Money, Inflation, Fear, and Industry: The Basis for Capital Gains in Gold and Silver

By: Dr_Jeff_Lewis

There are four major pieces to the ebb and flow of precious metals prices.  All of them are as interrelated as much as they aren't, and all of them are equally important in the current prices of any precious metal.   Let’s dissect the four pieces and explain the role each plays in today's market price.

Money

Money can be broken into two subsections.  First is the use of silver and gold as money or currency, but since the Swiss Franc broke away from a very small metals standard, you're unlikely to find any major currency around the world that is backed by precious metals. 

Instead of just plain currency, we'll focus on fiscal policy.  Silver and gold enjoy their biggest gains when governments are on a spending binge, whether it is from bailouts, stimulus efforts, or old fashioned deficit spending.  When governments opt for austerity, or turning deficits into surpluses, gold and silver fall due to a reduction in inflation (generally) and renewed confidence in the local economy. 

Inflation

This topic could be merged with money, but it is best analyzed alone due to the complexity of monetary policy.  To central banks around the world, both inflation and deflation are evil, but central banks are more tolerant of inflation than they are of deflation.  The reason, though flawed, is that sustained deflation cripples the ability to make long term contracts (so does inflation) and that continuously falling prices reward people in the marketplace who do not spend nor borrow. 

We saw this phenomenon most recently following the 2008 financial collapse.  As the world worried about deflation, precious metals bombed (temporarily) with the stock market.  However, after quantitative easing, bailouts, and worldwide stimulus efforts, precious metals rebounded, and forecasts were set for their highest price targets ever.  Deflation scared everyone, and inflation did too, but it was inflation, not deflation (this time), that sent precious metals to the moon.

Fear

Fear and uncertainty should never be discounted for its effects on the financial markets.  During uncertain times, investors flee as fast as they can to safety.  During the 1970s, investors ran to bonds. During the 1990s, they went into treasuries, and during the current recession, investors have flocked to harder assets, namely silver and gold.  With each and every financial dip, investors want more and more safety, and while they're still stocking up on fixed income investments like US Treasuries, gold and silver are as popular as ever.

You should note that fear does not always have to do with general uncertainty.  Fear is also a byproduct of the first two parts of precious metal pricing: the fear of inflation, or the fear of increased monetary policy measures.

Industry

Of the four parts of the pie, industry is perhaps the most constant.  Due to the fact that precious metals like gold, silver, platinum and palladium are used in relatively small amounts in production, huge changes in prices result in very small price changes in the final product being produced. 

For example, a laptop contains about 1 gram of gold.  Therefore, if gold were to double in price from $1200 to $2400, the price of a gram of gold would come to roughly $80.  The final product, the laptop, would need only rise in price by $40.  Since most laptops sell for hundreds of dollars, the price of gold doesn't have a great impact on industrial demand.

Money, inflation, and fear are the core drivers of the fluctuation in precious metal prices, and in today’s economic conditions, all of the pieces of the pie are ripe. 

By Dr. Jeff Lewis

Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com

Copyright © 2010 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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