than compensated the support from the US stock market. Especially the euro weakened further against the US dollar. While the euro fell to a 22 months low against the US dollar, precious metals prices recovered. However, this diverging development could be more attributed to closing short positions by hedge funds ahead of the weekend. But one has to notice that also the decline of the net long positions in Comex gold futures held by large speculators came to a halt. In the week ending May 22, the non-commercials increased the net long position by around 1,000 contracts to 115,151 contracts. Also holdings in the SPDR Gold Trust ETF increased again slightly at the end of the week, following a bigger drop earlier last week.

Nevertheless, we remain skeptical that precious metals have already found a bottom and will trade higher. The factors weighing on the euro are still in place. Thus, a further strengthening of the US dollar has to be expected, which would probably push precious metal prices lower.

The first factor is of course the situation in Greece and the fear of Greece leaving the euro. We have already pointed out earlier that the EU treaty has no provision for exiting the single currency. Thus, other eurozone member countries can not kick Greece out of the euro. Only Greece can decide to leave the euro, but this could imply that Greece would have to leave the EU too in this case. Thus, not even the radical left-wing party Syriza intends to re-introduce the Drachma. Nevertheless, some politicians still voice in public the demand to force Greece out of the euro. In addition, the more members of various governments in the eurozone, the EU administration or central banks of the ECB system talk about a Plan B for the case of a Greek exit, the more financial markets regard this case as the most likely scenario. Each statement about a possible Greek exit sent the euro lower versus the US dollar. It can not be expected that politicians or civil servants in EU institutions will keep their mouth shut. Thus, the euro might weaken further until the Greece elections taking place on June 17.

The second factor is the situation in Spain and its banking sector. Last Friday, the autonomous province of Catalonia sent a plea to the central government for financial help. As capital markets currently do not work properly, the government of Catalonia could not obtain funds. If the central government will borrow funds in capital markets and hand the means to the regional governments, the total public sector deficit would not be affected. Nevertheless, as the plea was made public, already jittery investors sold the euro, European stock markets turned negative and Spanish as well as Italian government bonds gave back their gains and yields rose again. The flight to save havens sent yields on German Bunds to record lows. Also the precious metals traded lower before rising later on position squaring. Thus, beside the capitalization of Spanish banks and the write-offs on mortgage loans, the funding of Spanish regional governments is another concern, which might weaken the euro further.

As long as the euro has not found a bottom against the US dollar, the risk for precious metal prices remains to be biased to the down-side. Support for gold and silver, which has held so far, might give way to lower prices at the next test. However, in the case that support should hold on a third attack, the odds would increase that gold and silver might rebound significantly.     

Rebound could be only a dead cat bounce

Last week, we wrote that precious metals might rebound. And indeed, precious metals came back. Gold and palladium even closed higher than at the previous Friday. Silver and platinum pared most of the losses suffered earlier last week. Thus, one might argue that the forecast was right. However, it was right for the wrong reason. Therefore, while the recovery of precious metal prices had been strong, it might be short-lived. The risk to the downside is still considerable.

The conclusion that precious metals might rebound was based on political factors. At the time of writing the previous article, news agencies reported that Greece had found a new government after the first round of talks with Greek president Popoulias took place. In this case, a recovery of the euro versus the US dollar was likely. Also stock markets were probably moving higher paring some of the losses occurred during the preceding week. These were favorable factors for the precious metal markets. However, the reports of forming a new government in Greece were based on a statement by the left-wing party leader, Mr. Tsipras, which turned out to be a lie and defamation of other parties.

Even the negotiations of Greek president Popoulias to form a new government failed. Greece is now governed by a care-taker administration and a snap election will be held on June 17. During this period, financial and commodity markets are likely to remain jittery about the result of this election. Unfortunately, statements by politicians of other eurozone countries, the EU and ECB council members increase the nervousness among investors and traders. Reports about preparing for an euro exit of Greece are counterproductive.

There were reports in the media, that eurozone finance ministers threatened to kick Greece out of the eurozone. Those who insist that Greece has to fulfill the treaties want to breach the Lisbon Treaty! There are no provisions in the treaty to leave the euro and other finance ministers can not expel Greece out of the euro. Only Greece can decide to leave the euro, but this would also imply to leave the EU. According to latest polls, roughly 80% of the Greek population wants to keep the euro.

Also statements from media reporters and strategists or investment fund managers that Greek has to leave the eurozone are not correct, even if repeated several times within one hour at TV stations like CNBC or Bloomberg.

But not only Greece, also Spain remains in the spotlight. The downgrade of 16 Spanish banks by Moody’s increases the fears that the Spanish government would have to increase the deficit in order to bail out banks suffering under declining real estate prices. This also weighs on the euro versus other major currencies.

