Fundamental View

[Samirofi]

What’s Up Ahead for Precious Metals in 2016?

The year is near its end and it’s clear that gold and silver, for the third year in a row, didn’t have a good year. Prices of both precious metals dropped by 9% and 8%, respectively. And while bullion prices did kick off the year on a positive note – at one point gold reached $1,300 and silver $18 – they have had a slow downward trend mostly during the last few months of the year, as indicated in the following chart.




Source: Bloomberg


In 2016, the focus will revolve around three issues that are relevant to precious metals:

1. The direction long term interest rates: On the balance are the expected Fed hikes that should push up rates. On the other is the rising demand for U.S. LT treasuries as the global economy isn’t doing well. If yields end up rising, this could push further down PM prices;
2. The uncertainty around global economic growth: Not only the EU isn’t doing well but also emerging markets. This includes China and Brazil. These economies’ economic woes could raise the unrest in the markets. And when people are concerned, some of them tend to invest in gold and silver;
3. The direction of U.S. dollar: Again, the above mentioned – Fed’s policy and global economic woes — will impact the direction of the U.S. dollar. But also the steps taken by other central banks. If they keep implementing additional policy measures to devalue their local currencies – the U.S. dollar will keep appreciating. And a stronger U.S. dollar means a downward pressure on PM;
4. Change in supply and demand: This could be the factor that will separate the direction of gold and silver. The silver market, perhaps even more than gold, is still more linked to its physical demand. And the production of silver is expected to drop – or at the very least not rise. Will this be enough to push up silver rates back up? That’s a big question that could determine whether silver will rally in 2016 or not.

Considering all these factors, I think that in the end it’s more likely that PM will experience another year of falling prices.

Some additional thoughts



Will we see a decoupling of gold and silver in 2016? Both precious metals are strongly correlated, and will remain so. But will their trend lines move in different directions? After all back in 2014, gold remained nearly flat on a yearly scale, while silver lost 17% of its value. And back in 2011, gold rose by 10%; silver dropped by 10%. This is certainly a possibility mainly considering the last factor listed above.


Some factors that may have been considered by some as valid in the past will take the back seat such as concerns over inflation: Considering commodities prices are low, and the Fed is expected to move towards raising rates, the concern over the devaluation of the USD or a sudden spike in inflation will become even less possible and fewer people will take a position on gold to hedge against such a possibility (not that there was any high concern to begin with).


Bottom line


I won’t hold my breath to see a recovery in gold and silver. Of the two, I think silver may have a better chance of a modest recovery solely on account of the expected drop in supply that could tighten the physical silver market. But in both cases, I think the more likely scenario will be another year of slowly falling prices.

[Samirofi]

BOJ Likely On Hold This Week But…

After the yen strengthened quite a bit, we heard different tunes from the BOJ and the government, willing to act and feeling uncomfortable with the strength of the yen. But will they act? Here is the view from Bank of America Merrill Lynch:

Main focus on assessment of downside risk BoJ. The next BoJ monetary policy meeting is scheduled for 28-29 January. Since the last meeting the risk scenarios that the BoJ previously warned about have started to materialize. Though at the upcoming meeting we expect the BoJ to stay on hold while keeping a close eye on the market and moves by governments such as China, we maintain our view that the BoJ is likely to ease further during 1H 2016, probably around March or April.

The BoJ is shifting to a new monetary policy meeting schedule this year consisting of eight meetings (down from 14 until last year). Of these, at four meetings (January, April, July and November) the BoJ will also release its Outlook for Economic Activity and Prices report. We expect the upcoming Outlook report to acknowledge the downside risk to growth forecasts, but maintain its outlook for a continued domestic demand-led recovery and only make minor adjustments. On the other hand, on the prices outlook we think the BoJ is likely to lower its FY2016 consumer price inflation forecast (ex-fresh food) from 1.4% into the 1.0% range, which is likely to be ascribed to the bigger-thanexpected decline in oil prices. We expect market focus in the Outlook report and postmeeting press conference by BoJ governor Haruhiko Kuroda to be on 1) how the BoJ views the current state and outlook for exports, and 2) whether the BoJ cites any other reasons for lowering its inflation forecast besides oil, such as slower-than-expected wages growth.

