Like most other investment asset classes, precious metals have dynamic pricing that takes into account a wide range of factors from the broader economy. Some of these factors, such as the ratio of supply to demand, have a direct and easy to understand effect on spot prices.
Others, however, have a less direct yet still important impact on the final prices that investors pay for their precious metal coins, rounds, and bars. Included in this latter class are the economic and political policies adopted by national governments.
Below, you’ll learn the basics of how federal policy can put upward or downward pressure on spot metal prices.
Economic and Trade Policy
The federal government is charged with many responsibilities—one of which is prescribing economic policy both domestically and abroad. Collectively, these policies contribute to the overall trade balance a nation has with the rest of the world. This balance, in turn, affects the nation’s gross domestic product (GDP) and, therefore, the strength of its currency.
Generally speaking, when a nation’s currency is strong, the country’s investors tend to keep more of their assets in liquid capital than in hard investments like gold and silver, which drives down the price of precious metals by reducing investor demand. By contrast, weak currency markets drive investors into these more stable assets, creating more demand for precious metals and putting a generally upward pressure on prices.
To fully understand how domestic and foreign economic policy may affect spot metal prices, first you need to understand the link between domestic business, foreign trade, and currency strength. In terms of domestic business production, the primary governmental driver is the tax rate applied to businesses. When tax rates are lower, businesses can afford to invest more of their profits into growth, raising production, and creating more value. From there, these businesses can sell in both the domestic and the foreign markets.
Policies that encourage production and business growth typically strengthen currencies, putting a slight downward pressure on investment precious metal prices. This effect isn’t universally applicable to all metals though, as those that see more industrial usage (like silver and platinum) will conversely experience more demand during such business upturns.
Foreign trade becomes a bit more complicated, as both regular market forces and laws governing the exchange of goods come into play. As a general rule, it’s best to assume that policies which facilitate open trading relationships tend to strengthen currencies, while restrictive trade practices like tariffs and import duties reduce international exports, thus diminishing currency strength.
Overall, the impact on currency strength is what ultimately allows these policies to affect precious metal prices.
National debt is another indicator of how government policy may affect spot prices. When debt grows relative to a nation’s GDP, the cost of making interest payments on that debt also continues to increase. If this debt cycle isn’t kept in check, the growing cost of servicing the debt will likely lead to tax increases to meet the government’s revenue needs. As described earlier, higher taxes make it harder for businesses to grow and generally restrict the creation of new value in the economy. This, in turn, creates an environment conducive to weakening the national currency that will likely drive more investors into precious metal investments.
National debt projections are one of the best long-term indicators for gold investors to look at, owing to the fact that costs associated with servicing existing debt are fairly predictable. Be aware, however, that new spending policies could be implemented that would raise or lower the debt level as a percentage of GDP over a long period of time.
When considering the effect national debt can have on precious metals, it’s also important to look at the balance of global debt, as investors from other nations facing large debt loads could jump into gold or silver and drive the prices up worldwide.
Central Bank Monetary Policy
While both federal economic policy and national debt have an indirect effect on the strength of a country’s currency —and therefore, the spot prices of precious metals—the monetary policy set by central banks is more direct. Central banks, such as the U.S. Federal Reserve, are ultimately responsible for setting interest rates and determining the size of the currency base. These two elements of monetary policy are directly responsible for a considerable share of a currency’s strength.
In many cases, the seemingly simple and passive role of central banks can be further complicated by political demands. The Federal Reserve, for example, sets its monetary policy in accordance with a dual mandate of keeping employment relatively high while not allowing runaway inflation to rapidly drive up consumer prices. Such political considerations can cause central banks to enact policies that pursue ends other than simply the strength of the national currency.
In the case of the U.S. Federal Reserve, the dual mandate typically makes a stronger dollar more favorable. In China, however, currency devaluation has been a relatively common strategy for keeping the price of exports low for international buyers.
Special circumstances may also divert central banks from their normal policies. In the aftermath of the 2008 financial crisis, the Federal Reserve and many other central banks engaged in a practice known as “quantitative easing,” which was meant to drive inflation back up to normal levels by drastically lowering interest rates and expanding the currency base.
Another component of the effect of central banking policy on precious metal prices is the bank’s role in maintaining target bond interest rates. Though this doesn’t have a particularly strong effect on currency strength, bonds are typically seen as similar to gold, silver, and other precious metals in that they’re considered safer stores of value compared to stocks and cash.
When bond interest rates are too low, investors find it advantageous to allocate more of their assets into metals. If bonds are yielding a relatively good interest rate though, investors are often willing to build more bond-heavy portfolios in order to reap the fairly reliable interest payments that bonds offer. Since either situation can have a marked impact on the demand for investment-grade precious metals, they can also put upward or downward pressure on the spot prices of those metals.
These are just a few of the ways in which national policies set by governments can impact the spot prices of metals. Though they may seem to be only distantly related to the actual price you pay for an ounce of gold or silver, it’s important to understand the effects they can have if you want to fully dive into the precious metals market.
Be sure to check out the other articles in this series to read about more key factors that impact precious metals prices: