Gold and silver hit the pause button

The past few weeks have been a volatile period for financial markets and that includes gold and silver.

Gold reached a record high in January of $5,405/oz after a remarkable run last year.  In March, the price declined by 12%, the worst monthly performance since June 2013. However, gold is up 5.5% year-to-date through March.¹

The conflict with Iran and the complex geopolitical environment led the market to become more sceptical about the outlook for rate cuts by the US Federal Reserve (Fed) while at the same time short-term inflation expectations held steady. Real interest rates rose, which is negative for gold and silver, and speculative traders sold off.

If the market expects central banks to change direction and to hike rates meaningfully, this is typically negative for gold and silver. We think that the speculative traders over-reacted, however.

Staying positive

The Middle East conflict has caused many investors to refrain from making big portfolio changes. We recognise the considerable uncertainty in financial markets, but even so we remain positive about the prospects for gold and silver.

The market for gold and silver has been driven by speculative traders and global hedge funds on one side and on the other side by retail investors who have bought into monetary metals as they rose over the last year or so. Central banks also have been increasing their gold holdings in recent years. 

What hasn’t been driving the market, however, are asset allocators and long-only investors. This would include global investment funds, and retirement and pension funds, who we believe are under-allocated to gold and silver. We would expect this to change over time. 

MAG 7 and private markets

Long-only investors have been transfixed over the last few years by technology stocks including the MAG7 (Microsoft, Apple, Nvidia etc) as well as private market assets, leaving little space for other assets to get a look in, in our view.   

The questions we ask are, how do you get momentum back into gold and silver markets, and how do you attract the attention of long-only buyers? The fundamentals that support  gold and silver haven’t changed, in our view. 

We believe we may be in the waning days of a long cycle of US hegemony, including the primacy of the dollar and US Treasuries as the main risk-free assets in the global financial system. There is mounting concern about the US government’s balance sheet,  its increasing deficit and financing costs. It’s not just a US government issue; France, Italy, the UK and Japan also have substantial amounts of debt. This is one reason that the major fiat currencies – dollar, euro, pound and yen – have lost value against gold over the last 25 years.²

Regardless of how the conflict in the Middle East ends, we think these longer-term, fundamental issues remain.

Two scenarios

If the war ends soon, the market may return to its view that the Fed will resume its rate-cutting cycle and inflation will be manageable. This would be positive for monetary metals, in our view.

A more difficult scenario for investors would be that the war drags on and causes supply chain disruptions, continued oil and gas price spikes and a 1970s-style stagflation environment.

This would be negative for risk assets and the traditional 60-40 portfolio (60% stocks, 40% bonds), in our view. It could potentially motivate long-only asset allocators to look to gold and silver. I sometimes use an aircraft carrier analogy – this huge part of the market would begin to turn, to take notice of gold and silver and to bring momentum to the market. 

It is important to recognise that investment outcomes for gold and silver and gold and silver mining stocks may differ materially from expectations. Price performance depends on physical supply and demand as well as capital flows, market confidence and macroeconomic developments, all of which can change quickly. 

At the time of writing, gold and silver seem to be paused, along with other asset classes, as investors await some clarity. 

Turkey sells?

There has been some comment in the press recently³ about the Turkish central bank selling gold to support the lira and the impact this may have had on the market. My view is that this has more to do with the state of Turkey’s economy and that this gold would be sold to another country’s central bank via the Bank of International Settlements (BIS) and wouldn’t have impacted market prices. The BIS is a global financial institution owned by member central banks. 

This event highlights gold’s role as a principal reserve asset of central banks, which use the yellow metal to protect against inflation and market risk. These institutions have increased their holdings in recent years, according to the World Gold Council.

Gold and silver have functioned as stores of value during periods of market volatility, geopolitical instability and economic uncertainty due to their diversification and liquidity attributes. We remain patient and positive about the outlook, as we believe gold and silver and gold and silver mining equities have a role to play in well-diversified investment portfolios.

Footnotes

¹All figures, World Gold Council, as at 9.4.26. Past performance does not predict future returns.

²Past performance does not predict future returns

³Financial Times, 10.4.24. https://www.ft.com/content/6c931469-495c-4860-a455-4888af072f58?syn-25a6b1a6=1