Why Precious Metals Will Continue to Move Higher

Stack of Chinese Currency
Liu Lei/Moment Open/Getty Images

In the wake of the 2008 financial crisis, central banks and monetary authorities around the world used all of the tools at their disposals to prevent economies from slipping further into recessionary conditions. Interest rates moved to the lowest levels in history around the world, and quantitative easing resulted in governments buying their debt, keeping bond prices high and interest rates low. In Europe, the European Central Bank took QE one-step further, purchasing the debt of corporations as part of their monetary stimulus program.

Governments designed these stimulative programs to inhibit savings and encourage borrowing and spending. The theory behind the policy has been to jump-start economic growth. Low-interest rates and government-supported bond prices increased liquidity around the globe and has amounted to an enormous amount of currency flooding the global system.

Fiat currency is the paper means of exchange printed by governments that rely on the full faith and credit of the nations that print the dollars, euros, yen and other paper money around the globe. “This note is legal tender for all debts, public and private” is written on each dollar which is a “Federal Reserve Note.” Years ago, many world currencies had gold or silver as backing. However, that is not presently the case. While governments still hold these two important precious metals as part of their foreign exchange reserves, paper monies are just paper and their value depends on the faith in the government that issues the money.

That is why the value of paper money can move higher and lower depending upon the market’s perception of the economy of the nation that prints the currency.

Gold and silver were means of exchange long before any of the major currencies now in circulation existed. The main difference between the precious metals and paper currencies is that the amount of gold and silver in the world is theoretically finite, limited only to the sum of the metals in circulation and their production potential.

Gold and silver exist in limited quantities in the crust of the earth as ores and metal. Central Banks of governments currently hold over 30% of all of the gold ever produced in the history of the world. The balance is in the hands of investors and hoarders in the form of jewelry, adornments or coins or bars. Silver is more plentiful on a per ounce basis, and it is both an industrial and a precious metal with a myriad of uses. However, many investors and hoarders also hold silver. While dollars, euros, yen and other currencies around the world are nation specific, gold and silver are global in nature.

As a result of their history as hard assets, gold and silver demand tends to rise at times when faith in paper currencies declines. Since 2008, the prolonged period of low interest rates and QE has amounted to a massive increase in the printing of paper currencies to stimulate economies around the world. Significant increases in the availability of foreign exchange made available by governments have naturally caused faith in paper money to decline. At the same time, many people have turned to gold and silver as the perception of the value proposition for these metals has increased among both governments and individuals.

Over recent years, there has been a net increase in gold holdings by the central banks of the world. China and Russia have been adding to their reserves, and many individuals have followed their lead. By the end of June 2016, interest rates in the United States were below 1%, and interest rates in Europe and Japan were in negative territory. The low level of interest rates has been the result of the policies of central banks and monetary authorities around the globe.

Currencies are assets, much like stocks, bonds, and commodities. One of the major attractions of currency over any years was the rate of interest offered to individuals for holding money in their bank accounts as savings. The growth of those savings via a yield caused many investors and savers to keep the paper money as their nest eggs.

However, the trend of little or no interest has made currencies a lot less attractive in the wake of the 2008 financial crisis. In some parts of the world, a deposit in a bank does not grow these days it declines, causing the popularity of precious metals to rise on the global stage.

The trend in paper currencies has been that their value, as an asset class, has been in a state of decline. At the same time, the perception of precious metals as a store of value has returned given the historical inverse relationship between paper money and precious metals. In 2016, gold and silver have increased in value when compared with virtually all paper currencies. As governments around the globe continue to print more money via low-interest rate and QE policies the trend of higher precious metals prices is likely to continue. That is why precious metals are destined to move higher. More paper currency means more money is chasing finite goods, and that is the core definition of inflation. Gold and silver is the ultimate hedge for inflationary conditions, and that is why the prospects for these shiny metals that have attracted humans for thousands of years continues to be positive. 

The trend in the world currency markets and the precious metals prices has significant ramifications for other raw material prices. One of the reasons that commodity prices across all sectors move up and down is changes in the value of paper currencies. The U.S. economy is the world’s largest and most influential and that is why the dollar is the benchmark pricing mechanism for most commodities. The trend of weakening global currencies and strong precious metals could be a harbinger for the path of least resistance for commodity prices in the months and years to come.

Markets, across all asset classes, are like a giant jigsaw puzzle. Each asset class can have dramatic effects on others, and that is why central bank policies over recent years will not only influence that prices of precious metals but all commodities will experience the side effects of weakening paper money around the world.