Draghi's interest rate status quo and impact on precious metals

By Jon Nadler
Taking into consideration the apparent calm that has settled over Europe's financial skies in recent weeks, ECB President Mario Draghi served up a healthy dose of risk-taking treats to precious metals, oil, and euro-oriented bulls yesterday. By leaving the ECB's key rate unchanged, Draghi did not imply that victory was at hand over the conditions that roiled Old World markets during most of 2012.

Draghi also did not imply that regional economic conditions were suddenly rosy; au contraire, recent gauges of economic activity showed additional deterioration and only a modicum of stabilization trends. In one sense, Draghi took a page from the Fed's policy playbook and indirectly said that his institution could/would act provided that conditions worsen –but only then. Otherwise, it is a case of status quo.

You will recall that last week, at least two FOMC members who are regional Fed Presidents, expressed some reservations about continued loose Fed monetary policies. In light of the fact that the prices of certain assets such as bonds, agricultural land, and leveraged loans are in quasi-bubble territory, the Fed's more hawkish voting members raised the specter that a prolonged period of zero-level interest rates might have not-so-welcome consequences not only now, but certainly down the road.

What Draghi's decision ultimately implied was the fact that a minor rate tweak at this juncture would not have done much to alter things. ECB watchers believe that Draghi may have also had one eye on the recent plunge in Spanish bond yields (to under 5%!) and thereby came to the conclusion that (at least) the bond vigilantes have been temporarily silenced by the prospect of the possible OMT program that was recently floated in EU/ECB summits.

In any case, the result of the ECB non-maneuver became apparent in a hurry: the euro climbed 1.48% against the greenback while the latter lost 1.1% on the trade-weighted index (dropping to 79.74 yesterday afternoon). Crude oil moved 0.85% higher ( to a three-month high near $94) on the session as traders flocked to commodities as a group.

The commodities' asset class rose to its highest level in eleven weeks on the back of the ECB (non-) move. Our good friend George Gero of RBC Capital in New York characterized Thursday as a "good risk-on day." We won't disagree, but still find it disconcerting in an "old school" sense of things to have to lump gold into the "risky" asset basket.

The dollar's losses also translated into a finally better day in the precious metals' complex. Gold gained over 1.1% on the session and reached a high of $1,680 before settling at $1,000 per ounce in New York's spot market. Gold's Thursday performance was also aided by news that China recorded a 14.1% jump in December exports.

Also probably playing into gold's strength was the fact reported rush among Indian gold traders to load up on (now much cheaper than in early December) gold ahead of a possible hike in import taxes to 6%. It was estimated but not confirmed that this proactive purchasing spree may have resulted in the placing of orders of up to 25 or 30 tonnes of bullion last week. As a result of such a putative spike in imports, India's government officials might now think twice before they leak stories about considering tax hikes instead of just decreeing them.

At any rate, the alleged buying spree among importers has been a story that was somewhat tempered this morning by India's Economic Times. The publication reports that albeit local prices for gold were at their lowest in a week, they were not enticing enough for importers to book orders.

"There are a few stray deals. People are not interested in stocking up at these levels as prices are in the same range since three-four days," said a dealer with a private bullion importing bank.

"There was an initial interest in the market after rumours of import tax, but after a few days buying fizzled," the dealer added. To buy or not to buy –ahead of a mini wedding/festival season? That is the question in India currently.

When it comes to a different set of question about gold, Marketwatch contributor and Pension Partners portfolio manager Michael Gayed opines that gold is facing a dilemma as this year gets started. The yellow metal's recent behavior (trading much like a risk asset, reacting more to deflation than to inflation, ignoring geopolitics, etc.) suggest that investors may be concluding that equities are a better asset of choice when it comes to inflation-hedging (not that we have manifest inflation to seriously hedge against).

Gayed notes that "One of the reasons many invest in gold is because supply is set and cannot be expanded. Against the backdrop of stock supply, which is shrinking, however, that particular reason for holding gold becomes an even stronger reason to own equities as a result of the share-buyback trend. Because investments must compete for dollars, this could explain why money has preferred stocks to gold under risk-on/reflationary periods."

When it comes to "risk-off" periods of turbulence, Gayed simply points to the chart of the ratio between the GLD ETF and the S&P 500 (SPY). He notes that the aforementioned ratio has been in a decline since mid-November as well as throughout the Fiscal Cliff Countdown period. The ratio recently broke a key support level-onethat was in place for about two years (see below).

He also opines that the ratio might ultimately fall to the May 2010 level (roughly one-to-one). Mr. Gayed's Accelerated Time and Capital models continue to indicate that gold is difficult to time in a situation where former tailwinds are suddenly becoming headwinds. Herewith, a graphical representation of the GLD/S&P ratio and its relatively recent "evolution" towards parity.



In addition, gold may also be factoring in the specter of soon-to-rise interest rates and the corresponding re-allocation out of bonds in an environment of (slowly?) rising real interest rates. The Fed's recent meeting minutes are cited as evidence of such a paradigm shift becoming a possibility –even before the calendar turns to 2014's first date.

Silver added 50 cents on Thursday, to trade at $30.88 bid-side per ounce. The 2.2% climb in spot platinum was the most notable one of the day however. The noble metal advanced $35 to reach $1,628 the ounce –at one point narrowing its discount to the yellow metal to just $40 an ounce. Palladium rose $11 to finish at just under the $700 per ounce mark. Rhodium was trading unchanged at $1,150 per ounce on the bid-side.

On Friday Morning, the opening of the final session of the week saw gold dipping sharply once again as a mild revival in the US dollar's strength prompted speculators to lock in short-term profits and sell the metal. Still, even with these truncated gains, gold appeared to finally be on track to enjoy a small weekly gain after seven consecutive weekly losses. However, the final tally will not be made until 5:15 pm, spot-wise. For the moment, it appears that the "Draghi Effect" had a half-life of but one day and that weakness persists in precious metals despite yesterday's glimmers of hope.

Overnight lows in gold came in at $1,665 while gold touched a high near $1,676 the ounce. Friday morning's low was touched at $1,655 after the yellow metal lost nearly $20 an ounce and fell below its 200-DMA once again. Silver fell 73 cents to $30.14 and it gave up the previous day's hard-fought gains. Meanwhile, platinum andplatinum each shed $11 an ounce but still remained in orbit near the $1615 and $690 levels per ounce.

Analysts at Standard Bank (SA) note that "Platinum is trading above $1,600 once again," and that "the metal continues to find good support despite gold [recently] coming under pressure." In fact, the gold/platinum premium is at its narrowest level since April of 2012 at this point. Standard Bank relays that "overall investment sentiment remains positive towards platinum especially," and that "this is not necessarily because of a stellar improvement in real demand growth, but rather because of a distressed supply-side."

The bank's initial price target for platinum remains at around $1,650 per ounce. Its team believes that at prices higher than that," jewellery demand may fade." The scenario that allows for platinum to trade much higher than $1,650 would entail yet another South African-based supply-side shock similar to last year's. "Strategically we continue to favour a long platinum position, with our target price of $2,000 by 2015," the SB team concluded.

Last week we brought you news related to the environmental impact of alluvial mining activities in beautiful British Columbia. As it turns out, news related to the fallout from small-scale but careless gold mining in other parts of the world as well does not appear to be in short supply. The collateral damage resulting from ultra-high gold prices keeps expanding to practically every continent where the metal is being mined.

The U.N.'s Environmental Programme (UNEP) released a study which reveals the fact that high bullion values are spurring operators of small mining enterprises anywhere from South America, to Asia, and to Africa, to use larger amounts of mercury in processing gold ore. The toxic liquid is poisoning mine workers and after it is washed into rivers and eventually the oceans it is contaminating people in faraway locations.

It is estimated that about 15 million people worldwide are engaged in the extraction of the precious metal via such health-damaging methods. It is also estimated that the amount of toxic mercury that is being emitted by such gold mining operations has risen to 727 metric tonnes as of 2010 –a figure that is double of that which the world witnessed as recently as 2005.

The head of the UNEP bluntly noted that "The very high gold price has ... brought more people, especially at the poorest end of society, into the gold mining sector." Some nations have taken drastic steps to try to curb mercury usage –the US banned exports effective as of last week, and the EU did the same in 2011. On the other hand, China is thought to be a large contributor to the approximately 2,000 tonnes of mercury which are being released annually, worldwide.

We will try to close today on some lighter notes by first relaying to you a story that not too many months ago would have been classified as complete "science-fiction" (at least by some alarmist newsletter writers out there). Remember when we were being frightened with warnings that the world's eighth or ninth largest economy (The Golden State) was going to go belly up- financially speaking- and that all kinds of heck would then ensue as a consequence? Sure you do. California was also just one of the dominoes among US states that was going to collapse and die of an ugly fiscal disease (AKA The Red Deficit Plague).

Well, enter Gov. Jerry "Moonbeam" Brown. In the same year (2010) that some of these predictions were being written, Brown retook the Governor's seat of in Sacramento. He took over in the wake of a decade that saw the state's deficits total $200 billion. He promptly raised the state sales tax, hiked the state income tax on those making more than $250K and tried to curtail spending. The Governor can now count on ending California's next fiscal year with...a surplus of as much as $851 million. Ka-ching! In case the "formula" is not clear, let's repeat it: higher taxes + lower spending = lower deficits + eventual surpluses. There's the kind of math that does add up. Literally.

Finally, we could not resist commenting on the Trillion Dollar Platinum Coin Hullaballoo that is making the headlines this week. So we are...tossing in a meager suggestion. No, we are not implying that Uncle Sam should go out and try to round up the 19,200-odd tonnes of platinum that it would take to mint the sucker in order to reflect its value kind of accurately. Current annual world platinum production: 195 tonnes.

Not even the Perth Mint –the maker of the world's largest and most valuable gold coin- could pull off that kind of a feat. So, let us entertain some more realistic facets of the issue: like whose picture should be on the coin. Our proposed loveable face to grace the coin (with special thanks to Paul Krugman):

(The author is the senior metals analyst - Kitco metals)