Panic on financial markets weighs on metals

The international financial markets are in a state of panic, and this weighs on the metals markets. Even the precious metals can not take advantage of their status as a safe haven but are under considerable pressure too. As long as there is fear among investors, the metals markets should also struggle to recover.

"We have nothing to fear but fear by itself" This quote a former U.S. President, which was taken up by the former Fed chairman Greenspan during the crisis after the bursting of the dot.com bubble is also true in the current situation again. Markets are dominated by fear, initially that Greece would go bankrupt. After the yield spreads over the Bunds as benchmark for the eurozone had widened and the CDS had risen strongly, the rating agencies fanned the fear further with the downgrading of Greece, Spain, and Portugal or with the threat of deteriorating ratings. A rescue package for Greece missed the expected effects on the markets due to the reluctance of the German government, particularly of Chancellor Merkel and Foreign Minister Westerwelle. Although Greece was hereby able to meet the payment obligations in 2010 and 2011, the markets fell further into trouble. The EU had to agree on a second bailout package totalling 750 billion euros and the ECB has taken the decision to buy government bonds from the countries concerned in the secondary market. But even this could not calm the situation sustainably and the euro fell to 1.21 versus the US dollar.

The widening of the yield spreads for the countries of the euro zone periphery, which went so far that Greece could not finance on the capital market, naturally has an impact on the budget policies of the countries concerned. They have taken additional measures to reduce the budget deficit and avoid a further downgrading by the rating agencies. Actually, this would have to be welcomed by financial markets, as it reduces the likelihood of bankruptcy. But in the financial markets, it has only reinforced the fear. Now the major fear is that these savings will reduce the growth in Europe. But this overlooks that the weak euro makes a positive contribution to the euro zone economy as exports get more competitive.

The culmination of the panic in financial markets was recorded in the past week and starting point was once again Germany. The Finance Ministry has informed a long time that it is working on a bill, among other things, also the general prohibition of naked short selling is scheduled. Thus, in fact, the decision of last Tuesday to ban from Wednesday on naked short sales in shares of financial institutions, government bonds in the euro zone and the purchase of CDS without actual risk positions should not come as a surprise. Nevertheless, the financial markets panicked. Markets have overlooked that covered short sales are still allowed. This is actually the normal procedures to the financial markets. Especially pronounced was the panic on the U.S. markets, although here naked short selling is not allowed for some time. Furthermore, in Germany the settlement in the spot market takes place after two or three days, thus, there is little scope for naked short selling anyway. Thus, the financial markets have made a mountain out of a molehill and fell panic. The comments in the media have intensified the panic. In this situation, it seems almost paradoxical that investors did not flight into the safe haven of gold, but in U.S. Treasuries, whereas the debt of the United States is significantly higher than that of the eurozone as a whole. Even Bunds continued to rally, even though they are no longer needed as an instrument for spread trades against bonds of the periphery in the case the ban by Germany should be as effective as markets fear.

On the metal markets  it is argued that investors needed to sell gold to cover losses elsewhere. This argument is unconvincing. The stock markets have fallen in the first week of May already under pressure and it came to the so-called "flash crash" in the US. This should have been even then a reason for investors to sell gold to cover losses in stocks. But gold continued to rise up to a new record high. The latest data from the CFTC on the "commitment of traders' does not provide evidence that the large speculators have liquidated their gold positions to a considerable extent. Furthermore, the gold holdings in the largest gold ETF, the SPDR gold trust, increased in the previous week yet.

The precious metals are regarded among investors as a risky investment. It often appears that the prices of precious metals also come under pressure if the risk aversion of investors rises dramatically. Then not only stock prices are dropping, but also metal prices are falling. The volatility indices like the VIX in the US or the VDAX are regarded as a measure of risk aversion. Both indices have increased significantly in the last week and have more than doubled since the lows of April. In the previous week, they reached the highest levels since early 2009. It often appears that gold gives way to a sharp rise in VIX index. It is a negative factor for the metals of the platinum-group that the car's shares also fell strongly in the previous week, which is considered in the markets as a sign of lower demand for platinum and palladium from this industry for the production of catalysts.

The other fundamentals have not developed positively for the precious and industrial metals. The US economic data were somewhat weaker than expected. The oil price has fallen temporarily under the mark of 70$/bbl. Although the US dollar traded weaker versus the euro in a week-over-weeks, comparison, the euro traded very weak at the beginning of the week and EUR/USD fell to 1.21. But the U.S. dollar traded firm against other major currencies. Thus, the US dollar was probably on balance more a burden for precious metals.

On Friday, the US stock recovered in the last hour of trading after the indices had pared previously made profits. In the case this was merely short covering before the weekend, the market could remain under pressure in the coming week, which would be negative for the metals markets. However, if the stock markets continue to stabilize, then this would be positive for the metals markets. But given the panic in the previous week, continued caution is appropriate.

Gold with new record high

After gold has reached a new record high in the previous week and also closed above the previous high, there is certainly still scope for a further rise. However, we advise caution, because the reasons for the increase to a new record are by no means convincing, and gold does not follow the usual fundamentals. Once investors return again to a sober analysis, this could have a negative impact on gold.

The participants in the financial markets form rational expectations. This is assumed by the academic theories. But it was observable during the financial crisis in 2008 that this assumption is not justified. And the development in the financial markets in the previous week clearly underlines this again. The herd of lemmings and the "stories" of analysts and so-called star economists to get the attention of the media play an essential role in the development of the markets. In addition, some commentators do not understand the context. The best example is the German magazine Wirtschaftswoche, which reproduced on the front page of the current issue a death notice for the euro. But it is well known, that those who are assumed to be dead live very long.

The EU decided in a late night meeting before the market opened last Monday (11th May) to defend the euro with a package with a total volume of € 750 billion. The ECB has held the same night a conference call and voted with a broad majority that it buys government bonds in the secondary market, but is absorbing the liquidity provided thereby otherwisee. The ECB has taken the right decision in this situation, because it is their mission to secure the currency. The threat was a conflagration and the collapse of the European Monetary Union as a result of attacks by the rating agencies and financial markets on the countries of the so-called periphery. Through the purchase of bonds of the countries concerned, however, the yield spreads against government bonds and credit default swaps have reduced again. Again, it was the representative of a German institution being responsible that the initial positive development could not continue, but reversed. Bundesbank chief Weber has commented negatively on the impact of the purchase of government bonds in the secondary market. It is incomprehensible that this man is supposed to be the next President of the ECB.

It is criticized by commentators that the ECB would have given up its independence with the decision on the purchase of government bonds in the secondary market. This is absurd, because the decision was still made by the Governing Council. The ECB is challenged to act quickly in crisis situations, and this was at the weekend concerned the case. Just because the head of the German Bundesbank does not understand the seriousness of the situation and the effect of the purchase of government bonds in the secondary market, it is not an issue of independence if the majority of the Council comes to a different assessment. Moreover, the ECB buys also bonds in the repo transactions. The only difference is that the ECB has not fixed timing for the sale of the bonds back to the original owner and the title can be held to maturity. And when ECB was forced to take the decision of the direct purchase of government bonds in the secondary market, this was due to developments on the markets. And of these, no central bank is truly independent.

The other criticism is the argument that the purchase of bonds in the secondary market would lead to inflation. This argument only testifies a fundamental lack of understanding of economic relationships. ECB President Trichet rightly stresses that the purchase of government bonds in the secondary market is no "quantitative easing is" as it is operated by the Fed or the Bank of England. The liquidity that is flowing through the purchase of the bonds in the market is absorbed again by other means. If the liquidity effect of a measure is sterilized, however, a widening of the balance sheet of a central bank - which is a prerequisite that can lead to inflationary effects - will be avoided. But even with a balance sheet extension, a rise of inflation is not the inevitable consequence. If the interbank money market does not function properly because the banks trust each other no more and prefer deposits with the bank, the balance sheet of a central bank can extended, but the net loans to commercial banks do not necessarily have to rise. The ECB sticks to its primary goal, to keep the inflation rate below, but close to 2%. Whoever sees inflation risks, also believes in ghosts in English castles or the monster of Loch Ness.

