“In Gold We Trust”

This is the headline at the title page of a German business weekly this weekend. It is an old market adage that it is time to exit a market if magazines report about this market on its title page. Given the price development of gold over the last two trading days of the previous week, the old wisdom seems to get it right again.

However, it is certainly not the reason gold dropped by 3.7% from the high reached on Wednesday to the close on Friday that a German business magazine devoted the title page to gold. The two factors causing this decline had been the FOMC meeting and the second press conference by Fed chairman Bernanke as well as the debt crisis in Greece and how the eurozone handles it.

Greece’s PM Papandreou reshuffled his cabinet the week before and faced a confidence vote in parliament last week. He survived this confidence vote. This week, the Greek parliament will vote on his austerity package. If markets were forming expectations rationally, as academic theory postulates, then markets should price in that with expressing the confidence to PM Papandreou, the majority of the lawmakers would also vote for his austerity package. However, financial markets still fear that the austerity measures demanded by the EU to support Greece would fail to pass the approval of parliament in Athens. As a result, the credit default swaps for Greek government bonds are still surging and the spread over benchmark German bonds and notes are rising. However, also the yield on German government bonds are falling due to safe haven flows into Bunds. The yield of 10yr Bunds dropped to 2.83% and is only 13bp above the eurozone inflation rate. Institutional asset managers taking their fiduciary duties seriously should not invest in bonds yielding less than the inflation rate. Nevertheless, they buy German government bonds along the curve and thus, harm their clients by holding bonds with a negative real yield.

Therefore, the Greek debt crisis has a negative impact on the euro directly and indirectly. The direct impact is the flight of capital out of the eurozone based on the fear of a Greek default. The indirect negative impact is via the yield and interest rate spreads, despite the ECB is going to hike the refi rate at the rate setting council meeting in July.

However, also the FOMC meeting had a negative impact on gold. The Fed revised its forecast for GDP growth down to 2.7 – 2.9% compared with 3.1 – 3.3% in April. The unemployment rate is now expected slightly higher at 8.6 – 8.9%. But unlike some market commentators and bank economists predicted, the FOMC decided to terminate QE2 as scheduled by the end of this month. In addition, as Fed chairman Bernanke pointed out, the Fed does not consider the implementation of QE3. However, it will reinvest proceeds from interest payments as well as maturing notes. Thus, the Fed will remain its current stance, but will not become more expansionary. As the market priced in further easing measures to support the economy, the US dollar recovered and this is a negative factor for gold.

We were never convinced by the argument that QE2 would be inflationary. The rise of headline CPI is the result of the supply shocks in the agricultural and crude oil markets. Both shocks are not the result of the Fed monetary policy. Nevertheless, those investors believing that QE would be inflationary had to revise their expectations about inflation after the Fed announce that they are not considering QE3, which is also a negative factor for gold and other precious metals.

All in all, we still expect the precious metal markets to consolidate over the summer month. The low reached in early May at 1,463$/oz should be a stronger support level.  

Gold torn between euro weakness and the Greek debt crisis

The ECB prepared the markets for a rate hike in July at its monthly press conference and the euro lost about six cents versus the US dollar to 1.41 within a few days. If the sell-off were triggered by profit taking according to the old market adage to buy the rumors and to sell the facts, the impact of the stronger US dollar on Gold should have been negative. One would have expected that gold would give back a bigger part of the gains made before. However, this was not the case. The weakness of the euro against the US dollar was not triggered by profit taking, but by renewed fears of a Greek default on its national debt.

Partly, the drop of the euro could be blamed on the continuing protests in Greece against the austerity policy. The Greek government is trying to push the sixth saving package through parliament. However, the Greek government is in an uphill struggle like Sisyphus. The more they try to save, the more the GDP contracts and the debt to GDP ratio increases, which leads to further downgrades by the rating agencies. The agencies are part of the problem as they pour gasoline in the fire and prevent the fire-brigades from EU, ECB and IMF to extinguish the fire.

However, also the German government is more part of the problem then the solution. German academics have demanded to let Greece default and restructure its debt. The finance minister resisted this siren calls and rightly pointed out that it could lead to collapse of the financial system like the bankruptcy of Lehman Brothers. But suddenly, he changed his course and demanded that the private sector would have to make voluntarily a considerable contribution to a second bail-out package for Greece as it is rather unlikely that Greece would be able to obtain funding in the capital markets next year given the high interest rates in secondary markets and poor ratings by the agencies, which keep the outlook still on negative.

