The prices of gold and silver haven’t performed well in 2012. Moreover, both gold and silver haven’t increased much in the past couple of years. Is it all over for precious metals? Is the global economy doing much better in 2012 than it did in 2008 so the growth in the demand for gold and silver as a safe haven investments has deteriorated? Let’s examine the performance of gold and silver during 2012, the main factors that may have affected their direction and guess where gold and silver are headed in 2013.
Gold and Silver Prices 2012
During the first couple of months of the year, silver price spiked and by the end of February silver increased by nearly 26%, while gold price rose by only 11% from the beginning of the year. The decision of the FOMC to extend its pledge for low interest rates until the end of 2014 may have contributed to this short term rally. Soon after, however, there was a sharply correction as both metals tumbled down. Since then the prices of gold and silver haven’t done much. They did have a short rally between August and November perhaps due to the speculations around: the fiscal cliff debates, the results of the U.S Presidential elections, and the next FOMC move. Despite this rally, by the end of the year the price of gold rose by only 3.7% and silver by 1.9%.
The chart below presents the development of gold and silver prices during 2012, in which gold and silver prices are normalized to 100 for January 3rd, 2012.
The next chart shows the development of the ratio of gold price to silver price (gold price/silver price) during 2012; the ratio had an upward trend during the last few months of the year as silver price under-performed gold price.
Gold and Silver Prices Outlook for 2013
Let’s examine what are the main factors that could affect the movement of prices of gold and silver during 2013. Before doing so, let’s analyze the main competing theories for the development of gold and silver.
Two competing theories try and explain the rise in precious metals: Hotelling’s model that explains the rise in gold and silver via the sudden and short term drop in long term rates. The other, precious metals are as a safe haven investment against the devaluation of the USD. I think that in both of these theories the bottom line is that gold and silver will only slightly rise in 2013 as they did in the past couple of years.
A note: the changes in the demand and supply tend to affect many commodities such as natural gas and oil, but this is not the case for gold and silver because these precious metals function more as a safe haven investment than consumable commodities. If the prices would have been govern solely by the changes in the actual supply and demand (for consumption) changes than the prices of gold and silver should have been around $500 and $7, respectively (as they did back in 2007). Therefore, a supply and demand analysis is less relevant and that is why my analysis will mostly refer to the demand for bullion as an investment tool.
Is it all over for precious metals?
Some analysts, such as Paul Krugman, explained the short term spike in the price of gold via the framework of Hotelling’s model. According to Krugman, the sharp drop in the long term interest rates may have led to a short term spike in the prices of gold and silver as investors require less motivation for a price appreciation to hoard precious metals. This, in turn, resulted since then in a steady and modest price appreciation of precious metals.
The chart below shows the development of the price of gold and 10-year interest rates during 2012. As seen, the long term interest rates have slightly declined during the year, while the price of gold moved during the year with an unclear trend.
This theory also predicts that the prices of gold and silver will plunge once the long term rates will sharply rise. This may occur in early 2015; if the FOMC will keep its pledge to keep rates low until the end of 2015 (the expectations will bring precious metals down again). This date, however, could be further into the future if the FOMC will extend its pledge and expand its QE programs.
The FOMC, Gold, Interest Rates and Money Base
The decisions of the FOMC to expand its balance sheet by purchasing not only $40 billion per month of mortgage backed securities but also $45 billion of long term treasuries, could lead to a drop in the long term interest rates as 2013 will progress. If the long term rates will precipitately decline because of QE3, then it is likely to pull up gold and silver prices in the short term. My guess, however, is that QE3 will only moderately pull down long term rates because there is a diminishing effect to the QE programs on the money base.
In the chart below are the development of the U.S money base and the price of gold in the past 12 years.
As seen, the U.S money base hiked between 2008 and 2010 following QE1 and QE2. The U.S money base, however, remained nearly unchanged during most of 2011 and 2012 despite the FOMC’s launch of QE3 at the last few months of the year.
I still think that most of the growth came from the demand side as gold and silver were treated as a safe haven investment against the devaluation of the USD. In this regards, the USD remained virtually unchanged against many “risk currencies” during the year: the Euro/USD rose by only 1%, the AUD/USD slipped by 0.2% and the USD/CAD fell by 1.7%.
In terms of inflation, the U.S inflation remained stable during the year around the 2% mark and thus lowered the speculations that the steps taken by the FOMC (e.g. QE programs and low rates) won’t devalue the USD and thus lowered the demand for gold as a safe haven investment against such a scenario.
The U.S economy showed some signs of progress: the rate of unemployment reached the lowest level since mid-2008, the GDP expanded by 3.1% in the third quarter of 2012 and the housing market is slowly rising. If the U.S economy will continue to show signs of progress, this could strengthen the USD and consequently lower the prices of gold and silver.
European Debt Crisis
The recent developments in Europe didn’t seem to have much of a long term effect on the Euro as it remained almost unchanged against the USD on a yearly scale.
The news of Spain’s rise in its financial risk and the recent election results in Spain, France and Greece may have contributed to the movement of the Euro. But the steps the ECB took to regain the confidence in the Euro Area seem to have worked. If the Euro will start to rise again, this could also pressure up the prices of gold and silver.
In the chart below are the linear correlations among precious metals and leading currencies pairs during the year. Based on these relations, it seems that if the Euro, Canadian dollar and Aussie dollar will appreciate against the USD than they are likely to help rally bullion rates.
China and India
It’s also worth noticing the developments in India and China two of the leading importers of gold and silver worldwide. These economies haven’t performed well during 2012. Furthermore, the devolution of the Indian Rupee against the USD during the year (mainly during the first half of the year) may have curbed the demand for gold in this country and could continue to do so in 2013. Nonetheless, if these countries will show signs of recovery during the year, this could contribute to the rise in the prices of gold and silver via an increase in the demand for these precious metals.
The Bottom Line
Based on the analysis above my guess is that the prices of gold and silver will only slightly rise during 2013 as they did in 2012. Nonetheless, if the FOMC’s steps to help rally the U.S economy will also lead to a steep plunge in the long term interest rates, and a sharp gain in the U.S money base, then this could result in a short term spike in precious metals. This scenario, however, is less likely in my opinion.
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