3Q 2013 Markets Outlook

The prospect of the end of QE3 from the Federal Reserve is possibly the biggest fundamental shift for the markets in years. Added to this, German Federal Elections could break the spell of sovereign stability in the Eurozone this quarter.

1, Fed looks poised to taper QE3

This could happen by the end of Q3, we assess how the Fed could end its asset purchases and what this means for markets.

Over the past few months market participants have been increasingly enamored by the topic of Fed tapering and they appear to be looking for any potential signal that may cause a change in the size, pace or composition of the Fed’s Quantitative Easing program. As a reminder, the Fed is currently purchasing additional assets at a monthly pace of $85B, with $45B targeted at long-term Treasury securities and $40B for Mortgage-backed securities (MBS). A primary difficulty facing the Fed appears to be the broad range of opinion within the FOMC regarding the pace of long-term asset purchases as well as their differing views on a potential ‘tapering’ strategy.

Bernanke has frequently indicated that the Fed intends to continue purchasing assets at a pace of $85B a month until there are ‘substantial’ gains in the labor market, however he has failed to indicate what a ‘substantial’ improvement would consist of; could it be a particular level in the unemployment rate or a series of monthly payroll gains above a specified threshold before they begin to scale back asset purchases? Quite regularly we have heard regional Fed Presidents make reference to job growth of 200K per month (for varying periods between 3-6 months) to signify a meaningful improvement in the labor market, yet the FOMC as a whole has been hesitant in affirming this as a prerequisite to reducing the pace of Quantitative Easing. This aside, the recent decline of inflation over the past few months has some members of the Fed questioning the validity of tapering altogether, since inflation is nowhere near the committee’s 2.0% objective with April core-PCE at 1.05% YoY.

While the upcoming FOMC meeting in June is likely to garner all the headlines in the near term, it’s still likely to be too soon to begin scaling back QE as many variables other than ‘when to taper’ still remain in question:

What to taper – Treasuries, MBS or a combination of the two?

How to taper – According to a schedule, by assessing economic data or via numerical threshold criteria?

Pace of tapering – Reduce by a smaller, but consistent, amount per meeting ($10-15B) or a larger amount ($35-50B) followed by a pause?

Asset duration – Curb longer-dated assets first or equally weighed throughout the curve?

Additionally, from a strategic perspective it makes little sense to taper asset purchases in the June FOMC meeting after the minutes of the previous meeting stated: “the Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes” in its May statement. Accordingly, if the Fed decides to stay on the sidelines for the upcoming meeting in June, it would be logical to wait until the next FOMC meeting associated with a summary of economic projections and a press conference by the Chairman, so that Ben Bernanke could thoroughly explain the committee’s rationale behind any measures related to the tapering of QE. Thus, the next viable Fed meetings to take action are Sept. 17-18th and Dec. 17-18th. In the minutes of the May meeting a “number of participants” expressed their willingness to reduce the pace of asset purchases as early as June, provided there was a continued improvement in economic data, and that U.S. 10-year rates have risen 60bps from the May lows. Thus, it appears more probable that a move may occur in September rather than December. Additionally, by the September meeting the Fed will have had time to examine three further employment reports, which should enable them to determine if 2013 was different from the prior 2 years of summertime swoons.

The potential end of QE3 as we know it is a major market theme this quarter. It has already caused volatility in stock and bond markets, and it will be a key driver of the dollar this quarter. If signs continue to point towards a potential tapering of QE at the end of this quarter, then rising Treasury yields could eventually support a broad-based strengthening of the USD.

Figure 1: Monthly change in Fed Assets Held Outright

Source: Federal Reserve,

2, More may be needed from the BOJ

More stimulus from the BOJ may be needed if the authorities in Japan are serious about achieving their 2% inflation target. The prospect of more stimulus will be a key event risk this quarter.

Since Kuroda assumed his role as the Governor of the Bank of Japan (BOJ) and announced aggressive easing at his first monetary policy meeting in April, the JPY has weakened considerably and the pace and amount of asset purchases by the Bank has increased significantly. For now, the BOJ appears to be satisfied with the level of accommodation as it tries to achieve its goal of 2% inflation within 2-years. Governor Kuroda has noted in the past that the Bank has taken all “necessary” and “possible” steps to meet the inflation target in two years and the latest BOJ statement indicated that “CPI is likely to gradually turn positive.” In the coming quarter, we think that the Bank of Japan is likely to remain on the sidelines with the possibility of only small tweaks in its asset purchase program. However, we are doubtful that the steps taken are sufficient and believe that more stimulus may need to be added to ensure the BOJ meets its self-imposed inflation target within its preferred time frame of 2-years.

