Rising volatility of gold

Most precious metals ended the week lower despite favorable fundamentals. What has been remarkable is the rise of volatility. After starting the month of June with a trading range of more than 80$/oz, gold consolidated. However, at the end of this week, gold traded on two consecutive days in a trading range of 30$/oz or more. With the events ahead, especially the election in Greece and France next Sunday as well as the bailout of Spain, the volatility is likely to remain elevated.

After several weeks of falling stock markets and crude oil prices as well as of a stronger US dollar, a countermove took place last week. The US dollar index declined while the S&P 500 index posted a gain and crude oil (WTI) ended the week slightly higher. This environment was initially positive for precious metals. Gold had to digest the strong advance of the first trading day in June, but managed to reach a higher high compared to the preceding week. However, three factors led to an increased volatility and they all are related to banks. Two central banks had been perceived as being negative for precious metals, while news of an EU finance minister phone conference on a bailout of the Spanish banking crisis caused a recovery later on Friday.

China’s central bank had already reduced the reserve requirements, which banks have to hold. Last week on Thursday, the People’s Bank of China cut the key interest rates by 25 basis points. The initial reaction in stock and commodity markets had been positive. However, the sentiment changed on Friday with the start of trading in Asia. Normally, if an economy slows down it is only a question of time that the central bank starts to ease the stance of monetary policy. The PBoC made the first step by reducing the reserve requirements. Therefore, cutting the key interest rates is only a natural follow-up action. Rate cuts are normally seen as positive and this was the initial reaction in European and the US markets. However, Asian investors and traders got scared by the move of the PBoC. They assume that the Chinese central bank has superior knowledge about the state of the Chinese economy and interpreted the rate cut as an indication for a stronger slow-down of GDP growth than the markets had already priced in. But this assumption is not well founded. Monetary policy is based on forecasts and the forecasts of government institutions are not superior compared to those from the private sector. Nevertheless, after the first rate cut since 2008 took place; the PBoC is likely to cut rates further in due time and eventually GDP growth will accelerate again in China. This should be supportive for precious as well as for base metals in the medium-term.

The reason for the spike of gold on June 1^st was the weak labor market report making further quantitative easing measures by the Fed more likely. Also statements from some FOMC members made during this week pointed in this direction. However, the expectations some traders and investors had about the testimony of Fed chairman Bernanke were just absurd and irrational. The Congress is not the place where the Fed chairman announces monetary policy measures. Decisions are made by the FOMC and are communicated by the FOMC statements. Furthermore, the Fed is an independent central bank. Informing the public during a Congress testimony could easily create the impression that the Fed decision was taken on political pressure. Therefore, the fact that Ben Bernanke just repeated the language of the official FOMC statement that the Fed would be ready to act if needed is by no means an indication that further steps of quantitative easing would be off the table. The likelihood for QE3 or an extension of “operation twist” beyond the scheduled termination at the end of this month has not changed by the testimony of the Fed chairman. Only financial markets reacted irrationally. The implication for precious metals prices is that speculations of further Fed easing measures are likely to re-emerge, which would be positive for gold in particular but also for the other precious metals.

At a phone conference on Saturday, the EU finance ministers agreed to provide up to 100bn euro help for the Spanish banking system. However, there are still some open questions. First, Spain has not yet asked the EU officially for help as it only declared its intention to ask for assistance. The Spanish government has also not specified how much financial aid it would not for its banking system. The government waits for two independent audit surveys, which should be presented some time before June 21. Thus, the risk prevails that financial markets speculate that he amount of 100bn euro would be insufficient to stabilize the Spanish banking system. Second, it is also open which EU facility would provide the funds. In the case the EFSF would have to lend the money, Finland will demand that Spain provides collateral (as Finland also insisted in other EFSF bailouts). The preference among the EU finance ministers is that the EMS should provide the funds. However, this requires that the ESM treaty is ratified right in time and that the EMS could start operations as scheduled on July 1. If financial markets welcome the agreement of the EU finance ministers, precious metals might profit from a recovery of the euro against the US dollar and of stock markets. However, if financial markets regard the agreement as disappointing, gold might be heading down again.

Another risk factor for precious metals is the general election in Greece taking place next Sunday on June 17. Opinion polls released during this week, could have a significant positive or negative impact on precious metals prices, depending on which party is leading in the polls. But as it is probably a close race between the conservative New Democracy party, which backs the austerity policy, and the radical left-wing Syriza party, which rejects the austerity policy. Thus, volatility in the gold market is likely to remain high during the coming trading week.