Madame NO weighs on precious metals

The precious metals suffered during the course of the week and all metals ended in the red. Gold held best with a loss of only 2.5%, while silver and platinum were down by 4.0% each and palladium was the worst performer with a loss of 6.4% over the week. The three major fundamental factors of our quantitative fair value models all had a negative impact on the precious metals. The US dollar index strengthened while the S&P 500 index and crude oil fell and thus signal slower future economic activity and a declining inflation risk.

However, there remains one common factor behind the fundamental variables of our fair value models, the never ending debt crisis in the eurozone. Spain was now the fifth country in the eurozone, in which the debt crisis led to a change of the government. The conservative people’s party gained a broad majority of the seats in parliament and its leader Mr. Rajoy will become the next prime minister. Already during the election campaign, he indicated that more austerity measures and economic reforms would be needed to regain confidence of investors in Spanish government bonds. But investors gave Spain the cold shoulder. At an auction of short-term bills, Spain had to pay interest rates at a record high since the introduction of the single currency in 1999. The lackluster auction also led to rising yields on longer dated government bonds. The ECB bought Spanish paper, but the amount was not sufficient to prevent yields to rise.

At the beginning of last week, French government bond yields rose after a report from Moody’s was understood as an indication that France could loose the AAA rating soon. An economist at this rating agency warned that "Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications". This demonstrates how dangerous it is, when an economist chooses the wrong reference. Elevated could refer to the average of historical yields, but even at around 3.7%, yields on 10yr French OATs are relatively low by historical standards. The spread of almost 170bp over 10yr Bunds is rather high. However, is the 10yr yield spread the appropriate benchmark to judge the creditworthiness of France? The answer is absolutely no, from our point of view. The right comparison would be either nominal bond yields with nominal GDP growth or real yields with real GDP growth. At the current eurozone inflation rate of 3.0%, the real yield on 10yr French OATs is just 0.7%. The projected real GDP growth for 2012 is currently at 0.5%. As France is also implementing measures to reduce the budget deficit further, the difference between the real yield and real GDP growth rate should hardly give any concern about the creditworthiness of France. It appears again that rating agencies, which were a major culprit of the debt crisis in 2008, attack those who came to the rescue, namely the governments.

Many investors, but also politicians, thought that Germany would be the safe haven. Even when other core countries with a triple A-rating came under pressure, yields on 10yr German Bunds declined to a recorded low of 1.65%. Germany appeared to be the only solid rock. But last week, also Germany came under pressure. The auction of 10yr Bunds was a disaster and shows that investors are no longer willing to fund the budget deficit of the federal government, which will increase next year according to the 2012 budget. The German debt management agency planed to sell 6bn euro of 10yr paper, but investors bid for only 4bn euro. Thus, the remaining 2bn euro of 10yr Bunds will now be sold by the Deutsche Bundesbank in the open market. The Wall Street Journal accused Germany that it would accept the Bundesbank buying Bunds but would resist that the ECB buys bonds of other eurozone member countries. However, the WSJ did not understand the procedure. The Bundesbank only acts as a fiscal agent for the government. It is not buying the Bunds from the German government. The federal government will only receive the funds after the Bundesbank has sold the paper in the secondary market.

Nevertheless, the WSJ is right in pointing out that Madame NO is the major problem for solving the debt crisis. German chancellor Merkel is not only opposing the introduction of Eurobonds but even wants to oppress any discussion about this instrument, as her attacks on the head of the EU Commission, Mr. Baroso, showed last week. She also opposes that the ECB acts as the lender of last resort. As the debt crisis turned into a wide spread crisis of confidence, the ECB is the only institution, which has sufficient funds available to bring yields down to a sustainable level and to prevent further escalation of the debt crisis. The EFSF will fail miserable to reach the target level as press reports revealed over this weekend. Mrs. Merkel and her consultants are obsessed that solving the debt crisis would lead to a transfer union or rising inflation. In her naivety, Madame NO believes that a change of EU treaties would be sufficient to restore confidence.