The BOJ has received minimal criticism and has gained support from the world’s major economies and organisations. The International Monetary Fund (IMF) stated recently that “we fully endorse the BOJ’s sweeping enhancements to its monetary policy framework.” As key policymakers express their support for BOJ policy, it is viewed as a green light for the Bank to continue to engage in aggressive purchases, which has had a negative impact on the currency. The Japanese yen (JPY) has continued to grind lower against its major counterparts and corrections have, so far, been relatively shallow. In the coming quarter, we believe that increased volatility may present sharper corrections but we maintain our view of longer-term JPY weakness.

Volatility in the bond markets has been evident with a sharp rise in Japanese government bond (JGB) yields. Governor Kuroda has taken an optimistic view noting that the increase in yields reflects a positive outlook for the economy and prices as it suggests inflation expectations are rising. However, the increased volatility in yields may reduce the impact of monetary easing as a rise in yields could be negative for lenders and dampen growth.

The government will also play a critical role in Japan’s reflation efforts as the success of its growth strategy will be important to lift prices out of deflation. Stimulative fiscal policy and measures to spur consumption such as a staggered increase to the consumption tax in two stages from the current 5% to 10% by October 2015 must be credible to aid accommodative monetary policy provided by the BOJ. The combination of fiscal and monetary policy will take time to filter through to the real economy and therefore we think that the Bank will be monitoring data for the next few months. For now, it seems that the Japanese economy is moving in the right direction as consumer prices have ticked higher.

National CPI still remains well in deflationary territory at -0.7% y/y excluding fresh food, however the more timely Tokyo CPI showed a positive reading for the first time since March 2009 with a print of +0.1% y/y excluding fresh food in May. Data suggests that national CPI may move to inflation territory in the coming months; however it is still a long way from the 2% target. If data fails to show improving economic activity and increasing prices, then it will become clearer that additional stimulus could be needed, which may weigh on the JPY.

Figure 2: Japan National & Tokyo CPI y/y ex fresh food

Source: Bloomberg,

3, Carney comes to town

Mark Carney takes the helm of the Bank of England in July. The market expects him to implement more QE, however, we think that the bar to more QE could be fairly high. We assess what this means for sterling.

The third quarter will see a new Governor at the Bank of England. Former Bank of Canada governor Mark Carney takes over from Mervyn King on July 1st. Personnel changes in central banks are big news for the markets, as they can signal changes in policy direction. So what should the market expect from Carney?

In fairness, Carney has been tight lipped about the UK economic outlook in recent months but back in February he was quizzed by British lawmakers. He ended up being less dovish than some expected and rather than expound the benefits of the Bank targeting GDP, which could open the flood gates to more quantitative easing, he concentrated on the benefits of flexible inflation targeting. The BOE already targets inflation, and back in March the Chancellor of the Exchequer formally gave the BOE more flexibility around its 2% inflation target. Since the UK’s CPI rate has been above 2% for the last 4 years, this “change” is hardly revolutionary; rather it makes it easier for the Bank to target stimulative policies like quantitative easing if growth is low without having to worry about inflation.

Some also expect Carney to add “formal guidance” to the BOE’s tool kit. This is where a central bank signals its monetary policy in advance. This was adopted by Carney at the BOC in 2009, and was most recently adopted by the Federal Reserve in the US who signal monetary policy expectations out to 2014. However, we don’t think that forward guidance will be adopted, at least not during the first few months of Carney’s time at the BOE, for three reasons. Firstly, during the March Budget Chancellor George Osborne asked the central bank to compile a report on forward guidance that needs to be submitted to the Treasury in August. This document needs to be thoroughly discussed at the Bank of England and at the Treasury, which could take many months. Thus, even if everyone agrees that forward guidance is right for the BOE, it may not be implemented before the end of this year. Secondly, it is not clear that all members of the BOE actually agree with forward guidance, some agreed with former governor King that it was not right for the UK economy. Carney may want forward guidance, but at the BOE the governor does not always get his way, as King found out with recent calls for more QE falling on deaf ears at the MPC. Carney will likely need to get the 8 other MPC members on board first, which may not be an easy task. Lastly, the UK economy is extremely unpredictable and in the last 5 years inflation has been high, yet growth has been extremely weak. Thus forward guidance would be very difficult to get right in the UK, which could jeopardize the BOE’s credibility.

