What Influences the Precious Metal Market?

To be a successful precious metals stacker, it is crucial to have an accurate understanding of the many factors that influence the precious metals market. Though it is impossible to predict each major event that causes the market to fluctuate, it can be beneficial for both new and seasoned collectors to read though several of these shaping forces. 

To be a successful precious metals stacker, it is crucial to have an accurate understanding of the many factors that influence the precious metals market. Though it is impossible to predict each major event that causes the market to fluctuate, it can be beneficial for both new and seasoned collectors to read though several of these shaping forces. 

In 2016, the four-year bear market that began after gold hit an all-time nominal high of $1,924 in July 2011 was reversed, and metals entered a new bull market earlier in 2016. Gold has been one of the best-performing assets of 2016, reaching a high of $1,363 shortly after the United Kingdom voted to leave the European Union at the end of June with their famous Brexit. This world event represented a 28% increase in gold for the year.

A couple of reasons that precious metals performed so well in 2016 were that interest rates were kept at extremely low levels while uncertainty rose with concerns about global economic growth, terrorism, and other geopolitical concerns. Even the rising role of nationalism and authoritarianism around the world has had an effect on the precious metal market. In fact, the International Monetary Fund recently said that political risk was the biggest threat to the world economy. These factors have increased the safe-haven demand for precious metals.

In early October, gold prices experienced a correction due to a strengthening dollar, increased chances of the Federal Reserve raising short-term interest rates, and the selling of metals by speculators. This final cause triggered technical, computer-driven selling. For some time, gold was up to about 18%!

Analysts were encouraged that the important $1,250 level for gold was maintained during this correction. Precious metal sellers reported in the days after the drop that demand picked up a great deal as buyers sought to take advantage of lower prices, a development which MCM’s General Manager, Andrew Salzberg, said was also true of his company’s business.

Silver performed even better than gold and also declined more during the recent correction, but was still up 26% for the year – an impressive performance!  Platinum was up 8% for the year. Most experts believe this correction was a healthy pullback in this year’s bull run as sellers took some profits.  

The five most import forces that shape the price of gold and other precious metals are:

1. Interest Rates

2. Value of the U.S. Dollar

3. Inflation and Money Supply

4. Supply and Demand Fundamentals

5. International Context

After the economic crisis of 2008, the Federal Reserve Bank took two key preventative steps for the future. The first was that short-term interest rates were kept close to zero, and have only been raised once at the end of 2015, by only a quarter of a percent. The second was increasing money supply by trillions of dollars through an unconventional program known as “quantitative easing” (QE) or “money printing.”

In the years since the crisis, the U.S. economy has rebounded considerably. Though growth remains sluggish, most other economies around the world face far greater challenges. To try to address those issues, central banks in Europe, Japan, and China have also engaged in their own QE programs. As a result of all this money printing, the U.S. money supply is at an all-time high, and the level of debt in this country and around the world is also very high.

Investors still have more confidence in the U.S. dollar than in other currencies, although that could change at some point if they come to believe that the U.S. will not be able to service its debt if interest rates rise a great deal. Due to the strength of the dollar compared to other world currencies in the past several years, the price of gold in dollars has been much lower than the price of gold in other currencies that have fallen against the dollar. For example, the declining British pound, which is at a 30-year low against the dollar since the Brexit vote, has meant a 40% increase in the gold price measured in Pounds. 

Many critics of QE thought that by now, all that increased money supply would have produced very high levels of inflation, but so far inflation has remained modest. However, former Federal Reserve Chairman Alan Greenspan recently said he is concerned that QE will finally begin to produce high levels of inflation about a year from now.

Another important recent development is that in eight European countries and Japan, banks are now imposing negative interest rates; i.e., charging customers to hold their money. This will hurt the performance of banks in those countries and over time, if this practice is continued, it will increase the potential for another banking collapse.

Depending on the extent of such a collapse, the entire world financial system could be threatened. With so many trillions already on their balance sheets, central banks could not credibly keep printing money at that point, without calling the credibility of their currencies into question. That would leave policymakers with virtually no way to keep the system from imploding.

Some experts such as James Rickards, author of the recent book, The New Case for Gold, believe that will require an eventual new international monetary system in which gold will play an essential role. He believes the countries with the most gold will shape the rules of that system.

In the meantime, central banks around the world, especially in China and Russia, have been steadily increasing their gold reserves. China does not release such information officially, but experts believe it now has the world’s second-largest reserves after those of the U.S., which are stored at Fort Knox and in the New York Federal Reserve Bank. China is the world’s largest producer and consumer of gold, and is believed to be pursuing a long-term strategy to use its gold holdings and rising economic status to enable its currency, the Yuan, to eventually replace the U.S. dollar as the world’s reserve currency.

On a day-to-day basis, gold and other precious metal prices are mostly shaped by trading on the futures market and in exchange-traded funds like GLD, but over the long term the fundamentals of supply and demand will assert themselves. Demand for physical metals in the first half 2016 was the second-highest on record according to the World Gold Council.

Such a supply crunch has been building for years with gold, because the price was so low during the 4-year bear market from 2011 to 2015 that it was not economically feasible for many mines to operate. In addition, demand for physical gold has been shifting from the West to the East as people in China and other countries in that part of the world focus on accumulating precious metals. 

For all these reasons, most analysts today have a long-term bullish outlook on precious metals, which is not impacted by day-to-day price gyrations. With U.S. interest rates likely to remain very low even with a couple small increases in 2017, and declining yields on bonds, now could be a great time to diversify your portfolio with gold bullion, silver bullion, platinum, and palladium.

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