It is found also in another context that the expectations of market participants are rational. For many weeks the dominant fear in financial markets was that Greece could suffer a national bankruptcy and other countries in the euro area might be infected thereof. Germany has repeatedly stressed that further savings in the national budgets of the affected countries with a large deficit to GDP ratio is an indispensable prerequisite to agree to an aid package. With the decision of the previous weekend, the risk of state bankruptcy or a "hair cuts" has clearly diminished. But now the financial markets fear the impact of the austerity measures, which they themselves have forced governments to impose, on the GDP growth rates in the euro zone. A weaker growth would not lead to an acceleration of inflation. It is absurd to expect both developments simultaneously. After the initial recovery up to 1.307 against the U.S. dollar, the euro has therefore once again come under pressure and fell to 1.236 U.S. dollars by the close of the week.

The rise in gold prices is thus based on a total of no load bearing foundation. Major fundamental factors as the EUR / USD exchange rate and the oil price are negative. Inflation fears may well have driven the flight to gold as a safe haven, but it is unfounded and in the medium term, the eurozone is more likely to struggle with the opposite. The gold price may rise even further in the short run, but it applies the principle of "caveat emptor".

Gold now on the way to a new historic high

In assessing the development of the gold price in the previous week we were correct, but the main reasons for the increase were the continued fear of a default of  Greece as well as a contagion of Portugal and Spain. But as long as the investors act out of pure panic and do not reflect the fundamentally different situation in other countries of the eurozone, a continuing flight to the safe harbour of gold has to be expected. The next goal is a rise to a new historical high above 1,226.1$/oz. 


After Standard & Poor's has already down graded the rating of the two Iberian countries, now Moody's  threatens to lower rating of Portugal’s creditworthiness. Spanish bonds at an auction had to be offered a higher return, but the demand exceeded expectations. This underlines really that Spain can continue to finance on the capital and is far from a bust. However, since the ECB had not discussed in their meeting on Thursday the purchase of government bonds in the secondary market, the market fell again in panic. 


The Greek Parliament has approved on Thursday the austerity package negotiated by the Government with the EU and the IMF. In Germany, the aid package for Greece, as was expected, has found a broad majority in the Bundestag and Bundesrat on Friday. The Act came into force on the same day. The Federal Constitutional Court has rejected an emergency petition to stop the credit disbursement to Greece. Therefore, the conditions exist that Greece receives timely financial resources to be able to afford this month pending redemption and interest payments. Nevertheless, the market has not calmed down. 


Gold could also benefit from falling prices on the international stock markets, particularly on Thursday after the Dow Jones index within minutes fell by almost 10% compared to the previous close. As long as it is not clear what caused this plunge, the nervousness in the equity markets is likely to prevail, as it has shown so well on Friday. This then remains for gold also a positive factor. 

On foreign exchange markets the euro is under continued pressure against the major currencies. Against the US dollar, the euro fell within a week up to about 8 cents to $ 1.252. In particular, the comments from U.S. analysts and investors are negative about the prospects for the euro. Some commentators even argue that Germany could leave the euro. This argument is absurd, given the advantages Germany pulls out of monetary union. But it could be repeated in the case of a defeat of the ruling parties in state elections in North Rhine-Westphalia. 

The EU leaders, at their meeting on Friday announced that the institutions of the EU were decided to fight against speculations and attacks against the euro and the monetary union. They have thus, in the words of former U.S. Treasury Secretary Hank Paulson during the financial crisis in 2008, put the bazooka on the table. However, this is not enough any more. The EU institutions also need to use it to calm the situation in financial markets. This would require that also the ECB supports the measures. Both, interventions in the foreign exchange market and the direct purchase of government bonds from the periphery of the euro zone on the secondary market, would be necessary. Only if speculators are forced to cover their short positions in the euro and the government bonds of Greece, Portugal and Spain, it may lead to a sustainable stabilisation. For gold, this is by no means negative. First, a recovery of the euro should stimulate demand for gold rather than be a burden as some investors who bought gold as a hedge against a state bankruptcy, are likely to remain sceptical and are expected to hold their stocks. Second, some market participants might classify the necessary measures of the ECB as inflationary, if the liquidity provided will not be absorbed otherwise. Gold could very well rise to a new historic high.