So what can Carney do? He could try and concentrate on the joint BOE/ government Funding-for-Lending (FLS) programme, which has, so far, had a fairly limited impact on levels of corporate lending.

We believe the pound will be sensitive to Carney’s arrival at the BOE and expectations that he will immediately turn on the printing presses could be overdone. If Carney disappoints these “dovish” expectations then we could see the pound continue the recovery that was started in Q2. However, we see gains in GBPUSD potentially limited to 1.59 in Q3. Obviously, if he does manage to convince the BOE to vote for more QE in his first few months in office, which we don’t expect, then we could see the pound fall sharply back to the 1.48 lows from March.

Figure 3: The BOE embarked on QE altough inflation was rising

Source: Bloomberg,

4, One more Act for German Chancellor Merkel

The German election at the end of Q3 is the biggest sovereign risk in Europe this quarter, in our view. While Merkel’s approval ratings are high, her party has had some high profile losses at recent local elections.

The Federal elections that take place in Germany will likely be the focus as we get to the end of Q3. On September 22nd Germany will go to the polls with 600 seats in the Bundestag up for grabs, they will also vote for the next Chancellor. Angela Merkel, the current Chancellor, will face Peter Steinbruck, from the Social Democratic Party. If Merkel can win she could solidify her position as the de-facto leader of the Eurozone.

The back drop to these elections is fairly sanguine: the sovereign crisis has stabilised and peripheral bond yields are back to normal levels, the ECB seems to have control of the situation and although the Eurozone economy is not exactly in recovery territory there are signs that it is stabilising. If we can maintain the status quo then it could be an upset during the German elections that proves to be the biggest risk to the Eurozone this quarter.

Germany publishes opinion polls throughout the election period, and at this early stage it is difficult to predict a winner with any certainty. However, currently Merkel remains the favourite, with Steinbruck some way behind. Since markets like certainty, a win for Merkel could be the most market-friendly outcome, and we could see a short term relief rally across euro-based markets if she does win. But we don’t think that German elections will have a long term impact on the markets, since in the past 12 months election risk has been mostly shrugged off by the markets (Italian elections aside), for example they barely blinked when Socialist Hollande won the Presidency in France in 2012.

How about Merkel’s austerity stance? She has tempered her insistence on austerity in recent weeks and she also gave her blessing to extending deficit targets for the most troubled economies of Spain, Italy, Portugal and even France. While this has given some breathing room to these economies, growth is still incredibly weak. Unemployment in the region is still at a record high and the Eurozone economy is unlikely to emerge from recession until 2014.

The ECB may have helped to stabilise the sovereign crisis, but it hasn’t managed to boost growth or corporate lending to the most troubled economies. Bank lending is still contracting (see the chart below), however this may not spur the ECB into action this quarter. After cutting rates in May, the ECB touted the possibility of cutting deposit rates into negative territory in an attempt to get banks’ lending. We don’t think a cut in deposit rates is likely to happen this quarter because 1, growth has started to stabilise in recent months, 2, although inflation is falling, deflation is not a real threat at this stage. Instead we expect the ECB to say that it is ready to act at any time, however in the absence of a major flare up of sovereign concerns or a sharp contraction in growth or inflation, we don’t expect any policy changes from the ECB this quarter.

The EUR and euro-based assets have been fairly immune to political risks in the Eurozone and the weak economic outlook in the periphery and France. We expect this to continue in Q3. However, a weaker EUR is one of the ways to help stimulate growth in the region, so if we see EURUSD climb above 1.3200 towards 1.3500 we think that the ECB could remind the markets about the potential for negative deposit rates in an attempt to cap EUR gains. Thus, we see limited upside for EUR this quarter. The downside may depend on the USD and the timing of tapering QE3 purchases by the Federal Reserve. Any accelerated tapering could cause a sharp move lower to the 1.25 region in EURUSD.

