Volatility Enhances Gold Price

Our screens are red this week, as losses continue for most assets. Notable exceptions are gold, palladium, and wheat, moving higher. This week could be economically volatile for many reasons, including geopolitical tensions involving Russia, the US and Ukraine, Chinese incursions into Taiwan airspace, and missiles intercepted over the United Arab Emirates. Food shortages have become an issue across the US for staple food items, contributing to food inflation and societal instability. It is also a huge week for economic reporting, with Federal Reserve meetings and announcements scheduled Wednesday. Other central banks are also meeting this week to discuss upcoming changes (see graphic). But whatever the short-term implications are for volatility, the longer-term destination for silver, gold, and platinum seem clear. We are in the midst of a historic setup for outsized performance by the metals, and today we will look at some charts that illustrate the setup.

By definition, short-term price action is a short-term phenomenon. This is important to remember in volatile periods like we are seeing today. Traditionally, we could expect a paper smash before the FED announcements throughout the day Wednesday. Tamping down gold and silver before the announcements often means that the information to be shared is expected to cause them to rise further. When looking at recent losses in the stock market and crypto, some analysts say that these markets are currently “oversold”, and due for a short-term comeback before falling again. So from here, it appears that both stocks rising and/or precious metals falling should be considered a short-term phenomenon. Longer-term, it is “look out below” for stocks and “up, up, and away” for gold, silver, and platinum.

One of the most familiar precious metals metrics referred to today is the “Gold-Silver Ratio”, which compares how many ounces of silver an ounce of gold will purchase. In the last 30 years, this ratio has been lower than today 84% of the time. In other words, even though gold is currently climbing in price, the message from gold is that silver is priced too low and will have to rise to return to equilibrium. A less-discussed metric is the “Silver-Copper Ratio”, which compares how many ounces of copper an ounce of silver will purchase. Even though copper has risen substantially in the last few years, this ratio indicates that silver is underpriced relative to copper and will likely rise in price. There are also other indicators suggesting silver will go higher as well.

The demand for silver is expected to continue to be higher than the supply of silver for the next several years, putting pressure on the price. One of the reasons for this is the growing demand from the automobile industry, as the push towards electric vehicles continues. Even though total vehicle production is expected to increase only slightly in the years ahead, the amount of silver needed to manufacture those vehicles is expected to rise 80% in coming years (see chart). This also supports copper, implying that the equilibrium between silver and copper will more likely be achieved by silver rising than by copper falling.

This is not to say that the rise of silver will come at the cost of gold, however. Gold has its strong narrative building and a history of strong performance following stagflation. The uncertainties touched on in the first paragraph also lend support to gold. While we may see down days from time to time, including this week, it is important to look out a little further. Encouraging historical patterns are emerging that suggest gold could see $8,000 in the next few years. This is not a “pie in the sky” projection but merely the expected path for gold to take if it follows historical precedent and imitates past performance in percentage terms (see chart). With many voices calling for $10,000, $20,000, or even $50,000 gold (based on money supply growth), $8,000 is a conservative estimate.

With all the good news surrounding gold and silver, we cannot forget platinum. As we discussed last year in the article “Going Platinum”, platinum spent much of its life priced higher than gold. Even if it does not surpass the golden monetary metal in price, we will likely see it at least close the gap between the two. While gold increases 4-fold towards $8,000, platinum shows signs of a 5-fold increase towards $5,500 over a similar period, based upon historical pricing patterns (see chart). Palladium will undoubtedly have up days and opportunities for growth as well (especially with production outages from a possible Russia-Ukraine conflict), but has already enjoyed a spectacular run up the last few years. For this reason, I favor platinum in the coming years over palladium. Time will tell.

While the long-term case for gold, silver, and platinum seems optimistic, the intermediate term case for equities and bonds seems less certain. With inflation pressures building, the Federal Reserve expects to begin a series of interest rate increases. Higher future interest rates suggest lower future bond prices. And an ominous gap has developed between the amount of goods shipped, and current stock prices. With difficulties experienced in supply chains and the number of truck drivers available to haul products to store shelves, fewer items are being sold. This directly affects the bottom line of corporations across America and implies that stocks are priced too high relative to sales. Either more goods need to be shipped/trucked, or stock prices must come down to reach equilibrium.

With nearly one trillion dollars worth of goods shipped into the US from Canada and Mexico (combined), policies that restrict the flow of those goods might negatively impact supply shortages across the US. New vaccine restrictions on truck drivers entering the United States make it more likely to make fewer goods across either border and onto store shelves. This implies higher price inflation for the goods that remain and lower stock prices for companies selling fewer products. Eventually, these imbalances will be resolved, one way or another. But in the meantime, it might be prudent to consider rotating out of paper assets currently overpriced and into tangible assets positioned to outperform.