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The Big Explainer

What are precious metals?

This week Roger Hirst is joined by Cameron Alexander, Refinitiv’s Head of Precious Metals, to talk about the precious metals market. Gold and silver have been two of the consensus trades of 2020, although these have been grabbing the headlines, there is more to the precious metals market than just silver and gold.

  • [00:00:00] We are asked the question all the time, why why invest in gold? And we say the main reason is that it's a hedge against uncertainties, a hedge against the unknown. 

    [00:00:08] Welcome to The Big Explainer. Gold and silver have been two of the consensus trades of 2020, although these have been grabbing the headlines, there is more to the precious metals market than just silver and gold. Refinitiv's Head of Precious Metals, Cameron Alexander, outlines the broad based sector. 

    [00:00:39] Well gold and silver are the main precious metals that most people would be aware of, but there are others we should also look at as well. Gold and silver obviously mainly jewelry and industrial use, but also heavily involved in investment. But platinum as well is something we should consider. Platinum jewelry takes up around 30 percent of the global platinum market in any one year. But combined with palladium and rhodium, they make up the main platinum group metals, or PGMs, and they're mainly used for industrial applications, and primarily as the auto catalyst in vehicle exhaust systems for emission control, pollution control. They are also used in glass manufacturing, in petroleum and also chemical manufacturing, as well as wider use in electronics. 

    [00:01:26] The outlook for industry such is the strength of the economy, drives the performance of many precious metals such as platinum and palladium. Gold is mainly influenced by the macro backdrop of fiscal and monetary policy or the outlook for inflation. In 2020 we've seen all these factors at play, creating significant price swings within the sector. 

    [00:01:45] Gold and silver tend to be driven by macro developments, whereas the other precious metals are much more driven by industrial movements and growth within the economy. And they're much more focused on the fundamentals of these metals, particularly platinum and palladium and rhodium, where often in case of palladium, the amount of demand is actually exceeding supply, so there's often a deficit for that metal, which drives the price even higher. In gold we don't have that situation, same for silver, the price is actually driven by macro developments and the actual fundamentals of the market don't have a great play in terms of the price movements. 

    [00:02:19] Gold and silver still tend to be the primary focus of this sector because they have a very long history as a store or medium of wealth. 

    [00:02:27] Gold has been around for thousands of years, more than five thousand years in fact. If you go back to three thousand six hundred B.C., the Egyptians who are using gold back then to adorn their caskets and and in the tombs. Fast forward a little bit to the Greeks and in five hundred B.C. and also the Romans in one hundred B.C., they started to use gold as a vehicle for placing value on it, and they started to use it as a currency. Silver also has a long history, with evidence of mining dating back to three thousand B.C. And in fact silver is responsible for many empires. Silver really gave the opportunity for communities to move out of a barter system and to start to trade using something with value. Gold often gets the top billing, but it was silver that allowed communities to expand. 

    [00:03:13] In many ways we saw the perfect storm for silver and gold in particular when the Covid pandemic hit global economies. Lower bond yields, especially real yields, were particularly beneficial to gold. 

    [00:03:24] Yes we have seen gold and silver really take off this year. They've been very popular given that we've seen so much uncertainty in the financial markets. Warren Buffett once famously said that to invest in gold is to invest in risk. We've seen significant risk this year as the global economy has dealt with firstly a health crisis, in a Covid crisis, but also more recently, an economic crisis that has needed significant stimulus from the government to try to get things moving again. Gold is also considered a major, a good hedge against higher inflation, and also due to rising costs of goods and services, which can devalue the US dollar and push gold prices higher. Cutting interest rates has also made low returns for investors who are investing in debt or also investing in bonds. And in recent years, that has also encouraged investors to look to other alternative investments. 

    [00:04:18] If you focus on gold in particular, there's a vast array of instruments through which we can gain exposure. Investment styles vary from region to region. Jewelry is popular with retail investors in Asia, whereas financial instruments such as ETFs and futures are more popular with institutional investors. 

    [00:04:35] Yes indeed, there is so many ways that people can invest in gold. I think most popular would be gold bullion and gold coins. In gold bullion you can buy anything from a tenth of a gram right through to large investment bars at 400 ounce bars, which can be bought from a retailer or trader and kept at home, or you can pay additional fees to have that stored somewhere secure. Of course, you can buy coins, and they also traded from mints and also from coin traders, but they tend to attract slightly a higher premium than you would find in bullion. Of course, across in Asia, we see consumers there buying jewelry as a means of investment in gold. And most likely we see that in places like China and across India and the Middle East, so really the developing world. That's because they have very high purity jewelry. So in China, we see 24 carat jewelry. In India the standard there is generally 22 carat. Whereas is in the Middle East it's around 21 carat. South-East Asia is a mix between 18 carat back up to 24 carat. Aside from just purity, it's really the mark up in these regions that encourages people to come back to market to buy. So the mark up is very, very small. You're really only paying for the making charge or the labor charge on any particular jewelry item. And so it's quite possible for those in these regions to buy and to sell gold, gold jewelry, and to still make money as opposed to in the West where the mark ups are very, very high, and you're always almost certainly lose money when you're trying to recycle that. In these parts of the world, like India and China, the rural areas or the farmers make a significant contribution to their annual consumption for gold. And it's not unusual that farmers would buy gold jewelry after a harvest and then sell that back gradually during the year if they need to generate cash flow. Gold plays a very important part in culture in many countries, including India. India is probably one where you see the religion playing a very important part of their gold consumption. This year has been a terrible year for Indian gold consumption - the first quarter was very poor, second quarter we saw demand fall way over 90 percent in terms of jewelry fabrication as the country was in lockdown for almost the entire period. Demand has come back in the third quarter, but is still quite weak compared to last year. Finally in the fourth quarter now we're starting to see demand come back as we move towards the wedding season and the religious festivals where gold is often traditionally given as part of a part of the festival. Diwali is coming up in the next couple of weeks, and that should also lend itself to higher demand. We've seen the local price in India start coming back into premium after being in a discount for pretty much the whole year, which signals that demand is coming, coming back to the market, albeit slowly. The retailers are finally happy because the people are coming back into the stores to buy ahead of these festivals. And over the next two or three months, we should see some solid demand coming back in from India. Other areas we could look in terms of investment this year has been ETF demand, which has really expanded over the last a few years, that's Exchange Traded Funds. And we've seen a significant increase this year and we're on target to see a record level in twenty twenty. This offers really a safe and convenient way of investing in gold that is backed by physical gold demand, which is stored and vaulted somewhere else. Of course there are other ways of investing, and we've seen growth within the digital space in the last couple of years. Digital gold is really sort of a block-chain technology similar to sort of Bitcoin, but although in contrast to Bitcoin, it's backed by actually something with value. So in this case, it's actually backed by physical gold. And while it's not physical investment, we are seeing an increase in investment in mining equities. So mining stocks, those involved in the gold mining and silver mining and perhaps PGMs. Investors are looking for a leveraged play here, hoping that the gold price rise will encourage a higher stock price movement. We're seeing a significant increase in this space. There is, of course, the futures market as well, which is not really attracted to the retail investors or mum and dad investors, and it's somewhat synthetic it doesn't have a huge impact on the physical market at all. 