The market for government bonds in the eurozone has been destroyed. The root cause is the ballooning Greece budget deficit during the Karamanlis government. However, the German chancellor played a major role that the initial problem could not be contained and the contagion now reached even the core countries of the eurozone. The demand that private investors would have to pay for the bailout of Greece while sovereign creditors get fully repaid was a major blow for holding government bonds. But also the European Banking Authority eba contributed to the destruction of the government bond market by several changes of regulations, which all lead to banks selling government bonds in a market, which is not ready to absorb them. It is a major construction failure of the euro that the ECB is not officially the lender of last resort. As long as Madame NO rejects all proposals which would involve a determined buying of eurozone government bonds by the ECB in the secondary market, the debt crisis will still prevail. For precious metals, this is a negative development. The current correction is likely to continue this week, unless there will be a convincing breakthrough to solve the eurozone debt crisis.

Precious metals dragged down by eurozone debt crisis

At the start of last week, gold approached the 1,800$/oz mark again, but reversed direction and closed lower. During the course of the week, gold headed further down and ended the week at 1,723$/oz, a loss of 3.6% over the week. Also other precious metals ended the week lower.

It might sound like a broken record, but the reason for the weak performance of the precious metals has been the never ending story of the debt crisis in the eurozone. After Mr. Berlusconi resigned and Italian President Napolitani asked former EU commissioner Mario Monti to form a new government, the financial markets got concerned that technocrat led governments in Italy and Greece would lack the skills of politicians. The week before, a major concern of financial markets was that politicians would not be able to solve the problems. This demonstrates how much financial markets are in panic. One week they are spooked by one factor and the next week just by the opposite. In Greece and Italy, technocrats now lead the new governments and in both countries, the new leaders have won confidence votes. Nevertheless, the debt crisis in the eurozone worsened further.

Yields on 10 year Italian BTP rose again above the 7% mark temporarily. After an auction of Spanish paper, where the yield was higher than at a comparable auction in October, also the yield on 10 year Spanish government bonds rose to the 7% level, which the markets regards as crucial because other eurozone countries asked for a bail-out once yields rose above this level. However, purchases by the ECB helped to push yields lower again. But the crisis is not contained to these two countries. Instead it has now also reached the core countries. France and Austria have both a triple A-rating, nevertheless, the spreads of 10 year bonds of both countries widened last week considerably over the benchmark German Bunds and reached almost 200bp.

The only institution, which could stop the panic in financial markets, is the ECB. During a conference last Friday in Frankfurt, Germany, the ECP president Draghi as well as the head of the Bundesbank Weidmann made it clear that they oppose to be the lender of last resort. Mr. Weidmann is even opposing the current purchases of government bonds in the secondary market. Also German chancellor Merkel still rejects calls that the ECB should be the lender of last resort and should assure the markets by setting a line in the sand for the yields on government bonds and defending this line by unlimited interventions. The common fear is that such a defense would lead to inflation.

Those fears appear to be overdone for several reasons. First, buying government bonds is not just printing new money. It is a traditional instrument of monetary policy to provide liquidity for the banking system by open market policy operations. Thus, the ECB could absorb the liquidity provided by open market operation by reducing the allotments in the weekly repurchase agreements. Second, even the announcement to buy unlimited amounts of government bonds to keep yields at a certain level does not necessarily lead to an increase of central bank money. Often the markets adjust to the target level and only smaller amounts are required to convince financial markets. A recent example has been the peg of the Swiss franc to the euro by the Swiss National Bank. Third, even in the case that the central bank money stock increases, the monetary impulse has to be transmitted to the real economy. The banking system has to increase the lending activities to governments and the private sector. However, banks in the eurozone reduce the holdings of government debt. The requirements to increase core capital ratios have also a dampening effect on lending to the private sector. Therefore, from our point of view, the risk of accelerating inflation rates as a result of acting as lender of last resort is overemphasized by the ECB.