The rebound of precious metals set in after the release of the latest FOMC minutes. The sentence “Several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough” was interpreted as an indication the Fed would embark on QE3. However, the crucial part of this sentence is the if-clause. The recent US economic data does not indicate that the requirements for additional monetary policy accommodation are fulfilled. We pointed out that the Easter holiday might have an impact on monthly data, which had been distorted even more by the seasonal adjustment factors. The latest initial jobless claims are stable and do not indicate a worsening of the labor market situation.

Thus, the recovery of precious metal prices based on hopes for more monetary easing in the US might be short-lived. The worries about a potential Greek bankruptcy prevail until the election on June 17 or even beyond that date depending on the election result. The downside risk remains considerable. Those, who want to enter long positions, are recommended to buy some downside protection also.

Precious metals knocked down by European politics

In the boxing sport, there is a famous adage saying “they never come back”. Precious metals had to take a hit by European politics and where knocked down. However, unlike a boxer being counted out, the precious metals might already come back this week. The reason for the recovery might be again political developments in Europe. But it all depends on success or failure to built a new government in Greece.

Two elections on Sunday May 6 were the trigger for a significant fall of precious metal prices. In France, a new president had been elected and Greece voted for a new parliament. In France, the candidate of the Socialist Party, Mr. Hollande, did win the presidential election and will be inaugurated next Tuesday, May 15. The opinion polls indicated already that incumbent president Sarkozy would be defeated by a wide margin. Thus, the victory of Mr. Hollande should not have come as a surprise and should have already been discounted in financial and commodity markets. Nevertheless, market participants - especially in Asia - were worried that the victory of Mr. Hollande would imply an end of austerity policy in the eurozone. From our point of view, these fears are overdone. The new French president is still committed to balance the budget, however, over just one year more than currently scheduled. During the election campaign, Mr. Hollande insisted that the fiscal compact should be enhanced by a pact to promote also growth in the eurozone. This demand should not worry investors. The austerity policy prevailing in many countries of the eurozone leads to recession. Therefore, measures would have to be taken to stimulate growth. The next EU summit in June will also have a growth initiative on the agenda. Thus, political positions of Mr. Hollande are not endangering the policy of reducing budget deficits. Quite the opposite, measures to promote growth could prevent a vicious circle that had been observed during the Great Depression in the 1930^th.

A stronger impact on precious metals had the result of the general election in Greece. The main winners were parties at the far right and far left wing, all opposing the austerity policy which the two parties supporting the government of Lucas Papademos agreed with the troika of EU, IMF and ECB. These two parties were punished by the voters. The leader of the conservative New Democracy party, Mr. Samaras insisted on early elections. He speculated to win the election and to become the next prime minister. However, his speculation failed miserably. His party gained the most votes, but it was not sufficient to form a new government. The radical left party Syriza, which opposes the austerity measures agreed with the troika, became second strongest party in the parliament. Failures to form a new government supporting the membership of Greece in the eurozone and the austerity measures had a negative impact on the EUR/USD exchange rate. The weaker euro pulled precious metals lower.

The pressure on the euro resulted to some extend also from calls of some politicians that Greece should leave the eurozone. Also analysts and strategists, media reports and traders often state that Greece would have to quit the euro. However, whether Greece is going to stay in the euro or going to leave the single currency is only up to Greece. According to the EU treaties, there is no provision for leaving the euro. Thus, neither Germany nor Luxembourg’s foreign minister can kick Greece out of the euro. According to latest opinion polls, 78% of the Greek population favors to stay in the eurozone.

At the time of writing this article, there is some confusion about the state of the final round of negotiations to form a new government. Greek president Papoulias had a first meeting with the leaders of the three main parties after last Sunday’s election. This meeting lasted for 90 minutes. After the meeting, the leader of the radical left party Syriza stated that three other parties would form a government, which has a majority of 168 from 300 seats in parliament. However, this has not been confirmed by the parties involved, the New Democracy, Pasok and the democratic left (Dimar). The leader of the New Democracy stated after the meeting with president Papoulias that negotiations would still go on. President Papoulias will also meet the leaders of the smaller parties today.

The major hurdle is the demand of Dimar that also Syriza should be part of a coalition government. If president Papoulias could remove this hurdle in the talks with the smaller parties, Greece would probably get a new government. If this stumbling block is insurmountable, then Greece is likely to hold another election on either June 10 or 17. The president has a few days left for the negotiations but a new government has to be built before the parliament session opens on May 17. If Greece will get a new government - either today or within the next few days - then this is probably positive for the euro, and therefore, also for precious metals. However, a failure to form a Greek government is most likely negative for the euro and thus also for precious metals.    

