Precious metal ratios and recessions

The ratios of gold to other precious metals such as silver platinum and palladium have been increasing over the past year. In the case of platinum, the ratio is near all-time highs. We find that historically gold has strongly outperformed other precious metals during every US recession since 1971. 

Gold prices and interest rates tend to move in opposite directions. We have already extensively written about this before (Gold Price Framework Vol. 2: The energy side of the equation, May 28, 2018, here (Part II, 10 July 2018) and here (Part III, 24 August 2018), as well as some follow up reports that built on the model (Gold Price Framework Update – the New Cycle Accelerates, 28 January 2021), (Gold prices continue to weather the rate storm, 13 April, 2022 and Gold prices reflect a shift in paradigm – Part I and Part II, March 15 & 16, 2023)

However, despite the rise in interest rates and, in turn, real-interest rate expectations, gold has rallied over the past twelve months (see Exhibit 1)

Exhibit 1: Gold prices are higher than a year ago even as real-interest rate expectations (TIPS yields) moved higher

$/ozt (LHS), 10-year TIPS yield in % (RHS)

Source: Goldmoney Research

At the same time, other precious metals are stagnating or are even declining. Silver prices have been rangebound for the last twelve months and even the recent rally in gold to new all-time highs didn’t manage to push it higher. Platinum did slightly worse, and palladium is outright collapsing. 

Exhibit 2: Other precious metals have performed significantly worse

% change in value since February 2022

Source: Goldmoney Research

This means that the gold-to-silver, -platinum and -palladium ratios are all sharply up. In the case of platinum it set a new all-time high. 

Exhibit 3: the Gold-to-Platinum ratio set a new all-time high

Gold price / platinum price

Source: Goldmoney Research

This is remarkable given that gold is the most interest-rate-sensitive of the four precious metals. Importantly, gold is not outperforming other precious metals because it is extremely strong (it rallied 13% over the past twelve months while the S&P500 is up 35% over the same timeframe), but because the other precious metals have been performing poorly relative to almost everything else as of late.

When looking at historical periods in which gold outperformed other precious metals, what stands out is that this happened in almost all US recessions that occurred since US President Nixon temporarily suspended the gold standard in 1971. 

Exhibit 4: Gold outperformed silver…

Gold price / silver price per same weight

Source: Goldmoney Research

Exhibit 5: …Platinum…

Gold price / platinum price per same weight

Source: Goldmoney Research

Exhibit 6: …and palladium in all US recessions since 1971

Gold price / palladium price per same weight

Source: Goldmoney Research

The below table shows the outperformance of gold vs other precious metals during all US recessions since 1971 (where price data available).

Table 1: Gold outperformance during recessions

Source: Goldmoney Research

We think there are two main drivers for this phenomenon. First, in a recession, the Fed tends to slash interest rates to ease financial conditions and in an attempt to mitigate the tightening of financial conditions a recession can have. All western central banks tend to act that way, and increasingly in coordination. More recently – since the great financial crisis - central banks have much more aggressively tried to “stimulate the economy” not just by cutting rates, but by deploying policies like quantitative easing. In our gold price framework, we have demonstrated how declining real-interest rate expectation and QE drive up gold prices. It also has a positive effects on other precious metals, but the impact on gold is far greater and thus gold outperforms other precious metals when the Fed uses aggressive policy to combat an economic downturn. However, often the Fed does not slash rates aggressively, or – in some cases – doesn’t even lower rates at all until the US is in a recession for several months (see Exhibit 7). Historically, the Fed also has continued lower rate even as the economy was no longer contracting and left rates low for long after the recession ended. 

Exhibit 7: The Fed tends to cut rates marginally or not at all until several months into a recession

% 

Source: Goldmoney Research

Hence, the positive effect of declining interest rates on the gold-to-precious metals ratios usually only plays out deep in a recession and beyond the official end of a recession. In the current environment, the Fed  hasn’t cut rates, but the market increasingly speculates that the Fed will begin cutting rates in the next few months. This has led to a reversal in treasury yields and TIPS yields from 2.5% to 1.8%. 