Figure 4: Loan growth in the Eurozone remains extremely weak

Source: Bloomberg,

5, Global growth to remain tepid

World growth is likely to remain soft and uneven as major economies try to get activity back on track.

World growth is likely to remain relatively soft and uneven as major economies try to get activity back on track this quarter. Output gaps in many stgeloped economies persist as recoveries have been fragile and the headwinds of fiscal policy in the US and in Europe remain key factors inhibiting stronger growth. In Asia, Japan’s economy has been gradually picking up due to the front-loaded benefits of both fiscal and monetary measures while China’s long-term growth trajectory slowly declines to more sustainable levels.

The IMF has categorised the global economies into three speeds. The first-speed, which includes emerging and stgeloping countries of persistent strong growth, the second-speed, which includes the US, Australia, Canada, New Zealand, Sweden and Switzerland as economies that are on the mend and the third-speed of economies that still have some distance to travel to get to recovery such as the Euro Area and Japan. The uneven nature of the global economy underscores its fragility, but the IMF suggests that with the right mix of policy, growth can resume. Indeed, policy effects take time to filter through to the economy but tail-risks have been drastically reduced and economic activity has been gradually picking up in 2013.

In the US, 2Q GDP is likely to have slowed from 2.4% in Q1 but leading indicators suggest that Q3 may see an uptick in activity. The US economy is likely to have strengthened as a result of increased consumption as consumer confidence has risen to multiyear highs as indicated from a number of sources. Surveys are conducted to gauge levels of consumer sentiment by polling individuals and translating responses into a numerical index value (where a higher reading corresponds to a more positive outlook from the consumer’s perspective). The University of Michigan’s reading of confidence rose to its highest level since July 2007 while the Conference Board’s measure of consumer confidence advanced to its highest level since February 2008. Leading indicators in manufacturing are not as bright, the ISM manufacturing reading dipped below the 50 threshold to signal contraction in May. Overall, we believe that US growth is likely to remain well below potential in Q3 although it could pick up from a soft Q2.

Figure 5: US consumer confidence readings

Source: Bloomberg,

We expect that Europe will remain in a recession as the peripheral economies struggle with high levels of unemployment and fiscal adjustments. Time frames to achieve deficit targets have been relaxed, the European Central Bank (ECB) continues to provide support to the economy, and policy makers are slowly moving closer towards banking integration. While these measures are a positive in the long term, they will take a considerable time to implement and the Euro Area is likely to experience negative growth in the coming quarter.

A gradual uptick in global growth is likely in Q3; however the world’s growth remains fragmented. The Eurozone will most likely continue to face recession while Japan experience stimulus-led growth. China’s economy is likely to experience a slowdown but remain relatively strong and US economic activity will likely be driven by the consumer. With the outlook for the global economy relatively subdued and subject to downside risks we think that markets will take a cautiously optimistic view to growth in the coming quarter.

6, Aussie and Kiwi: the worst is not yet over

The Aussie and Kiwi have been major underperformers versus the dollar in Q2, we assess the outlook for further declines in Q3 as the end of the commodity boom, expectations of looser monetary policy and weak Chinese growth continue to weigh on the outlook for AUD and NZD.

The Australian and New Zealand dollars were some of the worst performers against the US dollar during Q2. The prospect of lower interest rates in Australia, a drought in NZ and weakness in China weighed on the commodity currencies. When this was combined with a broad drive towards the US dollar, it was the perfect cocktail for AUDUSD and NZDUSD weakness. AUDUSD’s reign above parity has seemingly ended and NZDUSD was also hit hard. Between the two, key differences amid economic conditions in Australia and New Zealand have favoured the Kiwi more than the Aussie, which may continue this quarter.

The Reserve Bank of Australia (RBA) has been cutting the official cash rate at the same time as the Reserve Bank of NZ (RBNZ) has been holding interest rates steady at 2.50%. The RBNZ may have cut the official cash rate if housing prices weren’t threatening inflation, which is not the case in Australia. Overall, there are arguably more threats to Australia’s economy than NZ’s in Q3; hence, there may be scope for further rate cuts in Australia, at a time when the RBNZ is closer to raising rates than cutting them.

