Precious metals expected to perform positive in Q4

Precious metals are still in consolidation but held quite well during the past trading week. This is a positive indication given the fact that the debt crisis in the eurozone is back in the spotlight and fears over economic growth had a negative impact on the main fundamental drivers of precious metal prices. Thus, the chances are still good for a positive final quarter in the precious metals market.

In this blog, we pointed out several times that precious metals perform better when the risk appetite of investors increase and that a flight into the safe havens of government bonds is a burden for metal prices. This has been the case again last week. There were two factors, which caused a rise of investors’ risk aversion around the middle of the week. Both were not rational.

The German ifo-index surprised with another decline while the consensus among economists predicted an increase after the ECB presented the details of the OMT program for purchasing government bonds in the secondary market and the German constitutional court paved the way for the ratification of the treaty to create the EMS. However, the recession in many countries of the eurozone had a negative impact on the assessment of the current business conditions and the expectations for future developments. This initially weighed on stock markets. However, on Tuesday, the S&P 500 index pared the loss of the previous day and was also trading above the close of the previous week when suddenly the risk aversion of investors rose again. The triggers were two statements. First, asset management company Blackrock stated that the rally in the US stock market were over. This prediction of one of the biggest funds managers already led to some profit taking. However, more devastating was the statement by Philly Fed president Charles Plosser that he voted against QE3 because it would be ineffective and would lead to inflation.

The market reaction on the comments by FOMC dissenting voting member Plosser is another demonstration that the Chicago School theory of rational financial markets is falsified by the reality. Animal spirits, as first described by John Maynard Keynes, also play a major role in financial and commodity markets. Traders and investors in the stock market did not recognize the contradiction of Mr. Plosser’s comment. First, if Mr. Plosser were right that QE3 would not stimulate economic growth then the US GDP would grow further below output potential. In this case, production capacities and the labor force would not be fully utilized. Even if the unemployment rate and the capacity utilization rate would stagnate then there would be no risk of rising inflation, quite the opposite! However, if QE3 were leading to rising inflation rates then GDP growth would have to accelerate, capacity utilization would have to reach full employment levels and the unemployment rate would have to fall quickly towards the natural rate of unemployment. Thus, a rise of inflation rates would require that QE3 is highly effective in reaching the target of the FOMC. Furthermore, at the Jackson Hole seminar in late August, Fed chairman Bernanke presented sufficient empirical evidence that QE I and II were already working and contributed to stronger GDP growth compared to a situation without quantitative easing. Therefore, markets reacted irrationally on the Plosser comments and acted more according to the shoot first and ask later behavior.

Also irrational was the reaction of markets on the protests against austerity measures in Spain and Greece, which partly turned violent. Even a failure of Germany in an auction of 10yr Bunds and a successful auction of Spanish government paper could not prevent a flight into the safe haven of Bunds and US Treasuries combined with weaker stock markets. However, governments in Western democracies don’t bow to pressure of demonstrations. Investors are wrong to compare the situation with upheavals in Arabian countries. The Spanish government passed the 2013 budget with the required austerity measures, which are mainly spending cuts, on Thursday. This led to some relief among investors and the euro recovered against the US dollar. Also the result of the stress tests of Spanish banks did not bring negative surprises, which calmed further the nerves of jittery investors.

The Fed is likely to be successful again with QE3. Thus, we expect US GDP growth to pick up again. Also Spain will ask for a rescue by the EFSF/ESM sooner or later, which will also trigger buying of Spanish government bonds with maturities of up to 3 years by the ECB. Furthermore, also China is expected to take measures to stimulate GDP growth. This all should be positive for the major fundamental drivers of precious metal prices. Therefore, we expect that precious metals to perform also positively in the final quarter of this year.