Factors that Affect the Precious Metals Market
- Precious Metals prices tend to move down when the U.S. dollar is strong.
- Gold and Silver can help central banks hedge against instability.
- Quantitative easing has a mixed effect on the price of Precious Metals.
As with any stock, currency or commodity, the price of Precious Metals is affected by outside forces. Over the last half-century or so, economists have identified several relationships between bullion spot prices and other observable market trends. Among the many things that influence the price of Gold, Silver or Platinum at any given moment are three well-documented forces: U.S. dollar values, central bank instability and a relatively new government monetary policy known as quantitative easing. While these correlations have had their exceptions, paying attention to these three areas can be beneficial in understanding when to buy or sell Precious Metals.
The U.S. Dollar and Precious Metals Prices
Both private individuals and sovereign nations have long turned to Precious Metals such as Gold and Silver as a store of wealth. For several thousand years, these commodities have been traded in the open markets and stored by families and governments because of their accepted value as money. For most of this period, the metals themselves were the currency, but that changed during the last 100 years. Central banks, institutions set up and operated by governments, create their own money used by citizens when making domestic and foreign purchases. While many of these countries keep stockpiles of Gold and Silver among their assets, the value of their currency is no longer relative to the quantity of Precious Metals that nation has in storage. Modern money has value based on the perceived economic influence of the issuing government and the exchange rate it maintains to other currencies.
Exchange rates for the U.S. dollar are determined by analyzing factors like current American debt levels, interest rates and global economic market strength. Other considerations for the U.S. dollar are unemployment rates, consumer confidence, inflation rates and current oil prices. Gold, Platinum and Silver are all dollar-denominated assets because all global markets measure them in U.S. dollars. Since the early 1970s, Precious Metals and the U.S. dollar have shown an inverse relationship in their financial patterns. If the U.S. dollar is stronger, the cost of Silver and Gold typically stays low. When dollar exchange rates weaken, Precious Metal prices tend to rise.
Investors are less inclined to buy dollar-denominated Precious Metals when dollar values are high because the purchaser gets less for their money. This model is especially true for anyone using non-American currency since exchange rates against a strong dollar will be low. Exceptions include times when both the U.S. economy is strong and manufacturing demand for Precious Metal is also on the rise. Other markets tend to move in the opposite direction of the U.S. dollar, including oil and the euro. Keep in mind that you may not see this inverse movement every single day, but it generally holds when observing market trends over weeks or months.
Central Banks and the Precious Metals Market
Central banks are monetary institutions authorized by national governments to control the oversight of sovereign currency. These are typically operated by the government but can also be private establishments given sole authority by the heads of state. These central banks hold Gold, and sometimes Silver and Platinum, as reserve assets. The reserve portfolio of monetary authorities can also include foreign currency, bonds and other low-risk financial instruments. Central banks use Precious Metals as a kind of monetary insurance policy, helping maintain a diversified portfolio in the event of economic unrest, locally or globally.
Precious Metals such as Gold are always in demand and in the event of central bank instability, the institution can easily liquefy the assets. This can be done in the form of a loan to another central bank or by selling Gold to another nation. Because these metals are acknowledged around the world as valuable, they do not carry the same credit risk that other assets do. Precious Metals also offer a return to central banks in times of volatility. When economies in certain countries face uncertainty, demand for safe-haven investments increases and monetary authorities with Gold and Silver to sell can profit massively if they put reserves on sale at the right time.
Quantitative Easing and the Price of Precious Metals
Large-scale asset purchasing by central banks, a practice generally known as quantitative easing or QE, involves purchasing established levels of financial assets to stimulate the economy. The idea is that by putting new money into the economy, investors will be encouraged to take an interest in higher risk investments. The funds used by central banks to purchase these assets is new money. It doesn’t come in the form of printed paper currency. When someone who owns government bonds sells them to a central bank, the funds used by the bank to credit the seller's account are new. While quantitative easing does run the risk of increasing inflation, since more money is in the marketplace, it has proven effective in the past to help governments avoid recession.
Concerning the price of Precious Metals, the effect of QE has been varied. When utilized during times of high volatility and economic uncertainty, Gold prices have seen a boost. One example was after the 2008 financial crisis in the U.S. when the Fed introduced quantitative easing for the first time. While some of the new money probably went to Precious Metals investing, the use of an untested financial policy made some analysts anxious, a temperament that typically leads to higher spot prices for metals. However, after two more rounds of QE were executed in the U.S., investors did return to riskier stock investments, which led to a Gold price decline.