Figure 6:

Source: Bloomberg,

One of the biggest hurdles Australia faces in Q3 is an anticipated decline in mining investment later this year/early next. We are already seeing mining related companies trim spending in anticipation of the peak in mining investment, particularly in the mining services sector which is usually the first to get hit in the event of a slowdown in the resources sector. As Australia’s resource boom cools off, the market will be looking to the rest of the economy to fill the gap left in GDP. While we have seen some signs of strength in the economy, especially in housing, it isn’t enough to ensure a smooth transition as mining investment peaks. This could lead the RBA to loosen monetary policy even further and, in turn, weigh on the Australian dollar.

The economic situation in NZ is a little brighter. Reconstruction efforts in Christchurch are lifting GDP and a rebound in some dairy prices helped to offset some of the negative impacts of the earlier drought in the north island. One of the biggest hindrances to the NZ economy has been the high value of the kiwi. Ironically, rising house prices prevent the RBNZ from lowering the cash rate further to offset the detrimental impacts of the NZ dollar, which is NZD positive. The RBNZ can intervene in the FX market, but by the bank’s own admission this is designed to hinder NZ strength as opposed to materially weaken the currency.

One big area of concern for both commodity currencies is China. Recent economic data out the world’s second largest economy has raised concerns about the ability of Beijing to manage China’s slow down. At a time when the market would prefer that China has the option of loosening policy, house prices threaten to create a bubble of immense proportions, thus the PBoC is limited in what it can do to support China’s transition to a domestic demand focused economy from an export driven economy. Nonetheless, we think Beijing has both the will and capacity to manage China’s slowdown, which should prevent a hard landing.

Overall, long-term fundamental weakness in the Australian dollar, partly attributable to predicted weakness in Australia’s economy and the AUD being overvalued already, and the possibility of an unwinding of foreign money in Australian bonds may continue to hinder the commodity currency. Key support for AUDUSD is around 0.9140 and then 0.8545. The NZ dollar however, is backed by stronger fundamentals than the Aussie, which may make it more attractive in the medium-to-long term. In any event, AUDUSD and NZDUSD may be broadly driven from the USD side of the equation in the near-term as the market anticipates an end of the Fed’s QE3 programme.

7, China continues on the path of FX liberalisation, slowly…

It’s been an interesting start to President Xi Jinping’s regime. The Renminbi strengthened to its strngest ever level in Q2 and the rhetoric coming from Beijing suggests further liberalisation of the FX market could be on the cards.

Since mid-2005 the renminbi has broadly been on a controlled ascent versus the USD under the watchful eye of Beijing. There are many who still think China’s currency is undervalued, even though USDCNY has dropped from its prior peg above 8.20 to a low around 6.12. However, Beijing is unlikely to allow a massive appreciation of its currency from current levels. We have seen Beijing halt yuan appreciation in the past. Thus, a continued slow grind higher is more likely in our opinion.

Why higher? We favour a push higher, as opposed to lower, because of the fundamental strength behind the yuan. The renminbi is an attractive investment and a possible alternative to the limitations of investing in mainland China. Investing in the world’s second largest economy is made difficult due to regulations preventing overseas investors from entering the Chinese market (China’s infamous capital controls), but investors can purchase the renminbi. Furthermore, Beijing is taking steps to make the renminbi more of a global currency, which could also boost its attractiveness.

By expanding trade settlement in the renminbi and currency swap lines, Beijing is essentially multiplying CNY’s global presence. At the same time, the government allowed the launch of China’s second offshore renminbi fund earlier this year. Admittedly, the government is still a long way from completely loosening its grip on the flow of capital into China. In fact, as early as late Q2, Beijing blocked offshore credit card companies from processing renminbi transactions. Nevertheless, the government is still broadly opening the mainland to offshore investment, albeit slowly in many cases.

Therefore, we maintain our view that the renminbi will become more market determined, as evidenced by Beijing’s recent setting of stronger reference rates against the US dollar. However, current economic conditions prevent a full liberalisation of the yuan in Q3. As Beijing attempts a soft landing for the economy, a significantly stronger yuan may be detrimental to growth, thus the government may not want to risk losing overall control of its currency just yet.