As long as the debt crisis in the eurozone remains unsolved, it has to be expected that weaker stock markets, declining crude oil prices and a firmer US dollar will weigh on precious metals. In addition, also a technical indicator, the MACD, points to a trend reversal in gold. Thus, the correction in precious metals, which started last week is likely to continue.

Safe haven buying versus the fundamentals

In calls from journalists, the author of this blog is often asked lately, why precious metals declined during days the debt crisis in the eurozone worsened. This crisis has two effects. On the one hand, as politicians are unable to find a quick and convincing solution, there is an incentive to buy precious metals as a safe haven. However, one should not forget that this crisis now lasts for already two years. Thus, there was ample opportunity to buy precious metals and new buyers would have to enter the markets to push prices higher. On the other hand, the debt crisis also has an impact on the fundamentals of the precious metals. An escalation of the debt crisis normally has a negative impact on these fundamentals. Therefore, selling of precious metals driven by the fundamentals could have a stronger impact on the price development than the safe haven buying. But prices could also rise on days of slight improvements in the eurozone as buying driven by the fundamental factors outweighs the possible profit taking by safe haven investors.

Last week, all precious metals posted gains compared to the preceding weekly close. However, it was an up and down trading, where on one day safe haven buying dominated and fundamentals were the stronger influence during the other days. But on all days, political developments rather than economic data were at centre stage.

In the preceding week, Greece was in the spotlight. But after Mr. Papandreou won the confidence vote late Friday night, some movement came into the political landscape. After the publication of the previous blog article, also the conservative New Democracy party agreed to the formation of a national unity government. While it took some time to form a new government, there was finally an agreement that Mr. Papademos, the former ECB vice president, should lead the new government. Last Friday, he was sworn in.

However, last week, Greece was more on the sidelines and Italy was on centre stage. After protests over the preceding weekend and declining support from his own coalition parties, financial markets expected Mr. Berlusconi to loose a vote in parliament in Monday and to resign immediately. From various comments in the media, we got the impression that many market participants did not fully understand what the subject of the vote was. In Italy, the parliament has to approve the report of the PM about the preceding fiscal year’s budget. The parliament voted last Monday on the report for the 2010 budget, but many commentators were under the impression it would be a vote on a budget for a future fiscal year. The opposition parties abstained from voting, there was no risk for some former supporters of Mr. Berlusconi to demonstrate their dissatisfaction by not voting with a yes. Thus, the report was approved by parliament but not with the absolute majority.

But in financial markets, there was widespread disappointment. Some commentators were disappointed that the report was approved while other commentators were emphasizing that Mr. Berlusconi failed the absolute majority was the reason for the negative market reaction. However, gold and other precious metals profited from their safe haven status. Late Monday, after consultations with the president of the Republic of Italy, Mr. Berlusconi announced to resign after a reform package promised to the EU leaders has passed both houses of parliament. On Saturday, Mr. Berlusconi resigned and at the time of publishing this article, President Napolitano was still in consultations before announcing who should form a new government. Markets expect that former EU commissioner Mario Monti would be the next PM in Italy.

In the bond markets, the 2010 budget report had a devastating impact on Tuesday. The yields of Italian government bonds soared over all maturities. The yield on 10yr BTPs reached 7.5% in the peak. This massive sell off weakened the euro and stock markets. Thus, negative fundamentals weighed on precious metals. While the ECB was reported to buy Italian bonds, the purchases intensified towards the end of the week. This brought yields significantly down. Stock markets and the euro recovered. Thus, on Friday, precious metals rose also significantly driven by positive fundamental factors.

The panic in financial markets can only be stopped if the ECB accepts the role of the lender of last resort for government bonds in the eurozone, despite resistance from Germans. Well conducted, it is by no means inflationary. However, it would be far more effective to prevent a recession than another 25bp rate cut. For precious metals, it would also be positive. Unfounded fears of inflation accelerating might be a reason for some buyers. But the main factor would be improving fundamentals for the demand for precious metals by recovering stock markets and a firmer euro.

