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Gold’s complicated move, and the rising appeal of silver

4 min read 22 Apr 2024, 01:02 PM IST

Rahul Goel

Owning gold is most advantageous as a form of insurance. While it might slightly reduce your overall returns, it offers significant mental peace and security

Going by the gold-to-silver ratio pattern, either the price of gold could fall or the price of silver could go up. (Image: Pixabay)

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“You buy stocks for good times, and gold for bad times". At least that’s what is supposed to happen.

However, current trends present us with an 'everything rally'—where stocks, bonds (up until recently), gold, and silver. Hell, even real estate prices are bullish.

We are spoilt for choice. It seems to be the perfect time to potentially dilute the performance of your overall assets.

You see, in an everything rally like the one we are witnessing, there’s little room for deep thought through investment ideas.

You could almost throw a dart to pick asset class, and you could make good money in time to come. Perhaps, you would even beat a seasoned, sensible individual who may be doing everything right. Such is the irony of our times.

Today, however, in this edition of Contramoney, we limit ourselves to taking a look at gold. Why? It’s fascinating.

Now, I am not going into the basics here. If you wish to start with that, please read these earlier editions of Contramoney:

The best way for you to own gold

A broad gameplan for the right asset allocation for you

Four charts to help you minimise mistakes in asset allocations

Gold is shining brightly. Now, don’t start chasing this precious metal

Let’s try and understand why things are complicated but fascinating regarding gold.

In general, you buy gold for three main reasons.

First, for weddings, jewellery for use, and emergencies.

Second, for making a return, like you would buy a stock for capital gains, or make a fixed deposit to earn interest. You look at it as an investment.

Third, for insurance, which will pay off big time if something dramatically goes wrong in India or the world.

Let’s start with needs. I would say nothing much has changed on this account. These needs were always there, and I don’t see any pattern that suggests suddenly needs have grown, and as a result more gold is needed. So, the current rally in gold is perhaps not triggered by the needs of individuals like us.

Next, the idea of making a return on gold (an investment avenue), is perhaps partly responsible for rising prices. While sovereign gold bonds (SGBs) are becoming popular as they pay interest (physical gold pays nothing of course), it’s still small in the overall scheme of things.

So, that leaves a lot of investors chasing the price of gold to make a capital gain (like you would a stock). FOMO at play perhaps. And momentum strategies to back them up.

Finally, and perhaps the biggest drivers of gold are linked to its ability to act like insurance if something goes wrong in the world.

The world is currently witnessing two wars. Additionally, a large part of the developed world is reeling under high inflation. Add to this the large deficits of countries like the US (they are spending a lot more than they can afford) and the fear of inflation staying higher for long.

This means more erosion in the value of paper currency. Now at what stage the paper money system will collapse, or when will a war lead to a massive-scale geopolitical disaster, one cannot say.

But what we do know is that there’s a case to be made to get gold as insurance to safeguard yourself from either of these potential disasters.

There’s another group of players who are perhaps treating gold as insurance. It’s the central banks. They are increasing the share of gold in their reserves, reducing their dependence on the US dollar. Take a look at this chart, from World Gold Council:

...

The jump in demand for gold from central banks is significant.

To summarise this, I would suggest that long-term institutional buying, coupled with traders chasing the price of gold are the large reasons for the current rally.

Will this rise in gold prices persist in the near future? It’s impossible to predict that.

However, two key forces are pulling the price of gold in different directions presently. Higher for longer interest rates are hurting, while war and other geopolitical concerns are driving up demand.

How the price of gold moves would depend on how these two opposing trends play out.

Meanwhile, take a look at the chart below. This is a gold-to-silver ratio chart.

...

What this shows is the relationship between the price of gold and silver. As you can see, aside from the March 2020 breakout, the ratio is more or less in the same range since the middle of 1997.

Now I am no chartist, but I would assume that if patterns were to hold, one of two things could happen: either the price of gold could fall, lowering the ratio in line with past cycles, or the price of silver could go up.

How this will play out is difficult to predict. But then again, we know the odds are not really in favour of gold (purely from the gold-silver ratio chart perspective).

In conclusion, if you own gold as insurance, that’s perhaps the best use case. While it might slightly reduce your overall returns, it offers significant mental peace and security. This value, though intangible, is immensely valuable.

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.

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ABOUT THE AUTHOR

Rahul Goel

Rahul Goel is a finance and publishing professional with over 25 years of experience in the industry. He is the former CEO of Equitymaster, a leading independent equity research company in India. In the initial part of his career, he was also responsible for building out a mutual fund rsearch cum financial planning business, both online and across the major cities in India. Rahul is a double postgraduate, with degrees in management and finance. Rahul is passionate about empowering retail investors with honest and credible opinions on asset allocation and investing so that they can take better decisions. He currently writes a column on Mint called Contramoney, where he shares his insights on asset allocation and investing in general.