Are Precious Metals Due for a Relief Rally?

From around $600 in 2007, gold went on a parabolic rise to a peak of over $1900 in 2011, reflecting the worsening global economic conditions. Precious metals were one of the main “go-to” safe haven assets, and as such, they outperformed most other asset classes. Interest rates were slashed and bond yields fell dramatically, while equities found some support after the initial drop in 2008. However, that parabolic rise was never going to be sustainable, and so a big drop started in mid-2011 for both metals. Silver, in particular, has now lost over 70% of its value from the peak, in a spectacular sustained drop.

What are the potential reasons for the precious metals moves?

• The US Dollar has seen some strength since February 2018, with the DXY index, in particular, bouncing over 8% from the lows. Precious metals have always had a negative correlation with the Dollar (at least in the short term), and this has potentially been a reason for their weakness in 2018. Having said that, it’s worth noting that the Dollar weakened substantially in 2017 but precious metals didn’t manage to rally at all during that period.
• Global inflation has been steadily rising towards the widely-adopted 2% YoY target. The US and Eurozone are now at the target, while the UK has been well above 2% for a fair amount of time already. As a result, the Fed has been tightening rates for the past two years, and even the Bank of England hiked twice – despite the ongoing Brexit fears. On the other hand, the ECB hasn’t hiked yet but is expected to do so in mid-2019. While inflation is rising, so are rates, and it’s a well-known fact that PMs are sensitive to change in real rates (interest rate minus inflation). Real rates have in fact remained relatively constant at historically low levels, so effectively the argument that rising rates have damaged PMs doesn’t necessarily stand.
• Supply and demand for gold and silver have been broadly constant over the past years, with gold, in particular, is extremely stable. Silver, being an industrial metal, has seen some fluctuation due to changing demand and advance in technology (for example, miniaturization). However, the advance in technology also means that there are now more devices than ever which use silver, and furthermore, its use in areas such as photovoltaics and medicine is constantly growing. So, one could say that natural supply and demand (i.e. non-speculative) has been relatively constant.
• Global geopolitical events have been a source of volatility is most asset classes. Events such as the US-China trade wars, Emerging Markets chaos (Venezuela, Turkey, and Argentina to name a few) and the ongoing Middle-East situation are valid reasons for flight-to-safety flows to PMs, but this has not materialized. In fact, actions such as Turkey’s decision to sell gold in order to support the Lira have been greeted as price negative. But is this true? When a country is in crisis, its first line of defense is often gold, with its steady value and liquid market. If gold was not a useful and valuable asset, surely it would be one of the last tools a country would use to defend itself. It’s probably safe to say that global geopolitical dangers are not the reason for PM weakness, in fact, they should theoretically have provided support.
• Money supply is directly linked to the price of PMs, given their finite supply and difficulty in extraction from the ground. The Fed’s and ECB’s slow reversal of their quantitative easing programs will reduce supply, but that’s just one part of the equation. The constant generation of deficits by all major western economies (with the US leading the way at nearly $1trn annually), more than counterbalances this effect and causes money & credit supply to continuously increase globally.
• Bitcoin and other crypto-currencies have been hailed as precious metal “replacements” when it comes to finding assets that can be used as a store of value. Their convenience and lack of storage need make them worthy alternatives for sure, and as such, they have probably been adopted by many. On the other hand, they remain assets with practically no intrinsic value – they are simply digital assets that have been manufactured out of thin air, based on a specific computer code. This fact bears many dangers and has been a constant stumbling block for skeptics.
• Speculative selling has been a much-heated debate when it comes to precious metals. Whenever gold and silver have tried to overcome major technical levels (such as the 200DMA in silver), they have been met with violent selling in the futures market, with no other obvious prevailing reason. The moves have been sudden, relentless, and very effective. These speculative selling flows have seemingly been the main reason for gold and silver weakness over the past few years.