Central Banks and Economic Data might weigh on Precious Metals

Gold rose further this past week and reached a high at 1,347$/oz. However, it seems that the rise was not driven primarily by the movement of the gold forward rates or the gold lease rates. The 1 month gold forward rate increased from -0.078 to -0.053% while the 1 month gold lease rate came down from 0.269 to 0.240%. Moreover, the major fundamental factor driving gold higher was the US dollar. The US dollar index weakened from 82.623 to 81.656. For the coming week, the US dollar might remain the decisive factor for gold and other precious metals.

The focus in the coming week is on the central bank policy in Europe with the ECB and the Bank of England holding rate setting meetings as well as on the manufacturing PMIs for various countries. And as usual at the first Friday of a new month, the US labor market report will be released.

When the minutes of the latest meeting of the BoE’s monetary policy committee (MPC) had been released, many analysts were disappointed that the MPC decided unanimously to keep the volume of bond holdings unchanged. However, such a result should not come as a surprise. It was the first meeting under the new BoE Governor, Mike Carney. For the two members, who voted for further bond buying, it would not be a wise to oppose the position of the new BoE Governor. Voting with the majority had not changed the result of a vote, but with joining the majority, they demonstrate support for Mr. Carney. Also for Mr. Carney, it was smart to vote with the majority. Voting for more quantitative easing and thus, against the majority, could have been interpreted easily as a defeat damaging his reputation.

However, more important than the actual policy decision was the medium-term guidance, which the BoE gave. Thus, monetary policy remains accommodative, but appears less likely that the MPC will vote next Thursday for further QE measures. The preliminary GDP figures for the second quarter, showing an increase of 0.6% over the first quarter, have reduced the likelihood for further stimulus measures.

At the latest press conference, also the ECB provided the financial markets with a medium-term guidance. ECB president Draghi stated that rates would be at the current or a lower level for an extended period of time. Thus, the kept the door for a further rate cut open. However, also at the forthcoming ECB council meeting a rate cut appears as less likely for two reasons.

First, council members from the Northern Eurozone periphery already opposed a further rate cut at the latest meeting. Their opposition has probably not weakened over the last few weeks. There might be a slight majority in the council for a cut of the key refinancing rate to 0.25%, however, the ECB council is looking for a broad consensus for policy measures. The status quo will probably prevail at least for another month.

Second, the flash estimate of the Eurozone manufacturing PMI shows a reading of 50.1. It is the first time since July 2011 that the manufacturing PMI would be above the critical threshold of 50 if confirmed by the final figure. In Spain, the unemployment rate declined for the first time since 2008, which is another indication that the economic situation in the Eurozone recovers gradually. The ECB always expressed the expectation that the Eurozone economy would improve in the second half of this year. Therefore, it is more likely that the council will take a wait and see attitude and keeps the powder dry.

For the US labor market report, the consensus is looking for a slightly slower pace of new job creation and predicts 180,000 (after 195K in June) additions to the payroll. The unemployment rate is expected to decline to 7.5% from 7.6%. Thus, the percentage of Wall Street economists predicting that the Fed would start tapering the bond purchases at the September FOMC meeting could increase.

For the government bond markets, these developments would be negative. The markets already reacted on the better than expected economic figures in the UK and the Eurozone. However, keeping the monetary policy unchanged by both central banks could dampen hopes for more monetary stimulus further and could lead to another round of bond selling. Whether the yield spread of 10 year US Treasury notes over German Bunds will decline further depends crucially on the US labor market report. A strong report could lead to a renewed spread widening. Higher bond yields are expected to have a negative impact on the precious metals as they imply higher opportunity costs.

The impact on the US dollar is not so clear. Unchanged monetary policy in Europe would be normally negative for the US dollar. However, a strong US labor market report could give the US dollar a push as the market would probably price in a higher likelihood for tapering at the September FOMC meeting. Nevertheless, even with a strong US labor market report, the euro might hold well against the US dollar in the case that the manufacturing PMIs for the Mediterranean countries also improve considerably. Indications for economic improvement, in particular in Spain and Italy, would reduce the credit risk of the government bonds, which should lead to narrower spreads of the German Bunds as the Eurozone benchmark. Of course, the spread tightening could be triggered by selling Bunds and buying Spanish or Italian government bonds. But also investors, which have reduced their exposure in the Eurozone might return as buyers if the economic outlook improves. This could support the euro against the US dollar.

For the precious metals, the US dollar index is more relevant than a single currency pair according to our quantitative fair value models. Thus, a strong US labor market report might be negative for precious metals by leading to a firmer US dollar against the basket of five currencies in the US dollar index. Thus, we expect that gold might end the coming week lower compared to the close of last Friday. But a disappointing US labor market report might push gold above the 1,350$oz level, which is regarded as a resistance level.