In The Lead – The Euro Pit and the Chinese Pendulum


Precious Metals CommentaryGold staged an attempted recovery this morning following Thursday’s washout in prices that brought it to within striking distance of the pivotal $1,700 level. As things stood early this morning, the yellow metal was on course to record its largest weekly decline in circa two months’ time. Ironically, the vast majority of participants in various weekly price surveys were bullish on bullion’s prospects for this week last Friday.

However, this week’s near total eurozone meltdown and erosion in the common currency derailed the bullish track for precious metals and ended up bolstering the dollar instead. The greenback traded at a five-week high against an assorted basket of currencies mainly on the back of "lesser of all evils" perceptions and a continuing string of fairly positive US economic statistics coming into the news pipelines. In fact, based on the findings that the US economy is growing at the fastest pace of the current year and also at the best such pace in a year-and-a-half, it is not all that surprising that anxiety-ridden money is finding its way into America (via the dollar) at this juncture. What and where are the alternatives?

Spot dealings in New York opened on a mildly higher note this morning but players remained wary of pre-weekend book-squaring effects and of further negative news emanating from Europe. Some feel that the sell-offs might not be complete and that any further damage in the equity markets might bring about margin call situations which might prompt additional mobilization of precious metals positions.

For the time being, the maintenance of the $1,700 mark is critical for gold, as is the $30-31 zone for silver. The white metal fell hard on Thursday and overnight lows were recorded just under $31 per ounce. The persistent fear in the gold and silver markets remains the possible drying up of money markets in Europe in a liquidity squeeze. Little question remains as to the fact that metals would suffer under such a dire scenario (among other assets).

Gold opened with a gain of $9.60 per ounce but soon traded back down in negative territory and under the $1,720 level, while silver initially added 37 cents on the open and later traded under the $32 level per ounce again. Traders we polled in New York this morning indicated that the day could still end in the "red" but that it all depends on euro-flavored news at this juncture. The iShares Silver Trust (SLV) declined almost 7% yesterday and by this morning the SGE hiked silver margin requirements up to 18% of a contract’s value. The white metal has been on a nausea-inducing up/down/up/down path ever since it touched the $50 mark in late April and then fell into a bear market.

It is assumed that the new margin parameters will come into effect on Monday. There is still a chance of further such increases in required margins if today’s action goes beyond daily trade limits. Analysts pointed out that silver’s extreme volatility (since late April) has made for a very skittish Shanghai Gold Exchange — one that sees the price roller-coaster continuing, and one that aims to prevent devastating losses among small traders. Thus, the fresh record in silver contract margin amounts. Enough said.

Platinum advanced $10 to start the final trading session of the week at $1,591.00 while palladium was unable to join the group and went the other way with a decline of $1 per ounce and a quote on the bid-side at $607 at the opening bell. Copper and crude also made attempts at damage repair with gains of 1.6% and 0.9% respectively. The US dollar paused and slipped to under the 78 level on the trade-weighted index while the euro made efforts to get back closer to the $1.36 mark against it.

One fund manager whose view is not exactly bullish on gold is using the indicators currently flashing in the bond markets to make his case. Michael Gayed, chief investment strategist at Pension Partners LLC, notes that normally investors load up on gold in anticipation of severe inflation and when real interest rates are or are trending negative.

However, writes Mr. Gayed, "if the bond market is [currently] right, then we may be entering into a period where we are no longer in a negative real rate environment. If we are headed into deflation, that means the any interest rate which is above 0% results in a positive real rate environment (due to negative inflation). This is not an environment historically Gold can do well. That means that despite arguments that Gold continues to outperform Treasury paper, it could very well be that the pendulum swings to Treasuries outperforming Gold."

Mr. Gayed uses the ratio of the IEF (the T-bond ETF) versus the GLD to measure such pendulum swings in the cycle. Right now, and as of mid-August, the ratio of the two ETFs appears to not only have bottomed but it also shows the "early stages of an uptrend."

Mr. Gayed notes that "This would occur under a scenario of long-term deflationary expectations taking hold in the psyche of investors. It looks like we may be entering a period where paper beats rock."

No mention of scissors needed.

Over in Europe disaccord between France and Germany regarding the role that the ECB ought to play in the unfolding debt drama remained front-page news material this morning. The measures that were agreed upon at the late October summit by European leaders have yet to be implemented and the markets continue to await the materialization of austerity programs in Italy and in Greece. Meanwhile, bond yield of various eurozone countries continue to be rising and the 7% figure keeps coming up as the one beyond which danger/default/rescue paradigms could be lurking. Only Germany and the Netherlands appear currently immune to the effects of the crisis as regards bond yields.

While the Franco-German debate about how to keep the eurozone afloat rages on, there are signs that certain parties are still willing to help. Having come to what World Bank President Zoellick describes as the "tipping point," the European Union really needs to get its members to come to an accord and produce a concrete plan to stop the crisis in its tracks. China, Australia, Canada, and the USA, are all apparently ready to support the region via the auspices of the IMF if in fact an agreement is arrived at by the union’s policy makers. Obviously, all of the countries on that list have vested interests in Europe and would potentially suffer collateral damage if the situation were to be allowed to disintegrate into a chaotic free-for-all.

For now, the latest proposal (and one that appears to be gaining traction) is to have the ECB lend money to the IMF which in turn would use such funds to bail out one or another de facto insolvent eurozone nation. It is widely assumed that Germany and the ECB itself might be against such an idea but it is also widely accepted that the EU has run out of ideas, solutions, and the amount of road still ahead of it before a do or die decision has to be made. This morning’s market chatter was once again pointing to a modicum of bond-buying by the ECB as having taken place. The "Big Plan." Will it be this weekend? Will it be next? Only "The Shadow" knows…

No week would be complete if we did not mention that all-important (for commodity players) country: China. There, we just did. The country’s regulators are (once again) warning that funds for certain locally-backed property development projects may soon run out. The CBRC urged lenders last week to clean up their act and step up asset sales and debt restructuring while it urged banks to curtail (make that: cut) lending to "high-risk" projects.

The ratchet-tightening by Chinese officials comes amid an unmistakable slump in property prices. Chinese housing prices fell in nearly 50% of government-monitored cities last month. Now there’s a switch from what appeared to be an endless upward spiral. Analyst opine that the "turning point" in Chinese property values is upon us (possibly along with the turning point in the country’s economy). We close today with words of wisdom from neighboring Hong Kong:

"The government should start to be cautious about property prices over correcting on the downside as it will inevitably affect the economy," Wee Liat Lee, a Hong Kong-based property analyst at Samsung Securities Co., said in an e-mail. [to Bloomberg News].

When residential property accounts for 6.1% of a country’s GDP and when such a pivot point threatens to potentially wreak havoc on that sector, commodity bulls are well-advised to remain vigilant. Pendulums are made to swing. Heads (and wallets) are at risk when such objects swing above.

Have a pleasant weekend,

Jon Nadler
Senior Metals Analyst — Kitco Metals

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication. and

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