The ECB fears that the demand from Germany could trigger the credit event clause as the rating agencies already threatened. In this case, all Greek debt outstanding could be demanded to be redeemed immediately. In addition, the ECB would no longer be able to accept Greek government debt as collateral in the repo operations. This could trigger the default of banks in Greece. Fortunately, Germany has softened its stance after a meeting between German chancellor Merkel and French president Sarkozy in Berlin last Friday. This gave the euro a push higher and gold also profited from this move.

Also the politicians in Greece play a crucial role. The troika of IMF, EU and ECB demanded that also the opposition would back the agreement between Greece and the troika. However, the opposition party, which was responsible for the ballooning budget deficit between 2004 and 2009, is not willing to cooperate. They demand tax cuts, a measure the troika will not accept. Furthermore, the conservative opposition creates the illusion among the population that the austerity policy would not be necessary to avoid a default on the national debt and a collapse of the financial system. Thus, the support for the policy of the PM is decreasing. After a government reshuffle, the PM faces a confidence vote after this blog is published.

In the case that the PM of Greece will survive the confidence vote, the flight to the save haven of gold might ease somewhat. But in this case, the euro should strengthen versus the US dollar, which would be a positive factor for gold, especially as the diverging monetary policy in the eurozone and the US point to further dollar weakness. In the case that the development concerning Greece get worse, the euro might come under renewed pressure, but the impact on gold might be compensated by safe haven buying. In the short run, it looks like gold remains torn between these two opposing forces. 

Signs of slower growth mounting

Last week, metal markets were mixed but most metals ended the week slightly lower compared to the close of the preceding Friday. The dominating factor was the economic data released during the week, which had a direct negative impact. However, the indirect effect of the weaker than expected economic figures was supportive. We expected that metal markets would consolidate during Q2 and Q3. Thus, we are currently not much concerned that the weaker than expected economic data would trigger a bear market in metals.

Two types of important economic data are usually released at the beginning of the month, the surveys among purchasing managers in the manufacturing industries of various countries and the US labor market data. In China, the official PMI came in slightly above the consensus, but declined again in May. The HSBC PMI for China edged up to 51.6 after 51.1 in the month before. Nevertheless, the PMI in China is close to the crucial 50 mark. But as long as the PMI stays above this level, the index points to an expanding economy. However, it is understandable that the base metal markets remain concerned that the restrictive monetary policy of the PBoC could drag growth further down.

In the eurozone, the manufacturing PMI declined from 58 to 54.6 in May. While the decline is considerable, it is not a reason to worry as long as the PMI stabilizes around that level. We pointed out several times that readings close or even above 60 were not long lasting and that the PMIs often decline to readings in the mid-50 range. And the economy still could expand strongly with a PMI around 55. Thus, the eurozone PMI is still at a level, which would not prevent the ECB from increasing the rather low refinancing rate further towards 2% by the end of this year or early 2012. The ECB is likely to prepare the market for the next rate hike at the press conference following the council meeting this week.

In the US, the drop of the manufacturing ISM index was even steeper, from 60.4 to 53.5. Furthermore, the unemployment rate edged higher again to 9.1% and only 54 thousand new jobs were created in the non-farm sector. This indicates that the US economy has lost some pace. While it is rather unlikely that the Fed would embark on a new round of quantitative easing, the risk for a rate hike in H2 of this year has also diminished.

The indirect effect on commodity prices worked through a weaker US dollar. Despite the PMI feel in the eurozone and the US, the outlook for monetary policy remains dollar negative. Also the report of the IMF, EU and ECB on Greece with testify that Greek has made progress and the next tranche of the loans to be made in time have supported the euro. Thus, a weaker US dollar is like to partly compensate weaker economic data. Nevertheless, the consolidation is likely to last during the summer.

I will be at a conference this week and can not follow the commodity markets closely. Therefore, the next block article will be published on June 19.  

Metals recovered, but is it a new bull trend?