The Greek Tragedy and Precious Metals

Last week, we argued that the comments from German finance minister Schaeuble concerning the markets initial reaction on the EU summit could lead to declining prices in precious metals markets. While this remarks also played a role, two other actors entered the stage on Monday and one of them moved even to centre stage for the whole week and is likely the dominating figure this week.

The first actor was the Bank of Japan, which intervened in foreign exchange markets to weaken the Japanese yen against the US dollar. The BoJ already intervened on several occasions before. Thus, it should not have come as a total surprise that the BoJ would try to prevent a further strengthening of the yen. The yen was regarded as one of the safe havens. This is very strange with respect to two factors. First, the earthquake and the Fukushima disaster have hurt the Japanese economy, which is in a recession. GDP dropped in Q2 by 1.1% compared to the same quarter of the preceding year. Industrial production in September was down 4.0% yoy and the trend is still further down. Currencies of an economy being in recession usually tend to depreciate but this is not the case for the Japanese Yen.

Second, government debt in relation to GDP in the US and in Europe appears to be a major concern for investors. However, the debt/GDP ratio in Japan is exceeding those ratios in the other industrialized regions by far, being around 200%. According to the criteria presented by Professors Kenneth Rogoff and Carmen Reinhard, Japan should already be beyond the point of no return and bankrupt. However, as the example of Japan shows, some critical ratios are not set in stone. The level of interest rates on government debt is also a crucial variable in the calculation at which debt/GDP ratio the interest payments are unbearable. With a yield on 10yr JGBs of just 1.0%, Japan is in a far more comfortable position.

Especially former and current German members of the ECB council should have a look at Japan. The quantitative easing of the BoJ contributed significantly to the decline of yields on 10yr government bonds. Despite the extension of the balance sheet by the BoJ, inflation has not emerged in Japan. Of course, one could not transfer the situation and monetary policy response in Japan on a 1:1 basis to the eurozone. Nevertheless, buying of government bonds of those countries in the eurozone, which came under attack from financial markets, is not a sure way to inflation.

After the Swiss National Bank pegged the Swiss franc to the euro, the appreciation of the yen increased. The yen fell to 75.5 at the last day of October. This induced the BoJ to intervene. The US dollar did not only firm against the yen, but also against other major currencies. This dollar strength send stock markets lower, which also pulled crude oil lower. As investors risk aversion increased, also yields on safe haven government bonds like the US Treasury paper or German Bunds dropped. In addition, the Schaeuble remarks contributed to a flight into Bunds as investors worried about the still open details of the EU summit package. As a result, also precious metals had been sold.

However, the centre stage was taken on late Monday by the Greek PM Papandreou, who announced to hold a confidence vote in parliament and later a referendum by the population. It was not clear, what would be the question for the referendum. However, given the polls on the rescue package decided at the EU summit, the markets feared that Greece would vote with a “no” in a referendum. This increased uncertainty send risky assets lower and safe haven Bunds and US Treasury notes higher. Precious metals initially fell further, but could already recover on Tuesday. The situation calmed somewhat after German Chancellor Merkel and French President Sarkozy called for a meeting with Greece’s PM Papandreou on Wednesday ahead of the 2day G20 summit. Both demanded that a referendum should be about Greece staying or leaving the eurozone. Furthermore, they announced that no funds would flow to Greece as long as the bailout package decided the week before will be fully implemented.

Holding a referendum on remaining a member of the euro would have been like playing with matches at a fill station. As soon as such a referendum had been called officially, the only rational behavior would be to withdraw all deposits with banks in Greece and transfer them to banks in other eurozone countries. If the result of a referendum would be to leave the euro, the new Greek currency would depreciate against the euro. Thus, one would make a profit. If the majority voted for staying in the eurozone, no currency gain would be made. However, there would be also no loss. Therefore, the financial system in Greece would have collapsed like a house of cards even before a referendum took place.

