As Precious Metals Grow More Precious

The value of silver soared to an all-​​time high last Thursday, and plunged dra­mat­i­cally yes­terday, illus­trating the con­stant volatility of the precious-​​metals market, which includes lus­trous com­modi­ties like gold, silver and plat­inum. Here, Kamran Dad­khah, an asso­ciate pro­fessor of econo­met­rics and macro­eco­nomics at North­eastern, who has studied the value of silver and gold in the for­eign exchange market, dis­cusses how the declining value of the dollar relates to the ever-​​shifting value of pre­cious metals and other com­modi­ties, such as oil.

What causes the volatility of the precious-metals market?

Three fac­tors can be counted as rea­sons for the sharp rise over the past year in the price of pre­cious metals, including silver, which rose 156 per­cent; gold, up 34 per­cent; and com­modi­ties, such as oil, which climbed by 33 per­cent. First, the world economy has moved out of the reces­sion. In par­tic­ular, coun­tries like China, India and Brazil have shown impres­sive growth and there­fore, demand for com­modi­ties has been on the rise. Note that both gold and silver have indus­trial, med­ical and other uses.

The second factor is the decline of the U.S. dollar, which is the inter­na­tional cur­rency. When it loses its value, the price of every­thing increases. A biproduct of this is an expec­ta­tion of infla­tion. When people expect infla­tion, espe­cially during times of uncer­tainty, they tend to rush to assets and com­modi­ties that are deemed to keep their value.

Third, the fac­tors spe­cific to each pre­cious metal and com­modity play a role in the market’s volatility. For example, the price of silver had his­tor­i­cally been much lower com­pared to gold, and hence it is catching up. As we’ve seen, the sharp increase in the price of silver was tem­po­rary, so we should be cau­tious, espe­cially as investors in silver often hedge against a decline in its value by buying options.

In the case of oil, the tur­moil in the Middle East is a con­tributing factor, although, except for Libya, no other major pro­ducer and exporter of petro­leum has had an upheaval. Nev­er­the­less, the fear that this could affect Saudi Arabia has prompted spec­u­la­tion in oil.

With the U.S. dollar losing ground, will precious metals continue to climb?

There are two rea­sons for the decline of the dollar. Since the United States has a huge budget deficit, of neces­sity it has a trade deficit. This means there is an increase in the supply of the dollar com­pared to its demand; hence the decline in its value. Second, the Fed­eral Reserve has been pur­suing an “easy money” policy by keeping the fed­eral funds rate close to zero. The idea is that the lower interest rate would encourage invest­ment. Fur­ther­more, the lower rate would cause the depre­ci­a­tion of the dollar, thus increasing exports and lim­iting imports. The dollar has declined against the yen, the Swiss franc and indeed against a broad index of for­eign currencies.

It is dif­fi­cult to fore­cast what will happen in the com­modi­ties market. Since the reces­sion is over, we should expect a con­tin­uing upward trend in the price of com­modi­ties. How­ever, the Fed cannot con­tinue the cur­rent policy for long without causing severe infla­tion, so we should expect the increase in prices to slow down.

How does the precious-metals market in the U.S. compare to other countries?

Prices of pre­cious metals and com­modi­ties around the world are con­nected. When the price of silver or gold increases in the United States, the same hap­pens in Europe, China and other coun­tries. The dif­fer­ences among coun­tries stem from their exchange-​​rate poli­cies. In a country like Saudi Arabia that pegs its cur­rency to the dollar, the increase in the price of such com­modi­ties is one to one. If a country’s exchange rate is depre­ci­ating against the dollar, the prices of pre­cious metals increase faster than in the United States. It is inter­esting to note that recently Iran’s cen­tral bank started selling a con­sid­er­able amount of gold in order to sta­bi­lize its price. The action was prompted by the sharp increase in the price of gold in antic­i­pa­tion of a high rate of infla­tion and the even­tual depre­ci­a­tion of the Iranian cur­rency against the dollar.

– by Kara Shemin