Eurozone and US labor market weigh on precious metals

All precious metals ended the week lower compared with the preceding week. After a positive start into the new trading week, the beginning of May turned out to be a turning point for precious metals as they reached the high of the week. However, the major pressure set in the following day and again, it was the eurozone causing the reversal in many financial and commodity markets.

At the first trading day of a new month, markets are focused on the release of purchasing managers indices in the manufacturing sector for various economies. As many countries in the eurozone celebrated the Labor Day on May 1^st, the eurozone manufacturing PMI had been released the next day. In the US, the ISM manufacturing PMI posted a surprising increase, also the employment component increased. This had initially a positive impact on stock markets and also commodities. Also most precious metals reached the high of the week after the release of the ISM index. However, as the major fundamental drivers pared gains, precious metals also gave back a part of the advance.

The turning point has been the release of manufacturing PMIs in the eurozone. There is a widespread believe among investors and fund managers that factors, which are already discounted would not have an impact any longer. The events of Wednesday May 2^nd tell a complete different story. Markit, the company compiling many of the purchasing managers for various countries, released flash estimates for the major economies of the eurozone and for the eurozone already on April 23^rd. They already disappointed and came in far lower. As already the PMI in France and Germany as well as the in eurozone declined, one would have expected that also the Italian PMI would post a strong fall. However, the consensus of economists still overestimated the Italian PMI. Nevertheless, the market should have already discounted a negative surprise for further eurozone countries. The overall eurozone PMI had been revised down 45.9 from 46.0 in the flash estimate. Normally, a revision of 0.1 points is always within the margin of error. Nevertheless, if markets were rational and information efficient and do not react on information being already discounted, then they would not have reacted so strongly and negatively as they did on Wednesday.

Another negative factor had been US labor market data and again, markets showed a selection bias focusing more on negative figures and ignoring better more recent data. We have already pointed out several times that moveable holidays, like Easter, have an impact on the seasonal pattern of a time series. However, the seasonal adjustment procedures could even increase the distortions instead of smoothing them. The ADP estimate of private payrolls came in lower than expected, which intensified already the fall triggered by the PMI in the eurozone. However, the ADP estimate has only a very poor tracking record. Also on Friday, the non-farm payrolls came in lower than the consensus of Wall Street economists predicted. Both figures include the impact of the Easter holiday season and thus, should be taken with some care. But, it was the major focus of financial and commodity markets.

The initial jobless claims posted a strong decline from 392K to 365K. This indicates that once the impact of the Easter holidays is out of the statistics, the underlying trend in the labor market remains positive. Furthermore, the non-farm payroll figures for the two preceding months have been revised up. Normally, financial and commodity markets have taken the revisions into account. What is relevant is the number of non-farm payrolls. If the basis of the calculation for the change in non-farm payrolls is revised, these revisions play a crucial role. If the estimated change of non-farm payrolls is missed, but preceding months non-farm payrolls (the level) are revised up, then the number of non-farm payrolls implied by the estimate of the change in non-farm payrolls might still be reached or could even be exceeded. In the case of the May US labor market report, the change of the non-farm payrolls plus the revisions of the two preceding months came close to the latest consensus call of 170K. From our point of view, this is not a reason for such a negative reaction in stock and commodity markets. Furthermore, the unemployment rate declined further to 8.1%. One should not forget that the Fed’s second target is the rate of unemployment, not the non-farm payroll change. Some commentators argue that the decline of the unemployment rate was only due to people leaving the work force according to the household survey. However, as the baby boomers are going to retire, they also leave the work force. Thus, higher numbers of people leaving the work force due to retirement compared to the situation some years ago have to be expected.

However, what was striking has been the reaction of the precious metals on Friday after the release of the US labor market report. While during the two days before, all precious metals declined, gold and silver rebounded and managed to close even above the opening price (according to data from ThomsonReuters). On the other hand, the PGMs continued to trade lower and ended the session near the low of the day. The major fundamental drivers of gold and silver were negative, thus, one would have expected also a negative day for gold and silver. One explanation for this move might be the elections taking place in the eurozone. Greece is electing a new parliament and some observers fear that a party might win the majority, which favors an euro exit. Also France is electing a new president. The ballots are still open at the time of writing this article. However, in France, it should be now widely discounted that incumbent president Sarkozy is going to be defeated by the candidate from the Socialist Party, Mr. Hollande. In Greece, the potential for a surprising election result is bigger. However, the polls still saw the most likely case that the next government would be again a coalition of the parties supporting the current government of former ECB vice-president Luca Papademos. But as had been seen, what should already be discounted could nevertheless have an impact on metals prices.

The selective bias of financial markets, reacting stronger on data pointing to slower growth than on positive economic figures, the weakness in the major fundamental drivers for precious metals, as well as the flight into the “perceived” safe havens of US Treasury notes and German Bunds, this all indicates that the risk for precious metals is still biased to the downside.