Defeat of the Swiss Gold Referendum coincides with Deflationary PMI Reading
The result of the Swiss Gold Referendum is the first major event for gold at the start of the week. It has been defeated by a wide margin of 22% in favor against 78% against it, and all the cantons had unanimously rejected the referendum. The referendum would have required the Swiss National Bank (SNB) to purchase 1500 tons of gold, or 70% of world gold production, for 5 years to meet the requirement of having 20% of its assets in gold. In addition, the referendum obliges the SNB to repatriate overseas gold and be prohibited from selling gold.
The very prospect of such a large scale gold purchase supported gold prices to the run-up of the actual referendum on 30 November 2014. A good proxy for gold prices would be the highly liquid SPDR Gold Trust ETF (NYSEARCA:GLD) with average 3-month volume of 7.17 million and 27.73 billion in net assets. From 06 November 2014, GLD went from a closing price of 109.79 to 115.39 on 21 November 2014. This 5.1% rise represented the market positioning for the pending massive gold purchase. However, on the last trading day before the referendum on 28 November 2014, speculators left the market and GLD closed at 112.11. However, on Monday itself, with the defeat of the referendum, we saw GLD price shooting up instead as seen in the chart below. So what is the cause of it?
This is due to the surprise deflationary reading of the first major economic report of December. This is the survey conducted by the Institute of Supply Management's (ISM) Manufacturing Purchasing Manager Index (PMI). This PMI has a price component which reported 44.5 in November 2014 over a reading of 53.5 for October 2014. A reading below 50 means that manufacturers actually paid their suppliers less for the same goods in November when compared to October. This is the first time that it occurred in 15 months as seen in the chart below.
Source: Forex Factory
The surprise drop of the PMI Price index into deflationary territory comes 1 month after the official end of the Fed's QE3 on October 2014. This brings along immediate market speculation that the Fed might be influenced to push back the widely expected rate hike in June 2015. This explains the strong showing of GLD despite the defeat of the Swiss Gold Referendum. In fact, the USD also suffered a pullback as seen in the PowerShares DB USD Bull ETF (NYSEARCA:UUP) chart below.
Immediate Impact on Gold and USD
You would notice that this drop in price is on low volume, as the market remains unconvinced that a single data point would move the Federal Open Market Committee (FOMC) in delaying a rate hike. In fact, if we look at the XAU/USD which measures the price of gold in USD, we can see both a recent spike up and a corresponding pullback going on right now at the point of writing. Please note that XAU is the forex symbol for gold. In short, the market has recognized its error and is correcting it right away.
The drop of the PMI Inflation Index is significant given its wide scale of a 9 point drop to 44.5. The market was expecting slower manufacturer inflation to 52.6 in November given the end of QE3. If we recall back to the previous FOMC meeting in October, the sole dissenter, Minneapolis Federal Reserve President Narayana Kocherlakota dissented on the grounds that inflation is not properly anchored, while the rest of the FOMC members viewed that the growing economy would result in natural inflationary pressures. You can read more about it in my previous article here.
1 PMI validates both FOMC views
While the current PMI Price Index reading seems to validate Kocherlakota's view, this is only 1 price point in a niche area. The drop in inflation is significant, but not sufficient to suggest that deflation has anchored itself into the economy. This would require at least 3 other readings for the FOMC and the market to take it seriously considering the holiday season.
In addition, the overall manufacturing PMI of 58.7 shows that the economy is growing strongly which validates the mainstream FOMC view even if it is slowing slightly from October's reading of 59.0. So as far as the Manufacturing PMI reading is concerned, the mainstream FOMC view has greater sway, as the PMI has expanded for 18 consecutive months, while the PMI price index dips into deflation for the first time in 15 months.
Source: Forex Factory
As the chart above shows, the mainstream FOMC view would likely win the debate if we were to consider the Manufacturing PMI overall data. Hence, the weakness for the USD and the subsequent rally for GLD is misplaced.
The market has realized that it is premature in its judgment and it is rushing in to correct itself. There will be further confirmation for inflation data in the days ahead. On 12 December, we will have the result for the Producer Price Index (PPI) and core PPI month on month. This is followed by the Consumer Price Index (CPI) and core CPI month on month on 17 December 2014. On 23 December 2014, we have the core Personal Consumer Expenditure Price Index month on month, the Fed favored measure of core inflation together with the final GDP Price Index quarter on quarter.
The date to look out for among all these dates would be 17 December 2014 when the result of the FOMC's last meeting for the year is revealed. The FOMC statement is likely to have a lasting impact on the USD. Analysts all over the world will parse the statement in detail for hints of the FOMC direction towards the normalization of its conduct of monetary policy after its years of accommodation arising from the Great Recession. Hence in the interim period, traders should consider selling GLD on strength.
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