One Thursday, some movement came into the Greek political landscape. The finance minister opposed holding a referendum on staying in the eurozone. The PM Papandreou offered to give way to a coalition government of “national unity”, which should stay in power for some months to push all necessary legislation through parliament to implement the rescue package as agreed at the EU summit. Also opposition parties moved and showed some willingness to cooperate, but demands for snap elections in December remained on the table.

Friday night, PM Papandreou survived the confidence vote in the parliament. However, it is quite unclear how the political situation in Greece will develop. The major opposition party New Democracy insists on immediate snap elections. Some other parties in the centre appear to be willing to form a coalition government with currently ruling PASOK party. The main problem is that the party responsible for the mess torpedoes the clean-up work of the incumbent government to return back to power as soon as possible. Mrs. Merkel and Mr. Sarkozy should also make a strong call to Mr. Samaras, the leader of the New Democracy. All three are associated within the European Peoples Party, the conservative party in the EU parliament. But as long as Mr. Samaras puts his own interests above those of the Greece population, a solution appears hard to find. Thus, the political developments in particular in Greece, but also within the eurozone, are most likely the dominating factor for financial and metals markets. Investors should be on the defensive side as strong movements in both directions appear to be possible.  

A solution à la Cosa Nostra

One part of the business model of organizations belonging to the Cosa Nostra is to sell and to provide protection. However, what differentiates the mobsters from legal companies is that the mafia extorts protection money from unwilling customers by inflicting the damage, against which they are promised to get protected. Last Wednesday, Charles Dellara, the chief negotiator of the International Institute of Finance (IIF), a Washington DC based organization representing financial institutions, must have felt like a small shop owner in little Italy getting a visit from racketeers. Before the summit of EU head of states started on Wednesday, October 26, negotiations between the IIF and the EU on a higher voluntarily hair-cut for Greece debt reached a deadlock. At midnight, Mr. Dellara was asked to join the meeting of the eurozone head of states, where they faced him with the alternative either to accept a 50% hair-cut or Greece would default. Mr. Dellara accepted the lesser evil.

After the IIF agreed on a higher hair-cut, it took the eurozone head of states another four hours to reach a compromise on a package of measures. Banks will have to be recapitalized by a total amount of about 100bn euro. Also the EFSF, the European Financial Stability Facility, will be leveraged. Despite many details are still open, the financial markets welcomed the compromise.

However, it appears that the German finance minister Schaeuble is resistant against learning from past mistakes. Already after the EU summit in July, negative comments from Mr. Schaeuble increased the uncertainty among financial market participants and contributed to the rise of yields on peripheral government bonds and also a spill-over to the core countries. Now only two days after the summit ended, it is again Mr. Schaeuble warning against expecting too much from the summit. It would be a long way and many more summits would be required until the debt crisis in the eurozone is solved. Also outgoing ECB president Trichet sounded the same warnings in a newspaper interview.

Those warnings are counterproductive. Instead of giving the markets some hope that the crisis will be solved, those comments suggest that the worst might not yet be reached. Like Bill Clinton told former US president Bush senior in the presidential election campaign “It’s the economy, stupid” the German finance minister has to be told “It’s the market psychology, stupid”.

But the risk is not only that the financial markets might pare gains following the remarks from the German finance minister and the outgoing ECB president. The turmoil in financial markets during August and September had also an impact on business survey data. While real economic activity data remained resilient, the US GDP even grew stronger in Q3 than in Q2, expectations for future economic activity worsened, in particular in the eurozone. In the case that financial markets pare gains following the comments from the German finance minister, the already depressed business expectations could drop further. Then it would be only a question of time that falling business expectations also drag business activities down.

