Strange reaction in precious metals markets, better keep the powder try

The US labor market report has the reputation of causing higher volatility in financial and commodity markets. Last Friday, this had been the case again. While it appeared before the release of the non-farm payroll figure and the unemployment rate that precious metals might end the week higher, the labor market report triggered a u-turn and precious metals posted strong losses on the day. Gold and silver closed near the low of the week and lost 2% and 3.75% respectively. Only the PGMs managed to hold quite well in the week over week comparison with palladium even ending slightly higher than the Friday before. However, what is puzzling is the reaction in financial and commodity markets following the release of the US labor market report. Thus, for the time being, we would keep the powder try.

The non-farm payroll figure came in much stronger than expected by Wall Street economists. While the consensus was looking for 123K new jobs, the US economy added 171K persons to the non-farm payrolls. Also the figure for the September was revised up from 114 to 148K and August number was revised to 192K from 142K (already revised higher in the October report from originally reported 96K). The unemployment rate edged up from 7.8 to 7.9%, which was essentially unchanged as the Bureau of Labor Statistics stated in the official release.

Some commodity analysts argue that the drop of precious metals prices is based on expectations the Fed would not provide more liquidity following the strong labor market report. However, those traders selling precious metals based on this argument should read the two recent statements of the FOMC more carefully. At 7.9% the unemployment rate is still far above the target level of the Fed and also far away from a level the FOMC would consider to withdraw further monetary stimuli. Thus, US economy is improving after the weak second quarter and this labor market report provides further evidence. However, it requires a miracle that the US economy would produce so many new jobs that the Fed would terminate QE3 anytime soon. Nevertheless, it is a widespread misperception that precious metals would require further liquidity injections to move higher.

We pointed out several times that precious metals trade in line with other risky assets and therefore, the risk aversion of investors is crucial for the price movements. The reaction in markets for risky assets following the release of the US labor market report was very strange. Initially, stock index futures rallied. But only shortly after Wall Street opened, the market turned direction and closed down around 1% lower on the day. Position liquidations were not limited to stocks, but spread also to other commodities. Crude oil, another major fundamental factor for the price of precious metals, plunged by more than 2.6% on the day. As the labor market surprised strongly on the upside, the selling pressure across the markets for risky assets could not be attributed to the buy the rumor and sell the fact behavior of some traders and investors.

Some commentators argued that financial markets would now price in a victory of incumbent US president Obama at the election next Tuesday. Furthermore, they stated that Wall Street would regard a victory of president Obama as positive for safe haven Treasury paper while a victory of Mr. Romney would be positive for stocks. However, the weakness of this argument is that opinion polls showed for some time already that president Obama would win at least the Electoral College votes, even before hurricane Sandy hit the northern parts of the US East coast. Thus, it appears as really strange that investors start to price in a re-election of US president Obama just a bit more than one hour after the release of the US labor market report, which normally should have lifted stocks and commodities higher.

The sentiment of large speculators for commodities has definitively changed during the month of October. We pointed out that the sentiment worsened with the earnings reporting season as many companies provided a very cautious economic outlook. Some commentators also pointed to window dressing operations by hedge funds as for many managers the business year ends with the October ultimo. The recent CFTC report on the commitment of traders shows that the net-long position of non-commercials dropped further in the week ending October 30 to 170,222 from 182,043 in the preceding week. This would be fully compatible with window dressing operations. However, the massive position liquidations on Friday and the flight into safe haven assets can not be explained any longer as window dressing.

So far, we regarded the correction of precious metals more as a buying opportunity as the fundamental economic data surprised on the upside. Economic data of the two major economies is still better than economists predicted. However, the reaction of various markets for risky assets last Friday indicates that something is wrong when markets do not react positive on good news. Maybe markets react again normally after the Presidential Election next Tuesday. Until the markets show again normal reaction, we would keep the powder try.