Exhibit 8: Expectations for Fed rates cuts lead to a decline in yields on US government debt

% 12 month T-Bill (LHS), % 10-year Treasury note (RHS)

Source: Goldmoney Research

This reversal in long-term rates has supported gold prices for the past few months and in our view, this is the reason why gold prices are up. It also explains partially why the gold-to-precious metals-ratio is up, but this effect is small and limited to the more recent reversal in real-interest rate expectations. 

Importantly, historically gold tends to outperform other precious metals from the beginning of a recession, not only from the time when the fed aggressively cuts rates. Hence, there must be another reason why the gold-to precious metals ratios decline early on or even before a recession starts.

We have extensively written about the different price drivers of gold and other precious metals such as silver and platinum. Gold is primarily used as money. Its main price drivers are real interest rate expectations, long-dated energy prices (the most important cost drivers of mining and processing) and central bank policy. While there are industrial applications of gold in the field of dentistry and semiconductors, almost all of the gold used in industrial processes is later recycled. That means that the above ground stock of gold consists of almost all of the gold that has ever been mined. It is very stable and is growing at the rate of global mining output. Silver, platinum, and palladium on the other hand, are mostly used in industrial applications. Their above ground stock is a lot smaller than the gold stock because a large share of what has been mined over the years has been used. The prices of these metals are driven largely by industrial demand and supply and to a much lesser extent by monetary demand. In other words, gold prices are behaving like money while prices for other precious metals behave mostly like commodities and only to a much lesser extent like money.

Because precious metals other than gold are largely consumed in industrial processes, a decline in industrial demand for these metals has a very large effect on their price. In a recession, demand for commodities declines. Hence, in the beginning of a recession, gold tends to outperform other precious metals because the demand for these metals is declining. 

Importantly, this doesn’t mean that silver and platinum prices always decline in a recession. Because they are both a commodity and money, monetary demand can offset the decline in industrial demand for these metals. However, the decline in industrial demand weighs on the prices of these metals relative to gold. And because the fed often doesn’t react very aggressively to an ongoing recession for quite some time because the data that would show it is lagging, this is probably the main reason why gold outperforms other precious metals in the early stages of a recession.

The question is: Do rising gold-to-precious metals ratios always indicate recessions? The answer is no. Although it appears that in every recession gold outperforms other precious metals meaningfully, there have been several other periods where this happened, and the US wasn’t officially in a recession. 

However, there is more to it. Historically, when gold outperformed other precious metals outside of a recession, it seems to be often driven idiosyncratically due to the negative performance of one particular metal. The reason for this could, for instance be, that prices of that metal went up due to some supply issues and then subsequently came down again. During recessions, all three other precious metals underperformed simultaneously, as it is the case now.

We believe that if the current rally in gold-to-precious metals prices is indicative of a recession, it is likely that the recession is happening outside of the United States for the time being. The economies of the world have become ever more interconnected, and we think recessions are increasingly global in nature. The significant shortfall of energy in Europe and the corresponding high prices have led to a massive decline in energy consumption in Europe. The industrial base of Europe has greatly suffered, and many plants have closed, probably permanently. Hence, Europe is the epicenter of the global economic weakness, and many countries are probably already in a recession. But also, China is struggling to gain momentum, and several attempts by the Chinese government to jump-start the economy have been met with indifference by financial markets. Hence, even if gold-to-precious metals ratios indicate a recession, it might not be a US recession, at least not yet. It might simply be that global industrial demand for precious metals is weak. 

However, if the economic situation in Europe and China worsens, it will probably have spillover effects to other parts of the world, which all have to cope with sharply higher interest rates. The rally in the gold-to-precious metals ratio may not yet be indicative of a global recession just yet, but it certainly is a warning signal.