Why have gold and silver prices gone up?

Of late, there has been increasing investors' interest in precious metals. This is amply evident in the prices of widely known and often in demand precious metals such as gold and silver. In the past six months, the price of gold has jumped 16.1% to trade at US$2004 per ounce. In the same period, the price of silver has zoomed up 18.5% to trade at US$25.09 per ounce. This optimism about precious metals had a rub-off impact on well-known international metal trading companies such as ArcelorMittal S.A, Posco, Baoshan Iron & Steel Co and Nippon Steel & Sumitomo Metal Corporation as their share prices have appreciated in the range of 20-60% in the past six months.

Such high interest in precious metals may trigger a pertinent question in investors' minds: What factors have driven prices of these precious metals? This increase in the prices of gold and silver reflects a story of changing macro-economic dynamics in global markets especially the US. Let us understand these dynamics in greater detail. In understanding these macro-economic dynamics you will be able to understand why prices of these precious metals have gone up and whether interest in these metals will sustain in the coming months.

The interest rate connection

Globally, two variables which have shifted a certain amount of investors' interest to the universe of precious metals from equities are inflation and interest rates. It is important to understand the connection between interest rate, inflation and equities. When inflation is high, it impacts demand for goods. This in turn impacts revenues of companies. As a result, earnings of companies are impacted which is duly reflected in poor stock market performance of companies. This makes investments in equities less attractive. Similarly, when interest rates go up, the cost of borrowing funds goes up. This impacts demand in an economy and expansion plans of companies. This in turn impacts earnings' growth of companies as high interest rates reduce operating profit margins

In the backdrop of these facts, the prices of gold and silver have gone up. In the US markets, which is almost an epicentre of global markets, in 2022, there prevailed high inflation. Inflation in the US went up because the US Fed printed money to deal with the economic slowdown triggered by the Covid-19 pandemic. To bring inflation under control, the Fed increased interest rates. This made investments in equities less attractive. As a result of this, big institutional investors sold in most markets and this capital reached the US markets. This strengthened the dollar with respect to most major currencies.

Generally, when one asset class turns unattractive interest in another asset class develops. This is what exactly triggered high interest in the precious metals--gold and silver. Largely, when equities become less attractive, gold becomes a safe haven as investors of almost all types buy gold for a variety of reasons.

In 2021, gold lost almost 5 per cent in USD terms and in 2022 it appreciated by half a per cent. Gold did not lose ground despite strong dollar currency because prices of most other risky assets fell. From March 2022 to till date, the US Fed increased interest rates by almost 500 basis points. This pulled down most stocks and cryptocurrencies. Due to high interest rates which threatened to impact economic growth and demand for commodities, there emerged fear of recession. This also resulted in stock market correction and cryptocurrency debacle. Hence, investors began shifting their investments to gold.

Big institutional investors such as hedge funds began buying gold. Even central bankers too started buying gold. Gold bounced off from the lows of USD 1616 per ounce registered in October-November 2022 to close the year at USD 1824. As of CY2023, the gold remained in demand and the prices continue to go up though with some volatility. After correcting a bit, it has been trading around the USD 2000-mark. It is still far away from the all time high of USD 2072 recorded in July 2020.

The business of catching up

Among the precious metals, gold attracts higher attention from investors than most metals. Silver by the very nature of the metal is far more volatile and hence many traders prefer it to gold.

In October 2022, silver prices were lower than gold. Key markets such as India saw aggressive imports of silver in subsequent months. Silver, though is a precious metal usually, catches up with gold prices. There are reasons why interest in silver remains stable. It is an industrial metal and used as a key input in emerging sectors such as solar energy, electric vehicles, lithium batteries, and in the manufacturing of electronic gadgets. If the global economy grows, the demand for silver is bound to go up, which in turn leads to higher silver prices.

In this context, you have to look at the increase in economic activity in China. As the Chinese economy springs back to normalcy, there is high scope for significant increase in economic activity in China. Chinese policymakers are expected to boost its economy by making high investments. The Chinese monetary policy is not at all restrictive as it is in the US and Europe. This should lead to increased demand for industrial metals including silver. Also, it is a matter of time the US Federal Reserve and other central bankers will soften their stand on interest rates and yield to the pressure built by the demand for economic growth. In the context of these facts, the demand for silver is likely to remain stable.

In the coming months, experts believe that central bankers may not further increase interest rates and soon the liquidity will be infused. Recent failures of banks in developed markets is going to accelerate this process. If interest rates are cut and inflation still remains near the upper end, investors are bound to be nervous. It means that they may earn a negative real rate of returns – which is computed by deducting the rate of inflation from the nominal rate of return. In such times, savers and investors would like to allocate some incremental money to gold (and silver). This should keep prices of these precious metals high. Risk-averse investors, however, can trade in gold or silver by either investing in mutual funds schemes which provide exposure to these precious metals or directly shares of companies which benefit from the appreciation of prices of these metals.

It is the time to allocate money to gold and silver. It will diversify your investment portfolio and improve its risk-adjusted returns. But long-term investors must follow an asset allocation approach rather than impulsive decisions based on short-term price movements.