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Gold and Silver Are Down 8% and 21% Over the Trailing Year. Blame Bitcoin?

By Sean Williams - Updated Jul 14, 2017 at 4:44PM

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Is the cryptocurrency rally responsible for tarnishing precious metals? Maybe so.

Gold and silver mining might be among the top performing industries since the beginning of 2016, but since last summer, when physical gold peaked above $1,360 an ounce and silver touched $21 an ounce, precious metals have mostly been on the downswing. Over the trailing-one-year period, gold and silver spot prices are down 8% and 21%, according to data from Kitco.

Why precious metals have lost their luster

What on Earth is going on? There have been a number of reasonable explanations for the recent tumble in precious metals.

Gold bars on a dark background next to a stock chart.

Image source: Getty Images.

To begin with, the Federal Reserve has begun tightening monetary policy, which involves raising its federal funds target rate. This, in turn, has the effect of pushing interest rates and yields on interest-bearing assets higher. Assets like Treasury bonds are a preferred investment vehicle because their returns are nearly guaranteed, whereas buying and holding gold or silver offers no near-guaranteed return, and more important, no yield. Thusly, higher interest rates increases the opportunity cost of owning gold and silver.

Another issue for precious metals is that we've witnessed economic fundamentals improving. In other words, the unemployment rate is a low 4.4%, and the U.S. stock market has been off to the races, hitting multiple new all-time highs. Precious metals tend to feed off of uncertainty and do their best when equities are heading down or moving sideways. A market where bulls are winning in multiple industries usually equates to selling pressure on gold and silver.

The precious metals have also faced some exceptionally tough year-over-year demand comparisons. For instance, spot gold's nominal increase in value in the first quarter of 2016 was its top quarterly performance in 30 years. This wound up dramatically increasing demand for the lustrous yellow metal among investors and central banks. But according to the World Gold Council, though gold bar and coin demand grew 9% in the first quarter of 2017, overall demand for gold fell 18% year-over-year, mainly due to weaker central bank demand. Investors often forget that supply and demand do matter for precious metals.

A physical bitcoin on a red background.

Image source: Getty Images.

Is bitcoin to blame for gold's and silver's recent woes?

However, there could be another reason for the underperformance of gold and silver in the near-term: bitcoin.

Bitcoin, the blockchain-based cryptocurrency that's gained notoriety for challenging monetary theory, has gained 253% over the trailing year, leaving the broader stock market and precious metals firmly in its dust. Some pundits have theorized that bitcoin's outperformance, along with other digital currencies like ethereum, have been responsible for pulling investment dollars away from gold and toward cryptocurrencies -- and they may be right.

A quick look at the movement of the U.S. Dollar Index (DJINDICES: DXY) provides evidence to this theory. While there are no "givens" when it comes to investing, one of the near-givens is that gold and the U.S. Dollar Index tend to move in opposite directions. A stronger dollar usually means a weaker gold price, and a weaker dollar typically yields a higher gold price. However, over the past couple of months we've witnessed gold and the dollar moving lower in tandem, which is odd to say the least.

What's more, bitcoin shares a perceived commonality with gold and silver: finiteness. Unless we figure out a way to mine gold and silver from beyond our planet, the amount of resources available for production is finite. Similarly, the number of bitcoin that can be mined is considered finite at 21 million. In theory, it's possible that the number of peak bitcoin could be increased by changing its protocol, but as of now it looks unlikely that this would happen. Thus, bitcoin's rarity and recent momentum could very well be luring in investors who would otherwise have purchased gold or silver in the past.

Gold ingots stacked atop a hundred dollar bill.

Image source: Getty Images.

Gold and silver are your better (and safer) long-term bets

Despite the recent outperformance of digital currencies, this Fool continues to believe that your smartest long-term play is going to be traditional precious metals, or more specifically, precious-metal mining stocks, if given the choice between precious metals and bitcoin.

The biggest issue bitcoin will have to overcome is demonstrating to investors that it's worth nearly $2,400 apiece. But without traditional fundamentals that can be used for comparison and analysis, this could be next to impossible for bitcoin. Not to mention, the cryptocurrency's lack of a centralized exchange makes legitimizing the currency all the more difficult.

On the other hand, gold and silver have been used as a currency and store of value for centuries, and I don't foresee that changing anytime soon. These precious metals truly are finite in nature since their "protocol" can't be altered, period!

So, what investments in the gold and silver mining industry are worth a look given the recent swoon? One of the smarter ways to play precious-metal stocks is to consider a royalty and streaming company like Wheaton Precious Metals (NYSE: WPM). Rather than focusing on day-to-day mining activity and exploration, companies like Wheaton Precious Metals provide upfront cash to mining companies looking to expand an existing mine or develop a new one. In return, Wheaton receives long-term or life-of-mine contracts for a percentage of production at a per-ounce cost that's well below market rate. In the first quarter, the company's average cash costs were just $4.54 an ounce for silver and $391 an ounce for gold, leaving it with a massive gross margin. 

Dump trucks in an open-pit gold and silver mine.

Image source: Getty Images.

Mining companies with exceptionally low costs are also a good idea to consider. Barrick Gold (GOLD -3.52%), one of the largest precious-metal miners on the planet, has worked hard to reduce its debt by more than $5 billion since the end of 2014, and it currently boasts the lowest all-in sustaining costs (AISC) of all major gold miners at $720-$770 an ounce forecast for 2017. A low AISC combined with plenty of expansion opportunity in North America should yield healthy margins for years to come.

In short, yes, bitcoin may be adversely impacting the gold and silver markets in the short-term, but this is unlikely a long-term concern for precious-metal investors.

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