There is perhaps no material on earth that inspires people more or holds such a mystique as our precious metals. One can gaze upon a handful of gold or silver coins and wonder now many lives have been lost owing to the metals that went into producing them. For the entirety of world history gold has stood in the front rank of the most sought after materials ever mined from below the earth’s surface. The universal appeal of gold is attributed to its peculiar properties, its rarity, its luster and beauty. Wars have been waged over it, and empires have been built and destroyed in the pursuit of it.
Gold is the easiest of metals to work with, and because of this and other desirable properties (limited supply) it was considered precious, and was the first metal to be used for coinage. Its brilliance and near indestructibility have made it universally accepted as a store of value in most early civilizations.
Silver coins might be our oldest form of mass-produced currency. The shiny metal has been used for coinage prior to the days of the Roman Empire. The colonization of the Americas subsequent to the journeys of Columbus saw vast amounts of silver flow from South and Central America to the old world. Much of it was turned into silver coins.
Apart from coins, the best-known uses for gold and silver include jewelry making, electronics and works of domestic art. Silver and gold belong to that small group of naturally occurring precious metals known for their rarity, resistance to corrosion, ductility and high luster. Precious metals are actually pure chemical elements of high economic value. This important group of elements includes other such metals as platinum, rhodium and palladium. Once used exclusively for currency, today’s precious metals are now coveted mainly for their strategic and industrial value. Gold, silver, palladium and platinum are now regarded as investment instruments and constitute their own asset class.
Within a small economy, an ounce of gold is an ideal substance to use as a monetary unit. A small amount of the metal can be easily carried around and still represent a lot of purchasing power. The monetary value of gold has remained quite stable across the ages. Ironically, gold’s superior characteristics have hastened the ascent of the one thing that would replace it as the world’s preferred medium of exchange. In the process, the price of gold would forever be subject to extreme volatility.
The most widely used forms of paper money were at one time gold receipts — claims on gold pieces held in storage. The circulation of paper receipts as a proxy for gold made fractional reserve banking and the elastic money supply a new reality. Fractional reserve banking makes it possible for a government to increase the supply of money in circulation simply by printing more legal tender. An increase in the money supply can induce price inflation, and today, the latest fluctuations in the price of gold reflect the market’s concern with respect to perceived inflation and economic uncertainty.
When rising silver prices pushed the cost of minted coins above their face value, the U.S. government mandated a change to the use of a copper-nickel clad material for the issuance of coins. This, and increased utilization of silver in manufacturing and photography have permanently taken silver out of the realm of coinage. Today, silver is less a strategic metal and more an industrial commodity, but its inclusion in that class of assets known as precious metals allows it to take its place beside gold as a hedge against inflation and economic turmoil.
Platinum is in that group of precious metals that can be accurately characterized as strategic. It is one of the least reactive metals found in nature and is extremely resistant to corrosion. These properties make it ideal for the production of automobile catalytic converters. Other uses of platinum include laboratory equipment, dentistry equipment, and jewelry. Only a few hundred tons of the metal is produced annually. Because of this, platinum is one of the rarest elements in the world. The outlook for the future demand for platinum (and its price) is expected to follow the demand for domestic automobiles.
Palladium is a precious metal similar to platinum and with like chemical properties. Palladium has a lower melting point than platinum and is less dense. About half of the global supply of palladium goes into making automobile catalytic converters. The remainder of it goes into making electronic components, dentistry equipment, groundwater treatment equipment and jewelry. Palladium is vital to the emerging technology of manufactured fuel cells. Fuel cells in the future will be able to combine hydrogen and oxygen to create drinking water. An increase in global demand for drinking water should spur an increase in the demand for palladium. Although rare, palladium is mined on almost every continent. Its many practical applications and limited supply makes palladium very attractive to precious metals investors. Today, the one-ounce price of palladium stands at approximately 50 percent of the same amount of platinum.
Markets for buying and selling precious metals are numerous with a wide variation between them in terms of how they function. When investing in precious metals there are two different markets to consider. There is the “spot market” which concerns itself with the most current price of an asset, and there is the “forward” or futures market where contracts for future delivery of precious metals are bought and sold. The spot market for metals is where one would go to take or make delivery of the physical commodity and pay or receive the most up-to-the-moment price for it. The futures market is a place where contracts controlling the future delivery of a fixed amount and grade of physical gold, silver, copper, platinum or palladium are traded. The most important differences between these two markets are in the amount of financial leverage used to participate in them, and the time to delivery of the actual assets. The price differential between these two markets is never very spacious and market prices do tend to converge upon expiration of the forward contracts.
For the most part, the spot market for precious metals is dominated by producers and manufacturers of hard goods. There are very few places that the retail investor can turn to find standardized lots and grades of precious metals to buy outside of certain consumer service organizations such as Monex Precious Metals found on the web at Monex.com. In contrast, the futures market is very well represented by government regulated brokerage firms that can provide access to a global market for the trading of precious metals futures and options contracts.
There is a profound tendency for precious metals prices to trade in harmony. There are few asset classes that are so strongly correlated in terms of price action. This correlation is especially strong between gold and silver. The outlook for gold and silver prices going forward is mixed with a likely uptick in volatility. Gold and silver have traditionally been viewed as effective hedges against inflation and political or economic uncertainty. Historically, hard assets tend to move in the opposite direction as paper assets. If the present day bull market in U.S. stocks remains intact, gold and silver could both be in for a prolonged rough patch. Of course, this assessment assumes that there is nothing on the horizon to derail our current rate of economic growth.
Other risk factors influencing the precious metals markets include future Federal Reserve monetary policy and China. Any hint from the Fed that they intend to become aggressive in terms of increasing the domestic money supply will send precious metals soaring in price. Those looking for signs of a slowdown in global demand for metals are fixing their attention squarely on China, which has recently demonstrated a spotty record with respect to their internal growth rates. A slowing of the Chinese economy could create slack in the global demand for precious metals and trigger a new recession. Both are bad for precious metals prices. On the other hand, the Chinese government may just respond to this with aggressive stimulus measures. The idea of easy money suddenly coming into the Chinese economy at once may very well fan the fears of inflation in the minds of gold bugs everywhere. This could be the event that triggers a whole new round of accumulation of the yellow metal by investors.