Gold is likely to test 1,200$/oz mark

The Greek government has reached an agreement with the EU and the IMF on an additional savings program. This should stop the decline of the euro and could lead to a recovery against the US dollar. Gold should benefit from this development. The large speculators should increase their net long positions further, as it was the case in the previous week. Therefore, gold could test the psychological resistance mark of 1,200$/oz. Indeed, even an increase to a new all time high is not excluded.

Early on Sunday morning, the Greek government has agreed in the negotiations with the IMF and the EU on an austerity program that contains further cuts in civil servants salaries and pensions. Also another increase in the VAT rate is on the program. The decision by EU finance ministers still pending at the time this blog post was written. But it should be positive for Greece. In Germany, the federal government will on Monday decide on the bill and the legislative process is scheduled to be completed by Friday of this new week. Greece could obtain the funds timely before the maturity date of 8.5 billion euro for mid-month and thus, can redeem the bonds. Overall, Greece will receive 45 billion euro of credit by EU and IMF this year. So far it has been assumed that this is sufficient to avoid bankruptcy in Greece. However, the Greek Prime Minister Papandreou said today that his country would need 60 billion euro in order to avoid state bankruptcy.

In the financial markets, some recovery should therefore occur, although, it might be only a modest one, given any remaining doubts about the solvency of Greece. The euro is likely to stabilize and recover slightly against the US dollar. Thus, any effect on the gold price is positive. Those investors who bought gold as insurance against bankruptcy of Greece are expected to keep their positions. And investors buying gold as a hedge against a weaker dollar should return as the buyer to the gold market.

According to the latest report from the CFTC on the "commitment of traders", large speculative addresses such as hedge funds have increased their net long position in the week ending 27 April again. Now it stands at its highest level since mid-January. In the chart, the gold price is shown as of the reporting deadlines for the net long position of the large speculators. As the price of gold after 27 April has risen further, large specs should not have reduced their positions. With rising gold price, net long positions could increase and thus support the rally in gold. Gold is expected to test at least the psychological resistance mark at 1,200$/oz. In the case of a breakthrough, even a new historic high could be reached.

Platinum shines strongly among precious metals

Platinum develops better than gold in percentage terms. But whether this is going to continue in the coming weeks and months will depend largely on the development of the automotive industry. The sales figures show strong gains in the first quarter and the results were better than expected. However it is questionable, whether the car shares rise more strongly, as they are already clearly overbought. If auto stocks correct in line with the overall market, then this should also have a negative impact on the relative performance of platinum over gold.

We have in this blog several times already criticized the German Federal Government, in particular Chancellor Angela Merkel, for the policy in the Greece-crisis. The always hesitant attitude and vague statements have given Greece no rest and relaxation on the financial markets, but only exacerbated the crisis further. Also, it was not a smart idea from the Chancellor involving the IMF in a rescue operation for Greece. Fueled by statements of some U.S. economists this has only exacerbated the fear of Greece declaring state bankruptcy. This has weighed on Gold as new lows in the EUR/USD exchange rate are negative for gold. Another negative factor in the previous week was the SEC action against Goldman Sachs, which has reduced the risk appetite of investors and also the precious metals suffered under increasing risk aversion.

The platinum group metals are not spared of the negative developments in the foreign exchange markets. But the industrial use of the PGMs for catalysts in the automotive industry plays also a significant role and at present offsets the impact of the EUR/USD exchange rate. With the start of the global economic crisis in the autumn of 2008, which was triggered by the financial crisis and the bankruptcy of Lehman Brothers, some countries have established incentive programs for the purchase of new cars (scrapping premium in Germany, cash for clunkers in the US). Automotive experts, such as Professor Ferdinand Dudenhoeffer (a “leading German expert”), had criticized such programs as ineffective, indeed even as harmful to the automotive industry. After the expiry of the incentive program, there would be a massive slump in demand for automobiles, which would not only delay the crisis but would even make it more severe.

