3Q: As precious metals grow more precious

May 06, 2011
3Q: As precious metals grow more precious
Economics professor assesses the current volatility in the commodities market and the declining value of the dollar Photo by Lauren McFalls

The value of silver soared to an all-time high last Thursday, and plunged dramatically yesterday, illustrating the constant volatility of the precious-metals market, which includes lustrous commodities like gold, silver and platinum.

Here, Kamran Dadkhah, an associate professor of and at Northeastern, who has studied the value of silver and gold in the foreign exchange market, discusses how the declining value of the dollar relates to the ever-shifting value of precious metals and other commodities, such as oil.

What causes the volatility of the precious-metals market?

Three factors can be counted as reasons for the sharp rise over the past year in the price of precious metals, including silver, which rose 156 percent; gold, up 34 percent; and commodities, such as oil, which climbed by 33 percent. First, the has moved out of the recession. In particular, countries like China, India and Brazil have shown impressive growth and therefore, demand for commodities has been on the rise. Note that both gold and silver have industrial, medical and other uses.

The second factor is the decline of the U.S. dollar, which is the international currency. When it loses its value, the price of everything increases. A biproduct of this is an expectation of inflation. When people expect inflation, especially during times of uncertainty, they tend to rush to assets and commodities that are deemed to keep their value.

Third, the factors specific to each precious metal and commodity play a role in the market’s volatility. For example, the price of silver had historically been much lower compared to gold, and hence it is catching up. As we’ve seen, the sharp increase in the price of silver was temporary, so we should be cautious, especially as investors in silver often hedge against a decline in its value by buying options.

In the case of oil, the turmoil in the Middle East is a contributing factor, although, except for Libya, no other major producer and exporter of petroleum has had an upheaval. Nevertheless, the fear that this could affect Saudi Arabia has prompted speculation in oil.

With the U.S. dollar losing ground, will precious metals continue to climb?

There are two reasons for the decline of the dollar. Since the United States has a huge budget deficit, of necessity it has a trade deficit. This means there is an increase in the supply of the dollar compared to its demand; hence the decline in its value. Second, the Federal Reserve has been pursuing an “easy money” policy by keeping the federal funds rate close to zero. The idea is that the lower interest rate would encourage investment. Furthermore, the lower rate would cause the depreciation of the dollar, thus increasing exports and limiting imports. The dollar has declined against the yen, the Swiss franc and indeed against a broad index of foreign currencies.

It is difficult to forecast what will happen in the commodities market. Since the is over, we should expect a continuing upward trend in the price of commodities. However, the Fed cannot continue the current policy for long without causing severe inflation, so we should expect the increase in prices to slow down.

How does the precious-metals market in the U.S. compare to other countries?

Prices of precious metals and commodities around the world are connected. When the price of or gold increases in the United States, the same happens in Europe, China and other countries. The differences among countries stem from their exchange-rate policies. In a country like Saudi Arabia that pegs its currency to the dollar, the increase in the price of such is one to one. If a country’s exchange rate is depreciating against the dollar, the prices of increase faster than in the . It is interesting to note that recently Iran’s central bank started selling a considerable amount of gold in order to stabilize its price. The action was prompted by the sharp increase in the price of gold in anticipation of a high rate of and the eventual depreciation of the Iranian currency against the dollar.

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User comments : 4

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fmfbrestel
5 / 5 (1) May 06, 2011
Silver prices took a nose dive because the exchanges raised their margin requirements on futures trading. This led to a mass exodus of speculative buyers from the market. Speculation on gold doesn't really matter because it's not used for many industrial applications, whereas silver is heavily used in industry.

Google "Silver Margin" and you will get all the info you want. The "What causes the volatility of the precious-metals market?" section of this article completely misses the point.
baudrunner
1 / 5 (1) May 06, 2011
The article is skewed to the perceptions of the speculator, and those who only invest in the crap-shoot that is this game. Buying into silver today is the best investment decision one can make right now, because fmfbrestel is right, a busy electronics manufacturer can use a million dollars worth of silver a week for soldering components onto printed circuit boards. Therein lies the demand. Just think of the future.
fmfbrestel
not rated yet May 06, 2011
The article is skewed to the perceptions of the speculator, and those who only invest in the crap-shoot that is this game. Buying into silver today is the best investment decision one can make right now


Contradict yourself much? lol
rwinners
not rated yet May 08, 2011
Silver may have got ahead of itself. The very long term relation between silver and gold is about 40-1. On the other hand, citizens of emerging nations, particularly India and China have used precious metals as stores of value for eons. As they grow wealthier, this will drive the price. I mean, who really trusts paper money for that purpose anymore? It's great for gambling, but otherwise... buy some gold or buy a house or buy some land.
Since WWII, the US dollar has been used as the monetary unit for the whole world. This is changing. It has to. The dollar must decline in value against commodities and other currencies in order that the huge amount of dollars circulating around the world doesn't overwhelm the US economy.
And it will.