

 |  Includes: EWL, FXF, GLD
by: George Dorgan

We indicate several economic events that weaken the position of the Swiss National Bank (SNB). Moreover, we give several reasons for recent movements of the gold price and explain the correlation between gold, German economic data and the Swiss franc.

IFO data shows that Germany will not see a crisis

The IFO data on German business expectations has shown that Germany is unlikely to be dragged into a crisis. The value increased from its low in September of 93.2 to 97.9, higher than all estimates.

Investors and trading algorithms often associate the Swiss franc with the German economy. Certain tendencies, especially like rising prices in the Swiss housing sector, in exports and imports are correlated to Germany. Rising German salaries mean that Swiss imports from the biggest Swiss trading partner, Germany, become more expensive and this increases Swiss inflation. Therefore, the EUR/CHF often falls after good German data.

On the other hand, good fundamental data from France and the peripheral countries account more for an upwards move of the EUR/CHF. The bubble in the peripheral economies before 2008 was the main reason that the franc depreciated to EUR/CHF 1.68 in 2007. Currently, French purchasing manager indices seem to be much weaker than German ones, suggesting further weakening of the EUR/CHF rate.

US current account deficit is falling, but American consumption slowed

The US current account deficit is shrinking, but it was still higher than analysts expected. While real hourly wages were rising very slowly, the Americans consumed less and imported less than in previous quarters. The slowing oil and gas prices helped to reduce the deficit; gas prices are nearly unchanged against last year.

Imports fell for the second straight quarter, a rare occurrence - and one that has some economists worried about the health of the U.S. economy. Less domestic spending is not the best way to cut the current account gap, economists said. (Source Marketwatch)

It seems as if Merkel's medicine for reducing current account deficits via less spending has finally arrived even in the United States.

Traders are moving into Swiss francs, out of the yen and the US dollar

After the news, traders moved out of the dollar and bought Swiss francs and euros instead. Due to Asia's slowing and Abe's pressure on the Bank of Japan, even more flows were directed to Switzerland and Germany, two countries with strong trade surpluses. Thanks to support from FX traders that bought EUR/CHF at the lower end of the December 1.2075 to 1.2130 range, the EUR/CHF exchange rate did not fall more.

Gold - CHF correlation and SNB losses on gold

With the slowing in Asia and weaker US trade deficit, the gold price was under pressure.

Due to the stronger real effective value of the Yuan, the Chinese current account surplus has considerably weakened this year. Consequently, foreign currency and gold purchases by the Bank of China slowed down. If Asia's slowing and the US recovery intensifies, then the 2012 increase of gold buying by central banks may stop.

Click to enlargeChinese FX reserves buildup, trade surplus shrinks, but surplus with the US is rising (sources Peterson institute and Zerohedge)

The Australian dollar, but also the Swiss franc and gold, show strong correlations with the Chinese and other emerging markets' economies. The Aussie, however, gets strong when both the Chinese and the American economies expand. Gold and the franc are the "safe version", they improve when the American economy is relatively weak but China is strongly expanding like in summer 2011.

The graph below shows the strong correlation between gold and the CHF/USD between 2010 and September 2011. Only two weeks after the SNB decided to introduce the EUR/CHF floor, the gold price collapsed too. We believe the reason for this was that the economies of China and other emerging markets weakened and the United States became stronger. Today, gold is still at a high level, which is not justified by the current relative weakness of the Chinese and other emerging economies, especially when measured by manufacturing PMIs.

Click to enlargeCHF/USD vs. Gold 2010-2012

The recent weakening of gold had an influence on the SNB balance sheet: The SNB lost 1.85 billion francs in just one day with losses on the dollar, the yen and its gold positions.

Swiss trade surplus near record levels

As we noted in our recent Seeking Alpha post on the strong Swiss trade surplus, the SNB implicitly pays out tax-payer financed subsidies to the Swiss tourism and machinery industries. Splitting the export-weighted exchange rate into industries like here on VoxEU, gives hints that moving this machinery production partially abroad would have been a far cheaper solution than risking billions of tax-payers' money.

The other industries, especially the pharmaceutical industry (33% of Swiss exports) go from one record trade surplus to the next. The Swiss merchandise trade balance achieved its second-highest result ever; most profits are made with both the emerging markets and the US.

Swiss imports, and implicitly Swiss consumption, are rising

As opposed to the Americans that imported less, the Swiss increased their consumption of foreign goods. The trade data shows that both Swiss exports and imports rose by 5%. Thomas Jordan, however, said in the SNB monetary policy assessment that he expects Swiss internal demand to slow down.

Thanks to weaker consumer prices and a strengthening economy, we reckon that Swiss consumption will be strong even next year. The trade data has sustained our thinking and contradicts Jordan's view. His view was potentially driven by the idea that falling prices might lead to less consumption in the form of a deflationary spiral. The ordinary Swiss, however, see things differently: with the rising home prices, they are waiting for the moment that inflation picks up again.

This gap between people's inflation expectations and the SNB's inflation path for 2013 and 2014 is worth examining.

Swiss producer prices up 1.2%

According to Swiss Statistics, producer prices are up 1.2% against last year. Given that producer price inflation usually comes earlier than consumer price inflation, this completely contradicts the SNB consumer price inflation forecast of minus 0.4% in the year 2013. (For ideas to sustain the SNB arguments, at least partially, see our post where we detailed a list of drivers that push Swiss inflation downwards and several others that push upwards.)

Investment Recommendation

On several occasions (here or here on Seeking Alpha), in October, we suggested that long-term international investors should reduce the gold share and increase Swiss francs investments. We recommend the ETF FXF, long-term Swiss government bonds with maturities over 20 years (e.g., CH0127181169, CH0127181193) as a hedge against the long-term dollar weakness. Additionally, we prefer the EWL ETF with 45% holdings in the major companies Nestle (OTCPK:NSRGY), Roche Holdings AG (RHHBY.OB) and Novartis (NYSE:NVS).

Nonetheless, we judge that by the end of Q1/2013 gold's weakness (e.g. the ETF GLD) will finish. However, we have not seen the lows yet.