The metals market recovered last week. All precious metals closed higher compared to the preceding Friday. While the LME base metal index also reversed and closed higher, the development within the base metal sector was mixed. Some metals posted even stronger losses.

The technical situation of the precious metals has improved considerably. The MACD has crossed above it signal line and thus triggered a buy signal for all four metals. However, these signals are not very reliable. For example, the recent sell signal for gold was triggered by the MACD at the low reached on May 5. But one should also keep in mind that these signals could be very profitable in the case that the market enters into a new trend, which the trader could ride for some time. Therefore, before following a technical trading signal, traders should still have a look at the driving forces.

Stock markets were a bit in a roller-coaster last week. Economic data released came in below the consensus in cases. Especially the flash estimate of the eurozone manufacturing and service sector PMI, US GDP revision for Q1 and the US pending home sales disappointed. Thus, there is still some fear of a global economic slow-down in the markets. This would not be a positive factor for metals.

Positive for the metals had been that the euro stopped its decline versus the US dollar after falling below 1.40 at the start of last week. However, the rebound appears to be more driven by short covering. The uncertainties about the development in Greece are still high. The statement of the head of EcoFin that the IMF might not approve the payment of the next credit tranche cause a new wave of safe haven buying in the bond markets. However, on Friday, the acting IMF managing director John Lipsky stated that the IMF is still in negotiations with Greece and no decision is made yet. This calmed nerves a bit and contributed to the recovery of the euro above the 1.43 mark. However, it appears to be a sure bet that some European politicians can not keep the mouth shut making the wrong statement at the wrong time and nervous traders sell the euro again.

Positive for the metals markets had also been the buy recommendation from Goldman Sachs commodity strategists. After GS issued a sell recommendation earlier on expectations that commodities would be too expensive, the recent correction pushed prices down to levels, which GS regarded as price targets. As a consequence, GS issued now a buy recommendation.

One condition for a new upward trend in precious metals is that investors increase their positions again. According to the latest CFTC report on the “Commitment of Traders”, the large speculators have increased the net long position in gold in the week to May 24 by 7,791 to 172,394 contracts. In silver, the non-commercials added just 148 contracts to their net long position in futures. In platinum, they reduced the net long position further. Thus, there are positive signs that investors return as buyers to the market. However, as one swallow does not make a summer, more evidence of buying by large speculators would be needed.

As long as the markets are still concerned with the outlook for global growth, the recent recovery might be on a shaky basis. Especially as the rebound of the euro appears to be driven more by short covering the risk is that this short covering rally might not last long.

Most metals still in consolidation

In the previous blog article, we wrote that the consolidation in commodity markets is likely to continue. We also argued that it is probably too early for bargain hunting. Our assessment has not changed during last week, despite copper and lead posted a stronger gain on the week.

The large speculators reduced further positions in metals. According to press reports, George Soros has sold almost his entire $800 million stake in gold during the first quarter of this year, which weighed on sentiment at the start of last week. According to the CFTC “Commitment of Traders” report, non-commercials reduced their net long position by 11,766 to 164,603 contracts. Thus, the large speculators cut their net long position by around 25% within one month. In silver, the large speculators reduced the net long position in the week ending May 17, by 6,061 to 17,435 contracts. Thus, they trimmed down the net long position by more than 25% within just one week. Over the last four weeks, the net long position was almost halved. However, in copper the liquidation of net long positions was even more pronounced. Within one month, large speculators diminished the net long position from 25,059 to a mere 7,745 contracts, a decline of almost 70%. As long as large speculators close long positions in commodities, the risk for commodity prices is biased to the down-side and it is too early to go on bargain hunting. The knife is probably still falling and investors should listen to the advice not to catch a falling knife.

Gold ended the week higher thanks to a jump on Friday afternoon (GMT). Two factors led to this price spike. First, investors feared that something unforeseen could happen again over the weekend like the arrest of the IMF governor the week before or the secret meeting of a few finance ministers of the eurozone two weeks ago. Second, Fitch cut the rating of Greece to B+ reacting on the statement from the head of Ecofin, Mr. Junker, and warning that even a maturity extension would be regarded as a default. However, position squaring ahead of a weekend is less likely to lead to a trend reversal as long as the underlying fundamentals do not change.