Gold posted the strongest daily gain last week on Tuesday after the press release that the summit of EU-27 finance ministers, originally scheduled to talk place a few hours before the summit of the EU head of states, was cancelled. Many market participants and commentators were confused by this headline. They did not realize that the decisive summit is the one of the head of states. Thus, even at Bloomberg TV, the commentator gave the initial impression that there would be another postponement of the EU summit and a failure to find a compromise for a solution. However, as it got clear that the summit would take place, gold defended the gains. Also stock markets pared losses. We interpret the recovery of stock markets on Wednesday and the rally on Thursday as the decisive factor that gold held the gains and even advanced further to close the week with a gain of more than 100$/oz compared to the preceding weekly close.

The outlook for gold and other precious metals will thus depend on the market reaction on the warnings from the German finance minister. If Mr. Schaeuble’s remarks lead again to turbulences in stock markets, precious metals are likely to be dragged lower. However, if the market will ignore him this time, then stock markets might recover further as economic data recently come in better than expected. This would also be supportive for the precious metals.  

Eurzone debt crisis still moves gold price

The situation in Greece gets more and more severe, despite the eurozone finance ministers decided to transfer the next tranche of the bailout funds. The Greek government pushes one austerity measure after the other through parliament while protests and strikes don’t come to an end. The fall of Greek GDP growth accelerates with each austerity measure passing legislation procedures. At the same time, gold and other precious metals trade far below their highs made this year. Therefore, some commentators ask the question whether gold still serves as a safe haven and whether the eurozone debt crisis still has an impact on the price of precious metals.

Of course, gold is still a safe haven. Otherwise, it would not have rallied to prices above 1,900$/oz in September. However, even prices of an asset serving as a safe haven could fluctuate. If there is a wave of save haven buying, as it was the case over the summer, demand has to increase permanently to absorb supply, which usually increases with rising prices. Once the rush to a safe haven subsides, also prices retrace. Or put it in other words, once the last seeker of a safe haven has bought, who is left to push prices still higher? If those investors who bought gold were no longer convinced that it is still a safe haven, they would sell gold and prices would be much lower.

Therefore, we can draw a first conclusion. Gold is still a safe haven but the eurozone debt crisis is no longer leading to sufficiently high safe haven buying to lift gold prices to new record highs. However, the question arises, how is this compatible with observations that negative news related to the eurozone debt crisis does not lead to short term price increases but to falling gold and other precious metal prices?

The answer is rather easy. Precious metal prices follow again more closely those fundamental drivers, which are highly significant in our quantitative fair value models. The three major fundamental factors are the stock markets, the price of crude oil and the US dollar, either versus the euro or versus the basket of the major currencies as measured by the US Dollar Index (USDX). And these factors are currently still heavily influenced by the development of the eurozone debt crisis. However, negative news with respect to a solution of the debt crisis has a negative impact on the fundamental factors, which finally also have a negative impact on the prices for precious metals.

We have now an approach to explain the price movements of the precious metals with respect to the debt crisis in the eurozone. However, this approach is not very helpful in predicting even the short-term direction of precious metal prices. The reason for this failure is the lack of reliability and credibility of European politicians. For example, last week at the G20 summit, the finance ministers of the eurozone promised to deliver a solution at the EU summit taking place today at October 23. But already the following Monday morning, the German finance minister paddled back and stated that a final solution to the debt crisis should not be expected at this summit. Thus, gold initially rose in line with stock markets and a firmer euro against the US dollar, but turned negative after the comments from Mr. Schaeuble. It is already hard to understand that investors buy bonds with a negative real return, but it is even harder to understand that they also buy bonds of a country, whose finance minister is no longer trustworthy.

It remains doubtful that the eurozone politicians will find a solution at the EU summits taking place on October 23 and 26. France and Germany are split in the crucial question how the EFSF could be leveraged. Many German commentators already get scary when they hear the word leverage. Furthermore, the German position is driving more by ideology and dogmas. Therefore, Germany favors a model of guarantying a part of the nominal value of government bonds against a default. The position of France is more pragmatic by favoring to provide the EFSF with a banking licence, which would open the EFSF the access to the repo facilities of the ECB, like for every other bank within the eurozone.

