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Precious Metals Buoyed by Russia-Ukraine Conflict, Possible Fed Paralysis
The spot price of gold touched an all-time high above $2050 per oz this week, rising in the wake of an ongoing escalation of the Russia-Ukraine conflict and an ensuing flight to safety.
As we noted in our February viewpoint, Cutting Off the Punch Bowl, the outbreak of this war and resulting financial sanctions on the Russian economy will undoubtedly ripple through the global economy and create a downward risk to growth. Already, CME’s FedWatch tool indicates traders have effectively priced out the possibility of a 50bps rate hike at this month’s FOMC meeting (which previously saw a probability above 90%) as an aggressive tightening cycle in the US looks increasingly unlikely.
A standard 25bps rate hike still seems overwhelmingly likely, but it remains questionable how much of an effect that will have on inflation-adjusted “real rates” (the difference between the Fed Funds rate and YoY inflation) and the monetary policy outlook going forward. All of that is bullish news for gold, which usually thrives in high inflation, low interest rate environments like we have experienced over the past couple of years.
The silver market should not be overlooked in the current environment.
Back in 2019, MRP recognized a relative weakness in the price of silver when compared to gold, represented by the gold to silver ratio. By March 2020, the ratio had become so extended that it broke a 5,000-year old record, peaking around 125. As we noted at the time, an extended gold to silver ratio can sometimes indicate that the early stage of a precious metals bull run is underway. In the 2019-2021 period, that is exactly what happened as silver prices jumped from less than $15 to around $28 per oz, nearly cutting the ratio in half all the way down to 65 in 2021.
The ratio has started widening again recently, currently closing in on a reading of 77. That’s nowhere near the historic levels we observed in recent years, but it’s worth noting that the spot price of silver is not even back to a 52-week high, despite gold’s new all-time high. Meanwhile, the Silver Institute estimates 2022 will be a record year for silver demand, surpassing 1.1 billion oz, driven mainly by 5% growth in silver industrial fabrication.
Gold’s Monetary Qualities Face Global Stress Test by Sanctions
The biggest story in precious metal markets has recently become Russia’s massive gold reserves and international efforts to blunt their sanction-neutralizing abilities. The Russian ruble, Russian sovereign debt and equities, and the Russian central bank’s massive foreign exchange reserves have been early casualties of international financial sanctions enacted by European and North American nations.
Currency-focused sanctions from the US, European Union, and United Kingdom have decimated the Russian Ruble’s value, cutting its exchange rate with the dollar by nearly 40% in recent weeks. Worse, the majority of Russia’s $630 billion horde of foreign exchange reserves appear to have been rendered inaccessible by international banks’ requirements to comply with binding sanctions levied against their holdings of Russian reserves.
The Atlantic Council estimates claims on Russian banks have quintupled to ₽5.2 trillion ($44.5 billion), or 20% of its available reserves, and the availability of the country’s gold reserves will likely be one of the only assets left to provide liquidity and fill the gap.
According to the London-based World Gold Council (WGC), Russia’s central bank held about 2301 tons of gold at the end of 2021, meaning they hold the fifth-highest level of reserves worldwide. As Bloomberg notes, the Bank of Russia spent six years continually accumulating that gold horde, doubling its holdings and becoming the biggest sovereign buyer throughout the latter part of the 2010s. The bank halted purchases in March 2020 but indicated it would begin buying gold again at the end of February.
Russia was not alone, as Central banks added 463 tons to reserves in 2021, an increase of more than 80% from a year earlier, per WGC data.
Building a war chest of gold is one way to offset economic sanctions that threaten liquidity. Not only does gold have a universally accepted monetary value to all other central banks and financial institutions, but its price often benefits from global instability and uncertainty – exactly what Russia’s invasion of Ukraine has caused. Since Russia recognized separatist republics in eastern Ukraine as sovereign nations on February 21, gold has risen over 8%, swelling the value of Russia’s bullion by tens of billions of dollars. Essentially, as the war ramps up, so does the value of Russia’s safe haven of choice.
Though the international community cannot simply freeze and or seize Russia’s gold like they are attempting to do with the country’s foreign exchange reserves, they can attempt to make the yellow metal as illiquid as possible.
Per Axios, a bill introduced in the US Senate by Senators Angus King (I-ME), John Cornyn (R-TX), Bill Hagerty (R-TN), and Maggie Hassan (D-NH) would target Russia’s ability to sell gold reserves by sanctioning any American entities knowingly transacting with or transporting gold from Russia’s central bank holdings, or selling gold physically or electronically in Russia.
While the international community can work toward blocking Russian sales of gold, they will have less success trying to halt Russia’s accumulation of more gold reserves, considering it is one of the world’s largest gold producing nations – accounting for about 9% of annual gold output and 5% of annual silver output. That does, however, leave the nation’s mining industry vulnerable to sanctions like those enacted just this week by the London Bullion Market Association (LBMA), suspending its accreditation of six Russian precious metals refiners. Effectively, those refiners will no longer be able to sell gold and silver in the London market, the world’s largest.
That might be bad news for Russia, but some have speculated that putting up barriers to gold and silver circulation could send global gold prices higher and benefiting other precious metal investors.
While a ban on purchases of Russian oil has only now been adopted by the United States, no official action has been taken to block purchases of Russian oil. However, sanctions and scrutiny have been enough to scare many global companies away from even trying to purchase any of Russia’s energy products. Shell was one of the only companies still willing to pick up some flagship Urals crude from Russia (via Swiss trader Trafigura) last week and reportedly paid the price of Brent minus $28.50 a barrel, a record discount. Following criticism, Shell backed away from any future purchases of Russian oil and donated proceeds from that final batch to humanitarian efforts in Ukraine.
Perhaps Russian gold will become virtually untouchable for many nations in a similar way, or at least sell for a discount to any central bank willing to step up and take the risk of dealing with an increasingly unpopular Russian government. It won’t be surprising if nations with an appetite for gold like China and India, each of whom are already helping Russia find ways around its banks’ removal from SWIFT and other payment platforms, are still willing to buy Russian commodities or swap gold for foreign exchange reserves.
Investors can gain exposure to gold and silver via the SPDR Gold Shares (GLD) and iShares Silver Trust (SLV). |
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