For the PGMs, the platinum week in London was the main event. The supply/demand forecasts by Johnson Matthey were the main driver. JM predicts an almost balanced market in platinum but a supply deficit for palladium. However, Norilsk voiced that the palladium market would also be balanced. But over the summer month, demand for metals is usually lower and thus, the recovery of the PGMs might also be short-lived.

Two major fundamental factors would have to change to see again a stronger demand from consumers and investors in commodity markets. The US dollar did not strengthen further. But this is not enough for rising commodity prices. The dollar would have to weaken again considerably. The end of QE2 is looming, however, this is not a reason for a stronger dollar. As long as investors expect higher returns in other currencies, the US dollar could weaken further. The ECB is likely to hike rates further towards 2% by the end of this year or early 2012. This would argue for a weaker US dollar, but fears of a Greek default and a possible contagion to other peripheral eurozone countries is currently weighing on the euro.

The second factor is the outlook for the global economy. Investors are currently cautious as some economic data came in weaker than the consensus among economists predicted. Especially surveys among purchasing managers in the service sector and among analysts and fund managers disappointed, while the manufacturing PMIs are still at a very high level and point to strong expansion.  Usually, economists are slow to adjust their forecasts to lower than expected economic data. Thus, it might take some time that economic figures point still to robust growth and also exceed the consensus forecasts. Therefore, bargain hunters might find better buying opportunities over the next couple of weeks.

Dead cat bounce or time for bargain hunting?

At the start of last week, metal markets recovered from the sell-off in commodity markets. It is not an unusual behavior that markets rebound after a preceding plunge. This phenomenon is called a dead cat bounce. Those moves are only for extremely short-term long trades because markets are quickly returning back to the low, from which the bounce started. Often markets even fall further to fresh lows. Thus, a dead cat bounce is rather an opportunity to set-up short trades then a buying opportunity for traders holding a position for more than one trading session.

On the other hand, if panic caused the plunge and the market overshoot to the downside then it often presents an opportunity for bargain hunting. Once investors and traders analyze the market fundamentals soberly, they come to the conclusion that valuations of the market are extremely cheap and offer a buying opportunity.

Therefore, deciding whether it is time for bargain hunting or to use rebounds for going short requires an analysis of what caused the sell-off at the beginning of this month. Some commentators called the recent plunge of commodity markets a flash crash. Indeed, at a first glance, one might come to this conclusion. We fully agree that markets overreacted on the ECB press conference. As pointed out last week, it was not very rational to expect another ECB rate hike already in June. Also comments from ECB council members made it clear that the market misunderstood the message. Further rate hikes are likely to follow. And a one month delay really does not make a big difference.

However, we do not regard the current situation as a good buying opportunity for commodities. We disagree with Goldman Sachs commodity analysts this time, while we agreed when they recommended taking profits. Beside a panic reaction on the not as hawkish as expected ECB press conference, also the fundamentals – or at least how they are perceived - have changed.

After the report on Spiegel-online, the web-site of a German weekly magazine, about a secret meeting of some eurozone finance ministers and Greece leaving the euro, the nervousness of investors about a Greek default has risen again. Even after the finance ministers made it clear that Greece can not leave the eurozone and also Greece denied any intention to abandon the euro for a “new drachma”, some German professors regard this as unavoidable. They also demand Greece to declare default rather sooner than later. No wonder that S&P downgraded Greece by two notches to B- with outlook negative after this report at Spiegel-online. Also opposition within German government coalition parties against financial aid for Portugal, the creation of the EFS and further help for Greece is increasing. As it seems currently, the coalition is no majority in the lower house to push through legislation on eurozone bail-outs. Thus, the risk-aversion for the euro has risen last week and this is reflected by euro weakness against the US dollar, which is a negative fundamental factor for metal markets.

Chinese commodity consumers behave according to the Baumol model of inventory holding. As the Chinese central bank hiked interest rates and increased minimum reserve requirements several times, the higher funding costs for inventory holding have risen. Therefore, Chinese metal consumers reduce the inventories and also import less. The decline of imports is widely regards as a sign of slower economic activity in China. The summer season is also a period of normally lower import volumes. This could lead to further fears of a global economic slow-down.

