Top factors driving gold & silver prices in 2023

One of my subscribers asked me if I’m worried about downward pressure on the prices of gold and silver given the Fed’s current monetary policy and the potential for the dollar to stage a big rally. The short answer is “no” for a few reasons.

Addressing Fed Policy Concerns 

To begin with, the Fed’s monetary policy by definition is not “hawkish” or “tight.” While the “real” interest rate using the 10-year Treasury break-even calculus (10-year Treasury yield minus the 10-year TIPS yield) currently is 2.35%, the figure is derived from CPI “inflation,” which is highly flawed. Hence, the 10-year TIPS yield does not reflect the actual rate of price inflation.

Based on how the CPI was calculated in 1980, the inflation analyst, John Williams, has calculated a real inflation rate of around 12% – a figure more in line with most people’s experience. With the 10-year Treasury at 4.41% and using Shadowstats’ inflation calculation, the real interests are more like negative 7.6%. Negative rates are dollar devaluation, which is why gold does well in a negative interest rate environment.

Fed’s Inconsistent Balance Reduction 

While the Federal Reserve is talking the talk about its Quantitative Tightening (QE) program, over the last 17 months, it has reduced its balance sheet by just 10%, whereas it took just 13 months to move than double its size. 

The Fed has shown a propensity to inject $100s of billions back into the banking system, at the first sign of problems with the banks. Not only did it throw $400 billion immediately at the regional bank crisis, but it also set up a QE-like liquidity facility for the banks under which $107 billion has already been drawn. This too is dollar devaluation and positive for gold (and silver).

Surge in US Treasury Debt 

Another reason I’m not concerned about the effect of Fed policy on gold and silver is the evident mismanagement of the Federal Government finances. The amount of outstanding Treasury debt is now over $33 trillion, up $1 billion in just the last three months. The interest cost is about to exceed $1 trillion annually.

The charts show that both could be on the verge of going parabolic:

The spending deficit for the Government’s Financial Year 2023, which ends on September 30th, is projected to exceed $2 trillion.  Once Congress manages to approve the FY 2024 budget, I expect the 2024 spending deficit to again project north of $2 trillion – though maybe not initially – for purposes of political expedience. 

Impact of Shrinking Foreign Finance

The United States’ foreign financiers (China, Japan, and Saudi Arabia) have been reducing the amount of new Treasuries they are willing to buy. This leaves the Fed and the EU Central Bank to do the heavy lifting or rates could be spurred higher.

Until the Fed reinstates QE, the rate of new issuance will drive long-term rates much higher. I don’t see the Fed or the Treasury letting that happen, which means there will be a lot more QE in some shape or form in the near future.

Both the current Treasury debt level and the expected much higher level of Treasuries outstanding are not lost on the precious metals sector, which is why I believe gold has been holding firm above $1900 and silver has been holding at $23. Once the Fed flinches on QT/QE, the value of gold and silver priced in dollars will reprice quickly and substantially higher – similar to the late 2008 – mid-2011 bull run.

Global Demand Boosts Gold 

Finally, regardless of rising nominal interest rates and the Fed’s current faux-hawkish policy stance, physical demand in the Asian countries plus India and the Middle East is very strong right now. The premium paid above the spot price on the Shanghai Gold Exchange hit a record high recently.

The rationalisation was that China’s gold import curbs implemented to slow down the outflow of yuan from China that paid for the gold created a shortage of supply vs. demand. China recently removed the import curb but the premiums on the SGE remain elevated.

There’s a renewed appetite for gold in Japan. Gold recently hit an all-time high in Japan priced in yen because of the recent decline in the value of the yen. But there’s also a demand component. Gold buyers in Japan are paying a premium to the spot price, reflecting strong demand for physical gold relative to supply.

According to a recent article, “In Japan, where domestic gold rates were trading at record levels this week, dealers charged $0.5 premiums. A Tokyo-based trader said that it is ‘surprising’ that local investors are buying gold at these high levels”.

Like Japan, the demand for gold is strong in Saudi Arabia, where gold priced in riyals hit a record level this month. The riyal rose vs. the dollar in the first half of 2023 and has been stable vs. the dollar since then. This means that the rising price of gold there is not attributable to currency devaluation per se but is a function of supply and demand.

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Russia & UAE Amplify Gold Demand 

Two more sources of strong demand for physical gold are Russia and the United Arab Emirates. In early August, Russia announced that its Central Bank would resume buying gold after it halted purchases in January 2022 to conserve cash in the face of oil sanctions imposed by the U.S. 

Russia’s demand, whether the Central Bank sources domestically produced gold or imports it, will further stress global supplies. Adding to this is the fact that the UAE has become the biggest importer of Russian-produced gold, buying roughly one-third of Russia’s annual mine production.