Return of investors’ risk aversion weighs on precious metals

The increased risk appetite, which set in after the EU summit, did not last long. After only a few days, the risk aversion of investors returned again. At least during the first half of the next trading week, there is no major economic data release scheduled. This might provide some support for precious metals. Nevertheless, several central bankers will hold speeches, which could move the markets. In addition, the release of the FOMC minutes on Wednesday could move precious metal markets, depending on how close the FOMC is on embarking on QE3.

After consolidating the gains made on the last trading day in June, precious metals rose on Tuesday on speculation of further monetary stimulus by major central banks. However, as various central banks eased monetary policy, precious metals turned negative. But this was not just a typical “buy the rumor and sell the fact” behavior of traders. It reflects more an irrational behavior. The smallest impact probably had the decision by the Bank of England to implement another quantitative easing round by buying 50bn GPB of UK Treasury paper.

The People’s Bank of China lowered interest rates for the second time within four weeks. The lending rate has been lowered by 31bp to 6% and the deposit rate by 25bp to 3%. After the first rate cut, one should have expected that more steps will follow. The market was surprised by the quick next step, but the PBoC does not react as slowly as the ECB. Normally, financial markets had been forward looking. Two rate cuts within a short period of time had been regarded as positive. The central bank was considered to be determined to improve growth prospects. Traders and investors normally bought risky assets as the economic outlook was expected to brighten. However, traders and investors panicked and interpreted the rate cut as an indication the PBoC would expect a much steeper slow-down of economic activity. But what those jittery traders ignore is the fact that China’s official PMI just dipped below the 50 level. Thus, the PBoC reacted in a timely manner to stimulate the economy again.

The 25bp rate cut by the ECB had been widely expected, at least by the economists polled for the various consensus figures published by the media. Some economists as members of shadow committees of some financial news papers even recommended a 50bp rate cut, but were obviously not convinced the ECB would make such a strong move. After the release of the ECB rate cut, markets traded lower, but during the ECB press conference another major push lower set in. Media reports quoting traders provided several reasons for the sell off. One can divide them into two broad categories, irrational expectations or bad communication skills of Mario Draghi, the ECB president.

With the decision to lower the ECB main refinancing rate by 25bp to a new historic low of 0.75%, the ECB also reduced the deposit rate and the rate for the marginal lending facility by 25bp each to 0.0% and 1.5% respectively. This is the traditional behavior of the ECB that all three key interest rates move in line. However, financial markets were surprised by the cut of the deposit rate. They sold risky assets and bought safe haven German Bunds. This clearly is a case of irrational expectations and behavior as the ECB just did what it normally does when cutting or hiking rates. If markets were efficient as academic theory (especially from the Chicago school) pretends, then this should have already been priced in.

Furthermore, after the EU summit and the comments of Mario Draghi on the results of the summit, some market participants expected the ECB to take bolder steps than only cutting the key interest rates by 25bp. Some traders expected the ECB would announce another LTRO (long-term refinancing operation) with a maturity of maybe even more than 3 years. Others speculated the ECB might start buying again government bonds from Spain and Italy in the secondary market. However, Mr. Draghi did not provide any hint that one of these two instruments might be used again in the near future. Netherland’s central bank governor Knot even ruled out that the ECB would ever buy again government bonds in the secondary market. However, one has to keep in mind the June press conference of the ECB, where Mr. Draghi already stated that the ECB has done enough and it would be now up to the politicians to do their homework. Thus, it was also irrational to expect more than cutting rates from the ECB.

At the introductory remarks, Mr, Draghi stated “… economic growth in the euro area continues to remain weak, with heightened uncertainty weighing on confidence and sentiment.”  Furthermore, he added “The risks surrounding the economic outlook for the euro area continue to be on the downside. They relate, in particular, to a renewed increase in the tensions in several euro area financial markets and their potential spillover to the euro area real economy.” These remarks of the ECB increased the already high nervousness of financial markets. Risky assets were sold off. Yields on 10yr Spanish government bonds rose from below 6.5% below the ECB rate decision and press conference to more than 7.0% within 24 hours. Also yields on Italian government bonds rose, albeit less than those on Spanish paper. This rise of yields in peripheral eurozone bond markets is the result of spooking investors and traders by the ECB.

But not only risk aversion in bond markets intensified. The euro already pared gains make on the final trading day in June against the US dollar. However, after the ECB press conference, the euro got hammered and lost another 2.5 cents and fell even below the low reached at the start of June. The US dollar index gained 2.15% on the week.

Beside central banks, also some negative surprises from economic data releases played a role. The US manufacturing ISM index dropped below the 50 threshold and also the service sector ISM index declined strongly, but remained above the 50 mark. The ADP private sector payrolls estimate surprised on the upside. Thus, economists and traders revised their estimate for the non-farm payroll report higher. However, the labor market report disappointed with only 80k new jobs created instead of estimated 100k. The unemployment rate remained unchanged. But this report was not as bad as the previous one. The number of additions to the payroll was higher than the month before, which had been revised up to 77K from 69K. Average hourly earnings increased by 0.3%, which was stronger than expected and also the figure for the preceding month was revised from 0.1% to 0.2%. Also the average hourly workweek increased in June. Thus, the report still points to further growth of the US economy, but only at a modest pace. Nevertheless, stock markets dropped further and other risky assets were also sold. Precious metals could not escape the increased risk aversion of investors.

Uncertainty about the economic outlook might weigh further on the euro and stock markets. This would be negative for precious metals too. However, as there is no major economic data release scheduled for the first part of the new trading week, risky assets including the precious metals might stabilize. Nevertheless, there is one event scheduled for Tuesday, whose result is unpredictable. The German constitutional court will decide about the laws concerning the ESM and the fiscal stability pact. The ruling could push markets strongly in either direction.