Regime shift in precious metals markets

It was a mixed week for precious metals, with gold ending almost unchanged and platinum was the only metal posting a stronger gain, while silver and platinum closed lower in the weekly comparison. While gold and silver followed more the movements of the safe haven government bonds of the US Treasury and the German Bunds since the start of the year, the US dollar became the dominating factor after the ECB meeting. However, the reasons, which first led to a rise of precious metals and then triggered a drop on Thursday, are not based on a sound analysis. It is more following the herd instincts like lemmings.

At the start of the week, it was reports about political developments in Italy and Spain, which pushed German Bunds and US Treasuries higher. This also had a positive impact on precious metals. In Italy, the former PM Berlusconi is still lagging in polls behind the centre/left. However, he gained in popularity and reduced the lead of the centre/left to just 4 percentage points according to latest polls. But it is still not sufficient to form a new government. The centre/left under Mr. Bersani could form a coalition government with incumbent PM Mr. Mario Monti. Nevertheless, investors are worried that Mr. Berlusconi could become the next PM again. His promises made in election campaigns would be a clear end of the austerity policy. And this would also imply that Italy would not qualify for the ECB’s OMT program, which was the major factor for falling yields on Italian government bonds. However, analyzing past election campaigns of Mr. Berlusconi, analysts and investors should know that his campaigns are based on his media empire and populist promises. Mr. Berlusconi has to fight again for political survival to prevent from being sentenced to jail. But unlike in the past, the Italian industry association is not remaining silent but voices opposition to a return of Mr. Berlusconi to power. Thus, markets should have priced in that Mr. Berlusconi would catch-up in opinion polls.

The former treasurer of the leading Spanish Popular Party, Mr. Barcenas is subject of criminal investigations for some weeks already. On request from Spain for official aid, Swiss authorities found a bank account of Mr. Barcenas with a deposit of 22mn euro. One Spanish paper, El Mundo, reported that Mr. Barcenas delivered various leading members of the Popular Party cash in letters, but did not provide any proof. At the end of last week, another Spanish news paper, El Pais, published handwritten accounting notes, which link payments also to Spanish PM Mr. Rajoy.

As the Spanish opposition parties called for the resignation of Mr. Rajoy, many analysts and traders believed that the Spanish PM would have to resign. This demonstrates again the lack of political understanding among analysts. The opposition can not oust the incumbent PM. In the Spanish parliament, the Popular Party has a vast majority and it is rather unlikely that they force Mr. Rajoy to step down. Also snap elections are therefore not very probable. Fears among analysts and traders that a change of the government, which is not a likely scenario, would lead to an end of the austerity policy are also not rational. Markets have forgotten that it was the socialist government under Mr Rajoy’s predecessor, which included the obligation to balance the budget in the constitution even before this became part of the eurozone stability pact. Thus, the flight to the German Bunds and into the precious metals was not based on a sound rational analysis but driven only by fear.

On Thursday, the safe haven government bonds rallied, but the precious metals did not follow. Quite the opposite, they were pulled down by a weaker euro against the US dollar. The trigger was the reply of ECB president Draghi on a question about the euro exchange rate. However, markets did more react on what they wanted to hear than what Mr. Draghi actually said. First, Mr. Draghi pointed out that the ECB has no exchange rate target. This should be well understood by analysts and traders as the ECB emphasized again and again that its sole task is to maintain price stability. Second, Mr. Draghi attributed the recent appreciation of the euro as a result of confidence in the euro returning. As the fall of the euro against major currencies last year was based on fears of the euro falling apart, the fight of the ECB to do everything necessary to keep the euro intact would lead to a strengthening of the single currency. The ECB must have taken this into account and it was also welcome to reduce the inflation rate again towards the target.

Third, Mr. Draghi pointed out the the ECB council would have to observe the further development to assess whether the euro strength is only temporary or permanent and whether it would have an influence on its target. This was a more academic statement. Of course, the development of the euro must have a negative impact on the ECB’s target of price stability to trigger any policy action. So far, the strength of the euro is welcome, as it helps to reduce inflation. Only if a permanent appreciation of the euro would lead to inflation falling to dangerously low levels, the ECB would see a necessity for policy action. However, the markets took this as a signal for a further rate cut. The traders and analysts completely overlooked that Mr. Draghi emphasized several times that the current ECB interest rate policy is very accommodative. The ECB still expects that the Eurozone economy will pick up steam in the second half of this year. Thus, we would not rule out another rate cut if the economy situation worsens considerably. However, at present, another rate cut is not a very likely scenario.

           

Further speculation on a rate cut by the ECB to weaken the euro might prevail in the short run. However, as the ECB is likely to keep rates on hold, traders who sold the euro might have to buy back. The political development in Spain and Italy might be supportive for the precious metals. Thus, further range trading of gold and silver is the most likely scenario. Platinum and palladium are expected to perform still better than gold and silver. But some profit taking can not be ruled out.