Furthermore, possible CNY strength may have to be weighed against possible USD strength. If US economic data surprises on the upside, then the Fed may choose to end QE3 sooner than expected, which is broadly USD positive. However, underlying long-term fundamental strength in the renminbi may see it continue to appreciate against the US dollar, albeit gradually.

Figure 7:


8, Choppy waters for stock markets

It is likely to be a tough quarter for stgeloped world stock markets after record gains in Q2. The prospect of the end of QE3 in the US, fiscal drag in the US and Europe and a slowdown in global growth, could be bad news for stock prices this quarter.

At the end of Q2 the outlook darkened for global stock markets as the focus switched to the end of QE3, the Federal Reserve’s enormous stimulus programme. Speculation about the end of QE coincided with declines in the major indices, including the Dow Jones and S&P 500 in the US, which backed away from record highs, and steep rises in Treasury yields.

As we move towards a new quarter there are a few unanswered questions: how deep will the selloff be? Has the uptrend that began in 2012 come to an end? To answer these questions we need to look at three things: 1, the fundamental backdrop for stock markets, 2, the outlook for corporate earnings and 3, the technical picture for stocks.

As we mentioned above, the end of QE from the Federal Reserve is a major event risk for stock markets. Equity markets tend to move higher when central banks adopt loose monetary policies and QE3 was ultra-loose. Uncertainty about the timing of the end of QE3 may continue to weigh on stock markets at the beginning of this quarter as investors search for clues from Fed speakers and economic data about when QE may end. However, as we progress through this quarter we believe that ideas of a quick end to QE3 could be put to bed. While QE has to end at some point, in our view it will be a very slow process.

The Bloomberg surprise index measures analyst expectations with published economic data releases and creates a z-score, which represents the number of standard stgiations that analyst expectations lie above or below normal surprise levels. As you can see below, in early June analysts had over-estimated economic data, and so the surprise index was in negative territory. There are a couple of things to point out: the negative surprises were not as deep as they were in mid-2011 and mid-2012, which suggests that the summer slowdown may not be as severe this year, however, economic data also did not surprise as much on the upside in early 2013. A moderate economic performance supports a cautious approach to ending QE3 from the Fed, which could protect stocks from a sharp sell-off in the third quarter.

Figure 8: Bloomberg economic surprise index

Source: Bloomberg,

Corporate profits in the US are also a concern. In Q1 2013 corporate profits started to slow. The headline measure of corporate profit (with inventory valuation and capital consumption adjustments) decreased by more than $40 billion in contrast to an increase of $45.4 billion in Q4 2012, according to the Bureau of Economic Analysis (BEA). There were declines in both financial and non-financial corporations, and this drop in profits also reduced the amount of corporate tax flowing into the government’s coffers. Although this data is released with a lag it is still significant. Has the corporate profit cycle turned? If we have reached a peak in corporate profits then it could be even harder for markets to rally. The end of QE3 could mean that investors start to scrutinise corporate balance sheets much more closely than they have been doing in recent quarters, and they may not like what they see. Added to this, analysts expect a healthy 8.5% increase in earnings per share in 2013, but estimates may have to be revised lower. This may add to the downward pressure on stock markets in Q3.

Figure 9: US corporate profits ($bn)

Source: Bloomberg,

The technical picture for equity markets is not clear cut this quarter. The Nikkei had led global stock markets lower since early June when it fell below a key support level at 13,700, its 50-day moving average, which was a bearish stgelopment for this index. European and US stock markets have not fared as badly as the Nikkei and were still managing to stay above key support levels at the time of writing. However, the markets seem fairly sticky around key resistance zones including: 8,500 in the German Dax, 6,800 in the FTSE 100, 15,500 in the Dow Jones and 1,700 in the S&P 500. Right now the declines in global equity markets look like a healthy pullback and do not suggest that the global stock market uptrend is over just yet. However, watch out for any further breakouts to the downside that could see steeper declines in the S&P 500 towards 1,560 then 1,490 – the 100 and 200-day smas. Below these levels would jeopardise current uptrends in markets and may suggest further losses are on the cards. Overall, we could see markets range trading this quarter, however the caveat is that either economic data deteriorates sharply in the US or QE3 comes to an end sooner than we think. If these scenarios play out then we could see a much sharper decline in global markets.