But it came back a different way than the professorial experts had predicted. Although the sales declined slightly after the expiry of the programs, but in most countries car sales in the autumn of 2009 were higher than the year before. In particular, the car sales have risen considerably in China. This shows the success of the Chinese government’s policy to boost domestic consumption. Thus, even automotive brands, which have benefited little from the incentive programs, could increases car sales significantly. Last week, some automobile companies exceeded expectations considerable and reported surprising results for the first quarter of 2010. This argues for a further advantage of platinum compared to gold in the short run. 

The chart shows the ratio of gold to platinum price. A falling ratio means that platinum performed better than gold that is either increases stronger or decreases slower in percentage terms. In the previous week, this line has reached its lowest level since September 2008. At the same time, this represents a correction to the 61.8% increase from June 2008 to peak in December 2008. This Fibonacci correction is seen from a chart-technical point of view as a critical level. If the ratio of the gold and platinum price could continue to decline, then the low of June 2008 might be reached again as a target, suggesting a still significant potential for better performance of platinum. But in the case that the line does hold at that mark, then gold should receive sufficiently strong support and could perform better. At the same time, the chart shows the price of Daimler shares (other European car shares, with the exception of the Volkswagen Group would show a similar development) with an inverted left-hand scale. It is striking that platinum often performed better than gold when the Daimler share price has increased. After an increase of around 30% in two months, the stock is now clearly overbought. The international stock markets are overbought after two months' rise, too. The risk of a correction in equity markets has therefore increased significantly. And the case of Goldman Sachs shows how nervous investors are and how quickly risk aversion can rise. Falling stock markets, especially in automotive stocks would thus also be a negative signal for platinum, which should then perform worse than gold.

Copper could be due for a correction

When a market is no longer increasing on good news, this is usually a sign of a turnaround. This is the case for copper. In addition, the market doubts whether the fundamentals justify a price of about 8,000$/t. On the last Friday, in the course of the afternoon also the chart-technical situation has changed. Furthermore, also other industrial metals could be drawn down in line with copper.

In China, the largest consumer of copper, GDP in the first quarter of 2010 increased by 11.9%. Although the central bank had taken restrictive measures in January, GDP growth accelerated further. We had noted previously in this blog that increases in minimum reserve requirements and the restriction of credit would only slow down the pace of growth, but the increase in the demand for copper should continue. The message of China's GDP growth would actually be positive for the copper market. But copper has not been able to cross above the threshold of 8,000$/t significantly. In the market, the growth rate has once again raised worries that the copper demand could decline.

A further increase was prevented also by worries that China is deliberately taking measures to cool the property market and to avoid a bubble. This policy is under medium-term aspects positive for the copper market, as it tries to avoid, other than the monetary policy of the Fed, a collapse in demand and achieve a more even level of construction activity in line with demand. It does not mean that the central bank, the Peoples Bank of China, would bring about a slump in construction. However, the short-term demand for copper should be expected to be lower than it would be the case if construction activity would be unbridled.

With the crisis in financial markets in the year 2008, China has fixed the exchange rate of the yuan against the US dollar and now considers a return to a managed floating. This, too, has had a negative effect on the copper price on Friday. The market fears that a revaluation of the yuan, which is to be expected with a controlled floating, although the prices of copper in yuan would cheapen, but China's exports were likely to suffer from a stronger yuan. We consider this argument is not convincing enough. It would only be negative, if China would export all the copper imports after further processing, ie, exports alone would determine the amount of copper imports. With a yuan appreciation copper is also cheaper for domestic consumption and this may be the overall determining factor.

