Understanding the factors that drive the value of precious metals

Gold, silver and platinum have varying degrees of monetary value and this largely explains their price behavior. Gold is the purest form of money due to its intrinsic utility combined with its high stock-to-flow ratio of around 70-80x, meaning the value on the ground The metal stock is a multiple of the metal's annual mine supply. Silver has a significantly lower stock-to-flow ratio, estimated at 20-50 times, but this is still much higher than platinum, which is often as low as 1 time.

Different monetary and industrial characteristics have significant implications for how metal prices change over time in response to economic fundamentals. While gold is considered a hedge against inflation, its price is determined more by changes in real interest rates, and changes in inflation expectations have only a minor impact on the metal. This is in contrast to platinum, and To a lesser extent, silver, which is more sensitive to changes in inflation expectations, is more sensitive to changes in inflation expectations. The table below shows the continuous correlation of each metal with inflation expectations, interest rate expectations, and real interest rate expectations.

	Gold	Silver	Platinum
Inflation expectations	0.13	0.25	0.36
Nominal bond yields	-0.26	-0.1	0.08
Real bond yields	-0.44	-0.35	-0.20

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100-day moving correlation with US 10-year breakeven inflation expectations, US 10-year bond yields, and US 10-year inflation-linked bond yields since 2004.

Gold: An Alternative to Fiat Money

Due to its high stock-to-flow ratio, gold prices depend primarily on changes in demand, rather than supply. In the long term, this demand tends to depend on the supply of fiat money in the economy, while in the short term it depends largely on the real interest rate of fiat money.

Demand for gold increases when the opportunity cost of holding the metal decreases, which occurs when the expected interest rate on fiat currency falls relative to the expected inflation rate. This can be captured in the close inverse relationship between gold and inflation-linked 10-year US bond yields.

It should be noted that rising inflation expectations alone tend to have only a positive impact on gold prices. This may seem counterintuitive, given that gold is widely regarded as a hedge against inflation, but the weak correlation between gold and inflation expectations reflects the tendency of rising inflation expectations to push up interest rate expectations to the detriment of gold demand.

Silver: A hybrid between industrial and monetary metal

Silver is driven partly by monetary demand and partly by industrial demand. Like gold, silver is driven by the fiat money supply in the long term, but in the short term it is driven equally by monetary demand as a store of value and industrial demand.

As a result, silver tends to be more positively affected by rising inflation expectations and less negatively affected by rising bond yields, as these conditions tend to reflect rising economic growth expectations, which benefits demand for industrial commodities. This also explains why silver is slightly less negatively correlated with real bond yields compared to gold.

Another interesting feature of the silver price is that while it has underperformed gold over the past two decades, it has actually outperformed during periods of gold strength. This can be seen in the chart below, which shows the ongoing correlation between the gold price and the silver/gold ratio. More often than not, if gold goes up, silver goes up even more, while if silver goes up, it will almost certainly go up more than gold. This is because silver is a smaller market and can therefore rise more easily during periods of speculative demand for precious metals.

Platinum: An industrial metal with monetary qualities

While platinum has a certain degree of monetary value, its low stock-to-flow ratio means mine supply is a much more critical factor in driving prices and demand is driven much more by industrial use, with investment only accounting for around 10% of total demand on average.

As a result, the metal is much less dependent on changes in real bond yields. Platinum is instead driven more by inflation expectations, while rising bond yields tend to be slightly positive for the metal as they typically reflect periods of economic strength that support industrial demand.

Platinum's role as a predominantly industrial metal explains why it has closely followed the relationship between silver and gold prices over the past 20 years. The correlation is extremely high and strongly suggests that if silver outperforms gold, platinum will rise.