Summertime and The Livin Is Easy

The title of the famous aria from George Gershwin’s opera Porgy and Bess might describe pretty well the living of those who could afford to spend currently their vacations. However, it certainly is not an appropriate description for those holding or trading positions in the metals markets. But there is also an exception in metals markets, spread traders being long in the PGMs and short in gold or silver could also enjoy an easy living.

Several factors make the life of a metals trader currently a hard one. Amongst those factors is the Fed.  While at Wednesday of the preceding week the FOMC statement provided no hint that tapering would be implemented at the next meeting, at the start of the week two hawkish FOMC members voiced that the FOMC should taper bond buying at the September meeting, while one dovish member would not rule out that the FOMC could decide as early as at the next meeting to reduce the volume of monthly bond purchases. Before the recent FOMC meeting, Fed chairman Bernanke calmed markets by emphasizing that the decision to taper would be data dependent.

However, the recent data does not provide any hint that the urge to reduce the volume of QE3 has increased. The recent revision of US GDP data is the result of a modification of the definition which items qualify as assets. But the economic activity did not become more or less dynamic due to the GDP revision. As pointed out last week, the core PCE deflator heads down and thus also provides no indication that tapering would be required to avoiding inflation. But the PCE deflator indicates that the FOMC would better wait and thus, might not make the same mistake as the BoJ some years ago. Nevertheless, the hawks within the FOMC oppose QE3 for orthodox beliefs instead of sound and rational economic reasons.

The problem is that the market is currently nervous and uncertain about the timing of the exit from QE3. Thus, many market participants do not distinguish whether a hawkish comment is made by a voting or non-voting member of the FOMC. Every statement from a hawkish FOMC member is immediately treated as it would be the next FOMC decision. Thus, it is no wonder that not only gold and silver, but also the US stock market and the base metals traded lower at the start of the week.

Three weeks ago, we wrote about the impact of Chinese macroeconomic data on base metal prices, in particular on copper. In this context, we noted that copper related data like copper imports have a lower explanatory power than general macroeconomic indicators like the Chinese manufacturing PMIs. This week, it were the import data for all goods and services as well as for come base metals (of course, copper was among them), which excited financial and commodity markets and lead to a turnaround. Factory production data on Friday pushed the precious and base metals further up to end the week in the plus.  

The Chinese trade balance in July was lower than expected at $17.8bn compared with a consensus forecast of $26.2bn. However, the data from the Customs Administration showed that exports rose 5.1% from a year ago while the consensus expected only an increase of 3%. Even stronger soared the imports, which jumped 10.9% from a year earlier. The surge of imports was more than five times of what economists predicted. The rise in exports is regarded as a sign that global demand is picking up, while the rocketing imports are considered as an indication that domestic demand in China is rebounding. While this interpretation is correct, analysts and traders might easily overlook one fact, which could lead to a disappointment later.

What counts for the calculation of the GDP and thus for GDP growth is not the percentage change of imports or exports, but the difference in local currency terms between ex- and imports. A widening of an export surplus leads to a bigger contribution of the external sector to the GDP and vice versa. Thus, July’s surge in imports could lead to a smaller surplus of the external sector and thus to a slower GDP growth.

The Chinese imports of unwrought copper and copper products increased from 380 thousand to 410.6 thousand tons in July. Compared to the same month of the previous year, this is an increase of 12%. Some analysts argued that this increase of copper imports would be due to financing reasons. However, this argument is not very convincing. Of course, inventories of copper or other base metals are used as collateral for short-term financing operations. But in this case, the inventory is held either voluntary in order to have sufficient metal for the production process or involuntary because the goods cannot be sold immediately and are stored. But copper imports have to be paid at a certain payment date, which could be some months into the future. Freight letters of copper shipped to China could be used to finance the imports and this is a usual procedure in international trade finance. But in this case, the copper will not be imported just to obtain a loan for paying the import. The driving reason for importing copper is the use for consumption and not for holding it at warehouses and using it as collateral. Thus, the rise of copper imports in July is a positive indication for economic activity in China.

Another positive indication for Chinese economic activity was the increase of industrial production in July. The industrial output rose 9.7% from the same month last year, while in June the year-over-year percentage increase was at 8.9%. Unlike the official Chinese manufacturing PMI, the HSBC manufacturing PMI slipped below the 50 threshold and indicated a slowdown of economic activity in the industrial sector. However, the industrial output expanded stronger as expected. Another example that markets better follow the official PMI because size matters. If large companies increase production, it has a stronger impact on overall output than the reduction of smaller companies.   

Overall, the Chinese data might improve sentiment towards the second biggest economy somewhat. However, the next official data release will be only in September. Thus, US economic data and the fear of Fed tapering in September might quickly regain the headlines and move the markets. Thus, even the second positive weekly close of gold is not a harbinger that gold might rally towards the 1,400$/oz level in the short run.  Also the industrial metals, which have stabilized, are not yet out of the woods.