US labor market report not strong enough to justify losses of precious metals

Until Friday noon (GMT), all precious metals were up compared to the close of the week before. However, after the release of the US labor market report, precious metals came under pressure. Gold and silver erased the gains made since the start of the week and posted another weekly loss. The PGMs, however, managed to close higher.

We pointed out several times that the major fundamental factors explaining the movements of the precious metals in various quantitative models are the US dollar index, the S&P 500 index as a proxy for economic activity and the price of WTI crude oil as the oil price is one of the major factor for the direction of CPI inflation. These three factors had been positive for precious metals even after the release of the US labor market report with the exemption of the US dollar index, which pared some of the losses suffered earlier last week.

Since the Bernanke testimony to the Joint Economic Committee, the US stock market consolidated as many investors and traders feared that the FOMC could soon reduce the volume of monthly bond purchases. The US labor market report had been regarded as crucial for the FOMC whether to maintain or reduce the magnitude of QE.

From our point of view, the June labor market report is most likely not tipping the balance towards scaling back the bond buying program. The number of additions to the non-farm payroll at 175 thousand was only marginally above the consensus forecast. However, the figure for the month of April was revised down from 165 to 149 thousand new jobs. Lately, the revisions were to the upside.  Thus, on balance fewer jobs than expected had been created. Furthermore, the unemployment rate edged up to 7.6% whereas the consensus among Wall Street economists was looking for an unchanged rate of 7.5%. All in all, this labor market report indicates that economic growth in the US is solid and robust but not strong enough to induce enough members of the FOMC to vote for a reduction of monthly bond purchases.

As the major fear in the US stock market has been the possibility that the Fed might remove the punch bowl, the reaction following the release of the labor market report is logical. Also the rise of crude oil price makes sense as a continued Fed stimulus should be positive for the demand for crude oil. However, the foreign exchange market appears to have come to a different conclusion. A strengthening of the US dollar against the Japanese Yen and the euro following the labor market report only makes sense, if it is interpreted as strong enough to tip the balance towards reducing QE at one of the next FOMC meetings. Also the reaction in the US bond market was very volatile. Obviously, some algo-traders had the report a few seconds before the official release time. Thus, the US 10yr T-note future dropped ahead of the release, but traded up to the high of the day within the first 5 minutes after the official release time. But during the trading day, the market turned around and the yield on the 10yr US T-note rose to 2.16%

Also many gold market analysts argued that reducing the volume of QE by the FOMC would be negative for gold. Thus, the market reaction last Friday indicates that the labor market report was interpreted in the precious metals market as strong enough to induce a sufficient number of FOMC members to vote for cutting the volume of bond purchases.

Some analysts might argue that the rise of the S&P 500 index on Friday by 1.3% was the result of shifts in asset allocation where stocks profited from moves out of US Treasury paper. However, before the release of the US labor market report, it had been argued that a shift in the Fed policy would be negative for stocks and bonds. If this argument were correct, it would not make any sense to allocate now funds out of US Treasuries and precious metals into stocks. Furthermore, it could not explain the price increases in the energy market. Thus, the implication of the June US labor market report for the Fed policy and the volume of QE had been interpreted differently in the various markets. Gold and silver were in the pessimistic camp. However, this might be wrong one as this report is most likely not tipping the balance.