Thus, we can only come to the conclusion that gold would probably fall below the 1,600$/oz mark if the eurozone fails to deliver a convincing solution. However, if finally the eurozone delivers a package of measures that convince financial markets and therefore, also reduces the uncertainty within the real economy, then stock markets, the euro and also the precious metals are likely to rally. 

Recovery of the euro supports gold

One of the factors contributing to the fall of gold and other precious metals in late September was the weakness of the euro versus the US dollar. Beside the inability of politicians to solve the debt crisis in the eurozone and fears that the troika of IMF, EU and ECB would block the payment of the next tranche of bailout funds, the euro weakened also on speculation that the ECB would quickly reverse the direction of monetary policy. However, the ECB disappointed hopes to cut rates already at the October council meeting. The ECB repeated its stance in the monthly bulletin released last week. Inflation is expected to stay high during the final months of this year and is expected to decline next year. The risks for economic activity have increased due to the heightened uncertainty, especially in financial markets.

At least, the ECB forecast appears to be right for the trend of consumer price inflation. In the eurozone, the HICP inflation rate increased to 3.0% in September after 2.5% in August. Also the core inflation rate increased to 1.6% from 1.2% in August. Now also the underlying trend of inflation is getting closer to the crucial 2% mark. Thus, before cutting interest rates and embarking on a more expansionary monetary policy, the rate setting council might wait until the inflation data indicates that the peak has been reached. This would argue more for a rate cut at the end of this year or the beginning of 2012.

The fall of the manufacturing PMI for the eurozone to 49 in September and to 48.5 in October was probably a factor contributing to the warning of the ECB that downside risks for economic activity have increased. However, is seems that the turbulences in financial markets had an impact on the PMI, while actual economic activity is affected far less by the plunge of stock markets in August and September. The consensus of City economists expected that industrial production in the eurozone would decline by 0.8% in August. Instead industrial output increased by 1.2% on the month. While the fall of the PMI below the 50 threshold indicated a contraction in the manufacturing sector, industrial production expanded even faster than in July, which had been revised up to +1.1%. Despite increased risks, they have not yet materialized.

Thus, the ECB appears to be in a fix. Cutting rates early despite still robust economic activity data and inflation above the target by a full percentage point could prevent inflation to come down significantly next year. Waiting too long with a rate could bear the risk that economic activity eventually follows the PMI indicators down and that a possible downswing might be aggravated. This also indicates that the ECB would not be as quick in cutting interest rates as the market consensus had expected.

Keeping interest rates on hold will have an impact on gold and other precious metals via two channels. First, it has an impact on the exchange rate of the euro versus the US dollar. As long as money market rates remain higher in the eurozone compared to the US, there is an incentive to invest funds in the euro instead of the dollar. However, in this context also the eurozone debt crisis and the impact on the banking system play a crucial role. Plans to shield banks against the fallout of a possible default of Greece could reduce the risk of investing funds with European banks and thus could also contribute to a further appreciation of the euro versus the US dollar.

The second channel is via stock markets and risk appetite of investors. A delay of a rate cut due to firm economic data could reduce the fear that the global economy would head towards a recession. Value oriented investors already regard stock valuations as cheap after the drop in August and September. Thus, the risk appetite of investors could increase further and push stock market indices higher. A higher risk appetite would also be positive for gold and other precious metals.

Despite the better than expected economic data in the eurozone and also the US, the crucial factor remains the debt crisis in the eurozone. The G20 finance ministers urged the eurozone to present a solution to the debt crisis within one week at the next EU summit. Germany’s finance minister promised that the eurozone would deliver a solution. If it will be one convincing the markets, the euro might firm further and precious metals would probably be a beneficiary.