The stock markets have recovered from the plunge following the unrest in the MENA region and the earthquake in Japan with all its negative consequences. However, the rise of US equity markets since late August last year was driven by the announcement of QE2. Next month, the Fed will terminate QE2 as scheduled. This does not necessarily lead to a correction in stock markets. However, even if the US (and also the European) equity markets consolidate at a high plateau, the year-over-year percentage change is probably going to decline. The performance of the US stock market is also highly correlated with the ISM index. Thus, lower yoy-performance of the S&P 500 is likely to be accompanied by a declining ISM Index. This would be a negative for metal markets over the summer months.

All in all, we conclude that there is currently a mix of overreaction triggered by the ECB press conference as well as a cloudier fundamental outlook. Thus, we would recommend bargain hunters to keep the powder try.

Commodity markets in panic

This was a very negative week for commodity markets in general, not only for the metals. The fundamentals have not changed in such a way that plunging prices in most markets were justified. Academic research tried to convince that commodity prices follow purely the fundamentals and that speculation did not play any role for price movements. This research is based on tests of Granger causality. However, those tests are not appropriate to measure the influence of speculators on commodity prices. If speculators buy or sell commodities, it has an immediate impact on prices as soon as the buy or sell button is hit and the order is rooted to the exchanges. As prices change simultaneously with changes in the positions of large speculators, and not with a delay of one period, Granger tests conclude that speculation would not have an impact on prices. However, when the CFTC publishes its next CoT report on Friday, May 13, we would not be surprised to see considerable declines in the net-long positions of the non-commercials.

Silver already consolidated at the beginning of last week. It is not an unusual behavior that bulls would need to take a breather after reaching a long-term high following a strong rally. One argument was that small speculators liquidated long positions after the Comex increased margin requirements. It is quite normal that margin requirements increase if volatility rises or prices have risen strongly. This should not come as a surprise to speculators who have done their homework. It is also not a convincing argument that increasing the margin requirements would increase the costs of holding a position in a future as T-Bills could be deposited as margin.

The decline of precious metals and crude oil prices at the start of last week could also be explained by the death of Osama bin Laden. The market has regarded this as a reduction of geo-political and terror risks. However, this might be the wrong conclusion.

The economic data last week was dominated by the purchasing manager indices. While the manufacturing PMI in the US and eurozone came in higher than expected, the non-manufacturing PMI in the US dropped stronger than expected, but remained well above the crucial 50 mark. Looking at the various PMI charts, it should be obvious that readings above 60 are not sustainable for a longer period. They often come back to the mid-50 level, which still points to sustained economic expansion. Based on our models, we regard the manufacturing PMI as more important for the commodity demand and they are still at high levels.

The plunge in commodity markets set in on Thursday and might have been triggered by two factors. First, the weekly initial jobless claims rose to 475K, which was not expected and intensified fears of an economic slow-down. Second, at the same time, the ECB held its press conference. The market obviously speculated that the ECB would prepare the market for a rate hike in June. However, this was not a very rational expectation. At the start of a new tightening cycle, the ECB usually does not hike in a two month interval. Furthermore, at the June meeting, the ECB will present its own staff projections and the survey of professional forecasters. It was far more likely that the ECB would wait for new information at the June meeting and then prepare the markets for a rate hike in early July. Also the wording, inflation risks have to be monitored very closely, is an indication that another rate hike is in the pipeline. The outlook for the ECB refinancing rate has not changed. Many forecasters still expect that the refi rate would be at 2% in December or early January 2012. Therefore, nothing has really changed except that the next step might take place in July.

Nevertheless, as the ECB had not use the key words “strong vigilance” the markets panicked. At foreign exchange markets, the euro was sold off against the US dollar. A stronger US dollar then triggered also massive selling of commodities across the board. On Friday, markets initially stabilized and the higher than expected non-farm payrolls in the US were also helpful. However, then Spiegel-online, the web-site of a German weekly magazine reported that Greece would declare to leave the euro at a conference of EU finance ministers later in the evening, the euro dropped again and also some commodities came under renewed pressure. However, according to the treaties, Greece could not leave the euro without also leaving the EU. The Greece finance minister denied immediately that Greece would seek to leave the euro. Also eurozone finance ministers made it clear later that Greece can not leave the euro and that a debt restructuring is also not at the table. However, the damage was already done. Thus, still anybody believing that speculation has no impact on prices?