    [00:08:39] Mining stocks are often considered to be the high octane play on the underlying asset. Gold and silver miners regularly move with much higher volatility than the underlying asset. Supply and demand have also been influenced by central banks, whilst the Covid crisis has impacted supply chains, taking some mines out of production just as demand started to pick up. 

    [00:08:59] Central banks have played a significant role in adding additional demand over the last few years. What we saw in the third quarter was very interesting. For the first time in many years, we saw net selling from central banks. So this year for the full year, we'll still see net buying by central banks, but the volume of buying has come off significantly. That's primarily because we've seen a big decline from Russia this year. And also China has been absent from the market once more. Turkey in fact, has been the largest buyer this year. But in the last quarter, they actually turned to become a net seller. On the supply side this year, they've also been constraints due to the Covid. There was periods when we saw over 100 mines that were shut down or suspended for a significant period of time from one week to over three and a half months in some cases. Most of those losses were seen in places like South America and South Africa which saw significant closures for several weeks. Most of those losses will be made up however, in the second half of the year, and we are expecting to see only a modest decline this year in mine production, probably in the order of 3 and 4 per cent. A lot of that will be made up in 2021 as most of these mines are fully back on deck. 

    [00:10:07] The outlook remains good for gold and silver because of the macro uncertainty. Even if a successful vaccine has been found, the economic damage will linger on and fiscal policy response will be a powerful tailwind. This economic uncertainty however, will make the outlook less favorable for those metals which are mainly a play on industrial growth. There are also market-wide liquidation risks for precious metals, as we saw earlier in 2020 and during the great financial crash of 2008. 

    [00:10:34] Gold is playing a very important role right now as a hedge against uncertainty. And that's one reason why we're seeing a significant increase in the price over the last 12 months. I think we asked a question all the time, why, why invest in gold? And we say the main reason is that it's a hedge against uncertainties, a hedge against the unknown. There's a risk that the stock markets are top heavy and we could see a retraction in equities, there's a risk that we could see weakness in the US dollar, and that's, again positive for precious metals, mainly gold and silver. If we see a weakness in the economic growth that's likely to drag back the platinum group metals. So palladium and platinum are likely to pull back. But on the contrast to that, gold and silver are likely to rise on this ongoing uncertainty. With the current situation with Covid, governments globally are having to force into stimulus programs, spending vast sums of money to try to generate growth in their ravaged economies. This is likely to see further weakness within the dollar. So we're going to see further contraction with the currency, which again is going to lend to higher price for gold potentially. But what it does mean is that we're going to see low interest rates as governments try to stimulate growth and try to reduce the cost for the consumers. And that again, is going to make the cost of carry for gold lower, and it's going to make these assets for bonds and for debt non-yielding in fact, negative yielding. So gold becomes more attractive under that scenario. And under this situation, we believe it's going to continue for some time. We can't really see at this point an exit strategy for when things are going to change dramatically from where they are today. There is a potential risk that gold and silver get sold off in a broader sell-off among equities. We have seen earlier this year, in April, we saw a significant sell-off in equities, and at the same time, gold and silver was sold off dramatically. We saw gold lose 12 per percent over a period of three or four days. There is that risk if we see economic situation in the United States continue to deteriorate, then we could see a significant sell-off in equities. Under that scenario, I think gold could possibly be sold off quite dramatically over a short period of time. This is really a short term arrangement. I think longer term gold prices would come back, and would in fact trade even higher. But there is that risk that the gold prices could come down, which might provide the opportunity for a good entry point for those looking to invest. 

    [00:13:00] We often lump all precious metals together where there are, in fact, many different forces at work, economic, monetary and fiscal, to name a few. In general the current outlook for more fiscal policy should be supportive for gold and silver, and this outlook is unlikely to change even if a vaccine is forthcoming. The bearish case for gold is where economies return to normality and real yields can rise once more. There's been a very close inverse relationship between real yields and gold over the past 10 years. When real yields fall, gold rises. Given the colossal size of the global debt pile, however, central banks are likely to use more quantitative easing in future to cap real yields. We can expect more fiscal policy in the future. Currency debasement is supportive of gold and silver, and if fiscal policy creates inflation, it should also be supportive for the rest of the precious metal complex as well.