Only on Friday afternoon, copper came but under strong selling pressure. However, the trigger for this has not the least to do with the fundamentals for copper. The news that the U.S. Securities and Exchange Commission brought a fraud action against Goldman Sachs and an employee in connection with the issuance of a CDO in 2007, led to a sharp rise in risk aversion of investors, from which the metals markets were affected. Even gold, which is often regarded as a safe haven, came under massive selling pressure. This change in mood of investors is unlikely to reverse overnight. After copper has traded sideways in the last two weeks, it came to an downside breakout on Friday. Copper could therefore drop further.

In our forecasts for copper prices, we have assumed that the price in the current and also the following quarter would correct lower. However, this decline would not be due to a slump in demand from copper consumers. Rather, we expect that the leading indicators, as the OECD leading indicator showed earlier last week, were rising still, but losing momentum. Financial investors are likely to use this as an opportunity to take profits in base metals. In the case this coincides with a growing risk aversion, then a more pronounced correction in copper and other nonferrous metals might be looming and this, despite the LME warehouse stocks of copper could fall further.

Gold at new high of the year

After the gold price has risen on last Friday to a new annual high, gold could advance further to the next psychological mark of 1,200$/oz. But investors should be cautious. Because it is not the usual fundamental factors that have led to the rise in prices, but because of panic on Greece national debt. If markets return to a sober analysis, then gold could follow the fundamentals and give back the gains.

As stated earlier, the crisis of the high Greek budget deficit is a burden for the euro and is thus negative for the gold price. But it could become a supportive factor once gold is bought up in panic over a bankruptcy. Exactly this situation has occurred in the past week. And with these movements in the markets, two prevailing assumptions have been refuted. When asked during the recent ECB press conference to comment on the market development, ECB chief Trichet replied that the markets were always right. But this is not the case. Central bankers consider themselves infallible. However this statement of Mr. Trichet is obviously not correct. Second, it is often said that information would be processed rationally by the market, and thus academics in their models assume the hypothesis of rational expectations to be confirmed. They were already proofed wrong in the financial crisis and it is not true also in the panic of investors in the past week.

A panic can then be viewed as a rational behavior when it is triggered by new information that is true and leads to a completely new fundamental assessment of the situation. However, if the new information could be easily identified as false, a panic is an irrational behavior. In the case of Greece the panic was triggered by a message from Market News International that according to an unnamed government source, Greece's would refuse to ask the IMF for a loan because of possible conditions, but would try to negotiate a new assistance pact with the EU Heads of States. Greece's Finance Ministry has denied this report, but this has only strengthened the panic in markets. Obviously, the fear of some investors has switched off their brains.

If the markets really process information rationally, they would have quickly classified this message as a hoax and the denial of Greece must be regarded as accurate. The German Federal Government with its rigid stance pushed through an agreement at the summit of EU heads of government on March 25-26, that Greece take a loan from the IMF, before the other EU countries must determine by a unanimous decision the emergency and could grant loans to Greece on market terms. This is the lowest common denominator the various EU states could agree on, and it is not even guaranteed that Greece actually would obtain aid from the EU. For their stance, Chancellor Merkel has received the name Madame No. The attempt to achieve a better result in new negotiations for Greece would be like the battle of Don Quixote against the windmills. And both the Greek Prime Minister and Minister of Finance acting wise enough not to take up this fight. If the market were truly rational, then it should have realized the message of Market News International quickly as a rumor deliberately scattered and it would not have panicked.

Certainly more serious, however, are reports that Greek citizens reduce their deposits with the banks. They have already reduced their deposits within the first two months of 2010 by over EUR 8 billion and this trend has intensified in recent weeks. Part of these funds should have landed on accounts with foreign banks, or held as cash. One part could have flowed also in gold, although there is no hard evidence for this. If you look but to the intraday movements of the gold price, it is noted that physical gold demand in Europe has not had a big influence. The significant movements have occurred with the start of trading in the US. Recent data from the CFTC on the "Commitment of Traders" covers only the positions to Tuesday April 6, the day the panic broke out. But already at that time, the net long position of major speculative addresses increased by almost 30 thousand to 203,446 contracts. It should therefore once again be the hedge funds that have speculated on an escalation of the Greek crisis and a run on gold. With a calming of the situation, they could also reduce their positions again rather quickly.