Why Did Gold and Silver Fall Suddenly?

Reasons Why Gold and Silver Prices are Falling

#1 Dollar Strength

Due to the likelihood of the war in the Middle East continuing for longer than initial expectations, financial markets have been spooked.

Even more worrisome than the disruption to the crude oil market due to the closure of the Straight of Hormuz, is the possibility of a global recession...or at least a slowdown.

This is because, consumers in developed nations are in no position to handle high inflation due to high oil prices.

Add to that the economic impact of the disruption in the energy trade, and there is a high probability of a major economic slowdown.

Whenever there is a concern in financial markets about an economic slowdown, the biggest beneficiary tends to be the US dollar.

This is because the market perceives the dollar, due to its reserve currency status, as a safe currency to hold excess funds.

As commodities, including gold and silver, are priced in dollars, they tend to face selling pressure whenever the dollar strengthens.

#2 Speculation

And then there was good old fashioned speculation.

While it's all well and good to be bullish on gold and silver, we should not forget that a large part of the run up in these metals was speculative in nature, especially silver.

Many people who had never traded any commodity had begun punting in the futures market. The idea was that if these metals were going up then might as well make some quick profits using leverage.

Many investors become traders just because they thought the prices would continue to rise... and for no other reason. This is highly risky behaviour.

It was a case of FOMO (fear of missing out) at work.

However, speculative assets rise only as long as the speculation goes on. The moment it stopes or even reduces in magnitude, prices fall.

Conclusion

This is what Rahul Shah, Equitymaster's Co-Head of Research, wrote in the Profit Hunter...

• Between 2012 and 2019, gold did almost nothing.
  
  It sat flat for seven years.
  
  During that time, even a humble fixed deposit would have made you more money.
  
  We don't have a crystal ball; gold could easily enter another long "flat" period just when you need your money to be working for you.
  
  I'm not saying you should never own gold.
  
  It is a great insurance policy against "bad times" or a falling currency.
  
  If it helps you sleep better, it is perfectly fine to keep 5% to 10% of your wealth in gold.
  
  If you feel the world is becoming more uncertain, you might even increase that allocation slightly to act as a hedge.
  
  Stick to the discipline.
  
  Use stocks for growth and cash for safety.
  
  Leave the gold for a separate insurance fund.

At Equitymaster, we believe in having 5-10% of one's portfolio in gold at all times.

However, investors should not see gold as a potential substitute for any other asset. It makes sense to hold some precious metals in one's long-term portfolio, but it does not make sense to speculate on short term price movements.

While considering an investment in gold, have a time horizon well beyond 2026. Just because prices have gone up a lot recently, doesn't automatically make gold a great investment.

Do your due diligence.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...