Why gold and silver are rallying so sharply?

What exactly has driven this rally in gold and is it sustainable? More importantly, what about silver! Let us check out.

Jul 30, 2020 08:07 IST India Infoline News Service

Leading global investment houses like BOFA, UBS, HSBC and Goldman Sachs, recently upped their targets for gold. As we speak, gold has scaled its life-time peak of $1950/oz that it had last scaled in 2011. In Jun-20, Goldman had set a price target of $2000/oz by middle of 2021. But that price is almost there. HSBC and BOFA have scaled up gold price target to $3000/oz by end of 2021. Interestingly, this rally is not just about gold but also silver. The momentum of the rally is clear when you plot gold and silver prices versus the Nifty.

Figure 1 - How the 1-year gold and silver rally compares with Nifty

Chart source: Bloomberg

Over the last 1 year, leaving aside the volatility of 2020, overall returns on the Nifty was just 0.06%. In contrast, gold has given returns of 37.63% in the last one year while silver has yielded a whopping 48.41%. Interestingly, more than 75% of the returns on silver came in the last one month. What exactly has driven this rally in gold and is it sustainable? More importantly, what about silver!

Why the rally in gold prices?

To understand the rally in gold prices in the last one year and the reasons for the optimism of HSBC and BOFA, here are five key points.

a) Gold is considered a natural hedge against global uncertainty. With the economic slowdown post COVID-19 and the worsening trade war between the US and China, investors and traders are looking at gold as a safe haven investment.

b) Most investors want to avoid the wealth shock of 2020. In the first 3 months of 2020, equity as an asset class saw $20 trillion being wiped out globally. India alone saw $1 trillion wiped out in 3 months. Gold was the lone asset class standing.

c) Gold demand continues to grow in the early stages of any economy recovery. That is why, even though economists are expecting global GDP to pick up from the September quarter, demand for gold is likely to remain robust.

d) Currency debasement is another concern. When central banks infuse liquidity, they print currency leading to effective debasement of these currencies. Gold is a currency that sustains value in these times.

e) The interest rates in most of the large economies have been cut sharply but inflation is yet to follow suit. That means real rates in most countries are either zero or negative. In these conditions, gold is an obvious choice.

Indian gold prices at historic highs for some time now

Indian gold prices touched life time highs, well ahead of global gold prices. That can be attributed to a mix of high global gold prices and rupee depreciation.

24 Carat Gold Price (28/7/20) 24 Carat Gold Price (28/7/19) Returns (%) over 1 year
Rs,52,000 / 10 grams Rs.35,720 / 10 grams 45.58%

Global spot gold has given a return of 37.63% while Indian gold has given returns of 45.58%. Jewellery demand for gold in India has been the lowest in recent memory. Why has gold given superior returns in India?

Gold prices in India are hardly determined by jewellery demand. It is a mix of global gold prices and the rupee value. In the above case, over the last 1 year the rupee has depreciated from Rs.68.98/$ to Rs.74.60/$. This 8% depreciation in the rupee explains why the return on gold in India is 8% higher than the return on global spot gold.

But, why is silver rallying?

Unlike gold, that is purely a safe haven and store of value, silver is better known for industrial applications in electronics, medicines and solar panels.These account for more than 50% of silver demand. But, according to the Silver Institute, the demand for silver bars as an investment has been increasing since 2018. But the real explanation to the silver rally comes from the Gold/Silver Ratio. The Gold/Silver ratio is the ratio of the price of 1 Oz of gold to 1 Oz of silver. (Here Oz represents 1 troy ounce = 31.103 grams)

Figure 2 - How the Gold / Silver ratio moved over last 5 years?

Chart Source: Goldprice.org

When the Gold/Silver ratio touched 120 in March 2020, it was not only the highest level in the last five years but the highest in the last 100 years since the prices of silver of gold and silver have been regularly recorded. Historically, when the Gold/Silver prices gets above 80, it was a signal to either sell gold or to buy silver. In this case, since gold continued its safe haven rally, the bigger rally came from silver to bring the ratio down from 120 back to 80 levels. That probably explains why silver ended up being the top performing precious metal in the last one year.

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