“If You’re So Smart, Why Aren’t Your Readers Rich?”

If Youre So Smart, Why Arent I Rich
Photo by Viktor Ritsvall

From Peter Reagan at Birch Gold Group

This week we’re going to take a time-out and answer a customer question. For confidentiality reasons, I’ve edited the actual question (below) to its essentials:

For the last few months, you’ve been saying repeatedly, “The bubble is about to burst and only gold and silver will save us!” I’ve been investing in gold and silver for over 50 years, both physical precious metals and mining stocks. Through the years, my mining stocks have surged and plunged (they’re mostly worthless now). Since the beginning of the year, the stock market has been tanking. The S&P 500 is down nearly 20%, and yet the price of gold has barely budged and even went down earlier this month. Isn’t gold supposed to go up when the market goes down?

I want to explain some market dynamics behind moves like this, especially gold and silver’s price.

What makes gold and silver prices go down?

With most assets, it’s easy to figure out what’s driving prices: supply and demand. If prices go down, that either means supply went up, or demand went down.

There’s an old Wall Street saying: “In crisis, all correlations go to 1.”

Here’s what that means: when investors panic, they sell *everything.* Sometimes, when you’re faced with a margin call, you sell everything — because you HAVE TO. That’s one major reason why, during panics and even during really bad days, gold and silver’s prices go down along with everything else.

Panic selling is usually short-term, so that should only explain a temporary drop in precious metal prices.

What do investors, hedge funds, institutions, even global central banks buy during a panic? Treasury bonds. (Short-term Treasury bills and notes are the institutional equivalent of stuffing your money under a mattress.) Huge demand for Treasury bonds means their price goes up — and along with it, the value of the dollar goes up, too. This is usually a transitory effect, but if you look at a granular chart of dollar value it’s noticeable during the last three recessions:

Noticeable, yes, and also noticeably brief!

And there’s one more factor we have to consider: Like all other commodities, gold and silver are priced in dollars but their *intrinsic value* isn’t affected. So if the purchasing power of the dollar rises even slightly, that reflects in the price of gold and silver (and crude oil, and pork bellies etc.)

So, during panics, there are two reasons gold and silver price fall:

  1. Panic selling (everything, throwing the babies out with the bathwater)
  2. Temporary dollar strength (the dollar is briefly stronger than it was before the panic)

What makes gold and silver prices go up?

The same forces we discussed above: Supply, demand and dollar strength.

We saw severe supply constraints during the 2020 pandemic panic. Global mints were shutting down or working on skeleton crews, mines reduced output or suspended operations completely. As a consequence, global mints sold out of virtually *every gold and silver coin and bar* they had in inventory. That pushed prices up.

Demand can sometimes become a self-fulfilling prophecy. Let me tell you a brief story: I have a colleague who grew up in Moscow, in the former Soviet Union. Whenever she was walking down the street and saw a line at the door of a shop or store, she’d go stand in the line. Why? Because if the shop had a line, it must be selling something worth having…

Sometimes, news like the U.S. Mint running out of stock of silver eagles (like in 2020) perversely drives more people to want silver eagles. And that’s why the price of silver eagles went up.

Demand also comes from the safe-haven reputation of physical precious metals. Once the sell-everything panic is over and the dust settles, you’ll often see a rise in gold’s price.

Here’s an example from the Great Recession, with my notes indicating the three stages of a market meltdown:

Three stages of a market crisis

Gold and silver’s prices compared to S&P 500 (red), May 2008 – December 2009.

During Stage 1: Panic, remember, there are two forces pushing gold and silver’s prices down: selling pressure and temporary dollar strength.

Then comes Stage 2: Safe Haven, where the temporary dollar strength wanes and markets continue to decline. That’s when money tends to pour into gold as a safe haven investment, pushing the price up.

Finally, during the Stage 3: Business as usual, when investors slowly reallocate away from safe havens, back into riskier asset classes. That typically goes hand-in-hand with the dollar-strength component. A weaker dollar causes the dollar-denominated of gold and silver, along with all other commodities, to go up. The reason behind the dollar’s weakness doesn’t matter as much. The dollar’s strength could be suffering from, say, the highest inflation in 40 years. Or it could be suffering because investors are taking money out of Treasury bonds to invest in stocks.

A word about mining stocks

We at Birch Gold Group are not a big fan of mining stocks or other assets we call “paper gold” for a number of reasons. I’ll limit this discussion to mining stocks in particular, because that’s what the original question mentioned.

Correlation with stocks

Mining stocks tend to move with stock market rather than with gold’s price. In finance, that’s called correlation. Positive correlation means two assets tend to move in the same direction. Take a look at the correlation between the S&P 500 and this mining sector index fund.

Well, why not just buy stock in gold miners instead of an entire sector fund? Well, here’s why…

Concentration, not diversification

The Nobel Prize-winning economist Harry Markowitz once said,

Diversification is the only free lunch in investing.

Here’s the thing: if you’re investing in physical precious metals and gold mining stocks at the same time, you aren’t really diversifying your investments – you’re concentrating them. Prudent diversification means investing in uncorrelated asset classes. And, if that’s not reason enough, here’s one final consideration…

Idiosyncratic risks

I think that any individual business, whether it’s a scrappy gold mining startup or a global superbank, is always one crisis away from bankruptcy.

In other words, mining stocks expose you to individual companies’ risks, and to general stock market risks at the same time.

Final thoughts

When you speak with a Precious Metals Specialist at Birch Gold, they’re generally going to emphasize three key points:

  • Physical precious metals are about preservation, not speculation. If, like Mark Twain, you’re less concerned with the return on your investment than the return of your investment, physical precious metals may be worth a closer look.
  • Real, physical metals offer significant diversification benefits. These diversification benefits aren’t always immediate!
  • Most beneficial for those with a long-term outlook. Watching price movements day-to-day is for speculators, not investors.

Though it’s difficult to quantify, one of the major benefits of owning physical precious metals is peace of mind. There’s a lot to be said for the confidence you gain, knowing that you’re the owner of a tangible asset that isn’t going away.

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