Additional easing in March or April our main scenario: We think three factors in particular are being focused on by the BoJ in monetary policy decisions, namely: 1) conditions overseas and in financial markets (particularly forex); 2) inflation expectations and wages trends; 3) the capex trend. On capex, we believe the BoJ remains fundamentally optimistic, despite the sharp YoY decline in machinery orders in November, as this can be attributed to a reaction to the sharp growth in September and October, and due to growth in planned capex reported in the December Tankan. However, as a result of the rising risk-off mood in the markets amid uncertainty over the Chinese economy and the steep fall in oil, the yen has started to strengthen. Now USD/JPY is lower than the average forecast (¥119.40) of large manufacturers in the December Tankan, and this could be starting to have a negative impact on corporate profits. Moreover, as the trend for EM currencies to weaken versus USD has become clearer since China embarked on its change in currency policy since August, the yen’s effective exchange rate, a weighted average measure of its strength versus other major currencies, has strengthened even more than the actual USD/JPY rate. The effective exchange rate is now higher than in 31 October 2014, when the BoJ strengthened its QQE policy. In other words, the effective exchange rate is telling us that the yen weakening impact of the additional easing carried out in October 2014 has been more or less entirely negated. As the effective exchange rate tends to show up in core-core consumer prices (ex- energy and fresh foods) at an around one-year time lag, continued yen strengthening would raise concerns of a drag on inflation from 2H 2016.


The trends in inflation expectations and wages could also pose some concerns for the BoJ.Though the number of respondents expecting inflation of at least 2%, in the oneyear forward price forecast in the Consumer Confidence Survey, remain in the majority at 51.9% in the latest December survey, the downward trend has been gathering momentum. Meanwhile the proportion saying inflation will be under 2% or no change has risen to 38.9%. Although to some extent a result of the decline in oil prices, the fact that household inflation expectations are back where they were before the introduction of QQE (in April 2013) cannot be ignored.

The BoJ also released its latest Regional Economic Report (Sakura report) on 18 January 2016, containing an assessment of jobs and wage conditions in each of Japan’s regions. According to the report, while labor shortages are increasingly being felt around the country, wage increases have been “in recent years mainly occurring in urban based companies,” and while bonuses are increasing, base salary increases spreading steadily and hourly rates for non-full time employees increased across many regions, on the other hand there remains substantial caution in raising salaries “particularly at regionally-based SMEs.” On the outlook, the report states that “supply/demand conditions in the labor market are likely to remain tight for the time being. Despite which we are not yet seeing any increase in moves by companies to raise salaries in FY2016.” The BoJ also appears to be starting to recognize that wage growth is possibly lacking momentum. This makes the outcome of the 2016 spring wage negotiations, effectively underway since the 19 January policy announcement by employers’ association Keidanren, all the more important.

In light of the above, the possibility that the BoJ will loosen monetary policy further in 1H 2016 has increased in the past month, in our view. However, as a central bank the BoJ does need to avoid over-reacting to short-term trends in the stock market, and with the current market concerns being mainly due to overseas factors, we believe the BoJ will need more time to assess the policy reaction of the Chinese authorities and US economic data. Also, by March it should have various other data on which to assess the trend in salaries, including the outcome of the 2016 spring wage negotiations (most settlements being made by mid-March), the trend in winter bonus payments (December monthly data is for release on 8 February), and January onward wages data free of sample bias (for January due for release on 4 March). Given the size of the volatility in financial markets and time-lag before monetary policy works its effects, our main scenario is for additional BoJ easing in March or April, though we cannot entirely rule out the possibility of additional easing at the upcoming meeting.

[Samirofi]

Fed decision: hard to keep it balanced – 4 scenarios

The Fed made history in December by raising the rates for the first time in nearly a decade after an extremely long preparation. Despite putting an emphasis on inflation, Janet Yellen and her colleagues expressed confidence and according to their own dot-plot, they are theoretically on track to hike rates 4 times in 2016. An even spread of these hikes implies one coming up in March.
The world did not collapse on that historic move, but after the holidays came and went, stock markets suffered quite a bit. Worries about China, its stocks and currency, oil prices, global demand geopolitical issues joined not-so-convincing US data releases. Will the stock-sensitive Fed respond and hint of a hike-hiatus? Or will it stick to its guns? It can also be something in the middle. Here are 4 scenarios, with probabilities and impacts on currency markets:

1. Dovish because of markets: In this scenario, we have a repeat of the September rate decision, in which the Fed decided not to hike because of financial market turmoil. Also then, it was the Chinese stock market fall in August that made the Fed sit on its hands. A statement saying that the economy looks OK but for the next hike they would need to examine also financial stability conditions and go gradual would of course be positive for stocks. It would also be positive for other “risk” assets such as oil and commodity currencies. Less pressure on emerging markets is good for commodity exporters. CAD, AUD, NZD and also GBP could gain. Such a statement would also imply that the US economy is doing well and can lead the world economy forward. The good news comes from core inflation at 2.1% y/y, which removes worries expressed by the Fed. And the other Fed mandate, jobs, looks great according to the jobs report. Such an environment is not favorable for the doom and gloom safe haven euro and yen, which would slide despite a dovish Fed.
2. Dovish because of the US economy: A hint that there is no rush to hike in March could result in a very different reaction if the reason is the US economy. And while the recent NFP and inflation reports are good, retail sales, the manufacturing sector and GDP prospects in general are not looking good at all. Jobs could be lagging: they are still rising while the recent slowdown could be reflected in jobs only later on. The US releases the first estimate of GDP on Friday and the Fed may already have the data in front of their eyes. If they err on the side of caution because they worry about the economy and not markets, the outcome could be different: a risk off move favoring the safe haven euro and yen while further depressing all the rest. The reason for not hiking is critical for the reaction.
3. Hawkish all around: In the somewhat less likely scenario that the Fed hints that the next move is coming in March, barring any major disaster, we could see the US dollar storm across the board. Markets are expecting some kind of dovish move and if they don’t get that, it’s not only commodity currencies that suffer but everybody, especially after Draghi went dovish and the BOJ is also ready to act. It would also imply a super-strong GDP report on Friday, which also has low chances.
4. A finely balanced statement: This is probably what the Fed will do its best to achieve as it wants to leave all the doors open towards the next meeting and they certainly do not want to rock financial markets. Their well crafted December decision triggered a very calm reaction. However, this time, the Fed can try the best tricks in the circus, but it is hard to see markets remain calm. This scenario has the lowest probability not because the Fed does not want that, but because markets will look for the subtle hints and choose a direction. They could try and say that employment is good while inflation needs improvement, and that they are cautiously optimistic, or any other kind of attempt to say everything and not say anything. We could have choppiness in a limited range at first, until the verdict falls on one of the three scenarios, with a higher probability of scenario No. 2 – a sell-off and a resumption of the “risk off” mood.

[Samirofi]

GBP/USD: Trading the British Preliminary GDP

British Preliminary GDP, one of the most important economic releases, is published each quarter. GDP measures production and growth of the economy, and is considered by analysts as one the most important indicators of economic activity. A reading which is better than the market forecast is bullish for the pound.


Indicator Background


British Preliminary GDP is a key economic indicator, and provides an excellent indication of the health and direction of the British economy. Traders should pay close attention to the GDP release, as an unexpected reading could affect the direction of GBP/USD.
Final GDP in Q4 posted a gain of 0.4%, shy of the forecast of 0.5%. The estimate for Preliminary GDP in Q4 stands at 0.5%.


Sentiments and levels
The Federal Reserve is unlikely to raise rates anytime soon, but the safe-haven greenback has benefited from market jitters in early 2016. With the US economy outperforming that of the UK, there is room for the pound to lose ground and possibly slip below the symbolic 1.40 level.. So, the overall sentiment is bearish on GBP/USD towards this release.
Technical levels, from top to bottom: 1.4635, 1.4562, 1.4346, 1.4227, 1.4135 and 1.40.
5 Scenarios

1. Within expectations: 0.2% to 0.8%. In such a scenario, GBP/USD is likely to rise within range, with a small chance of breaking higher.
2. Above expectations: 0.9% to 1.3%: An unexpected higher reading can push the pair above one resistance line.
3. Well above expectations: Above 1.3%: A surge in the reading could push the pound higher and the pair could break a second line of resistance as a result.
4. Below expectations: -0.3% to 0.1%: In this scenario, GBP/USD could drop below one support level.
5. Well below expectations: Below -0.3%. A very weak reading could hurt the pound, and the pair could fall below a second level of support.