9, A silver lining on the horizon for precious metals

bears remain in charge, but things could change by the end of this quarter, so watch out for a potential reversal of fortunes in the precious metal sector.

The declines witnessed in both gold and silver after taking out their previous lows over the past 2 years, at $1520 and $26 respectively, during the second quarter was even greater than we anticipated. Sure enough, gold ended up breaking below all 3 of our noted 2Q support levels: $1450 (38.2% retracement), $1440/35 (200-week sma) & $1400 (measured move objective), and silver did its part as well: $24.30 (61.8% retracement), $24.00 (measured move objective) & $21.35 (2008 high), before ultimately finding a near-term bottom. While this was most evidently a technically/stop-driven move to the downside, it may also be explained by the disinflationary trend posted by some of the largest global economies – US April CPI: 1.1%, China April CPI: 2.3% and EU April HICP: 1.2%, as well as the potential reduction of Fed monetary stimulus in the US.

Combined, this seemingly leaves precious metal bears firmly in control as we enter Q3. Accordingly, we could see both gold and silver break to fresh 2013 lows, below $1322 and $20.30 respectively, in the first few weeks of Q3. Below here, the next potential support levels in XAUUSD: $1280/85 (38.2% retracement of rally since 1999) and in XAGUSD: $19.40/80 (key highs in 2008-10). However, there is a possibility of finding a more meaningful bottom near these levels towards the end of the summer as our proprietary model indicates a potential bullish bias for the yellow metal as we move into autumn.

Figure 10: Gold 2013 Actual vs. Proprietary Model

Source: Bloomberg,

10, Crude oil – the range persists

Oil is faced fiscal drag in both Europe and the United States (as they continue to de-lever and attempt to reign in their debts) we envision a rather tepid demand driven outlook for crude oil throughout the remainder of 2013.

Still faced with a palpable fiscal drag in both Europe and the United States, as they continue to de-lever and attempt to reign in their debts, coupled with slowing growth as witnessed by the likes of China, Australia and much of the emerging world, crude oil is faced with a challenging fundamental environment. That said, we adjusted our oil forecasts slightly to the topside as it appears the global economy is reaching a better balance between crude oil supplies and demand. Thus, barring a drop in overall GDP or the rapid removal of monetary stimulus from one of the major central banks, the balance should mitigate any swift declines in price.

On the other hand, we still envision a rather tepid demand driven outlook for crude oil throughout the remainder of 2013. Accordingly, we do not foresee a material move (±$10) in US or UK Oil from present levels, at $95 and $103 respectively, before the end of Q3 2013. Please keep in mind that tensions in the Middle East have elevated over the past few months, namely in Syria and more recently in Turkey, and should this continue to intensify the market could be poised for a supply shock, perhaps as early as this summer.

11, Copper still under pressure as growing pains persist

Technically copper looks vulnerable to a further decline, we assess the fundamental factors that could impact copper this quarter.

In our Q2 outlook we noted copper as a key driver of commodity performance overall and highlighted a long-term triangle pattern with potentially bearish implications. More specifically, we emphasized that “a break below $3.50, followed by a move below the November low around $3.40 would imply a resumption of the downtrend (as it would see lower highs and lower lows). Based on these patterns, the next key levels of support are $3.20/25 (2012 low), $3.00 (2011 low) and $2.50/55 (triangle measured move projection). Of course this pattern took years to stgelop, thus it could take several quarters to fully play out, if it does at all.”

Thus far our forecast for copper has been spot on, as the base metal broke below triangle support, retested it from below, and then declined in rapid fashion – taking out the noted $3.40 level, followed by the 2012 lows around $3.20 over the ensuing weeks. Interestingly enough, it came perilously close to another cited support level around $3.00 (2011 low), however just as weekly RSI broke below corresponding triangle support several weeks prior to price, it’s leading characteristics slowed as it too approached its corresponding 2011 low around 25. Ultimately, copper found a short-term bottom, yet as previously stated this triangle pattern “could take several quarters to fully play out” – Accordingly, should $3.00 give way in Q3, the next potential levels of support are $2.70/72 (2010 low), $2.65/66 (Aug. & Oct. 2009 lows) and $2.50/55 (triangle measured move objective).

Figure 11:


12, FX ranges for Q3

Get our price ranges for the major FX crosses this quarter

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