Gold and silver markets took a hit this week following the Federal Reserve’s meeting announcement.

Although Fed officials didn’t make any policy changes, they did strongly suggest that they will hike their benchmark interest rate in March. Although widely expected, some investors thought the recent stock market swoon might cause the central bank to back down.

The financial media reported Fed chairman Jerome Powell’s tone as hawkish, which in turn spooked markets.

The reality is that Powell is the most dovish central banker in the history of the Federal Reserve. That’s just going by the numbers. Under Powell, the Fed has embarked on an unprecedented Quantitative Easing program that has ballooned its balance sheet to $9 trillion.

It has also pushed interest rates down to record lows in real terms. The Fed funds rate is running at -7% when adjusted for the Consumer Price Index.

Powell admitted during remarks to the press that inflation has been running hotter and has persisted longer than he had let on to the public when he repeatedly called it “transitory”:

Jerome Powell: Both sides of the mandate are calling for us to move steadily away from the very highly accommodated policies we put in place during the challenging economic conditions that the economy faced earlier in the pandemic. There are multiple forces which should be working over the course of the year for inflation to come down. We do realize that the timing and pace of that are highly uncertain, and that inflation has persisted longer than we thought.

And of course, we're prepared to use our tools to assure that higher inflation does not become entrenched.

And speaking of entrenched inflation, rising prices continue to pinch the pocketbooks of consumers even as the stock market seems to be deflating. Falling equity values don’t necessarily imply a broader trend of disinflation.

While the S&P 500 moved lower in volatile price action again this week, commodities continued to move higher. The CRB commodity index broke out to a 7-year high on Wednesday with West Texas crude oil prices hitting $87 per barrel.

Gold and silver markets, however, are diverging. Gold prices are down 2.7% for the week to trade at $1,792 an ounce. Silver is taking a near $2 or 8.0% pounding this week to bring spot prices to $22.44 per ounce.

Platinum is trading 2.8% lower to come in at $1,013. And finally, palladium prices are diverging positively – up 10.8% or nearly $250 this week to trade at $2,370 per ounce as of this Friday morning recording.

Despite price weakness in most of the metals, we are seeing underlying strength in terms of demand. Over the past few days, gold and silver exchange-traded products have seen their biggest inflows since 2019.

ETFs function as convenient trading vehicles for investors who may want to rotate out of stocks within their brokerage accounts. But at the end of the day, any security that trades on a Wall Street exchange is still a financial asset that carries counterparty risk. Even if it purports to track the price of a precious metal or be backed by physical metal, no exchange-traded product can substitute for bullion itself.

Much doubt has been cast on the extent of actual gold backing of the largest gold ETF. Meanwhile, the biggest silver ETF, the SLV, changed its prospectus last year to allow for the suspension or restriction of new shares when it is unable to obtain enough metal.

The change occurred after the SLV was deluged with unusually high trading volumes last February. The large-scale inflows and outflows caused discrepancies between the market price of SLV and the value of its underlying assets.

As an open-ended fund, SLV doesn’t hold a fixed quantity of silver. It instead relies on layers of financial intermediaries known as “authorized participants” to create shares and adjust its asset base.

That entails counterparty risk, including the risk that some of the silver claimed in vaults by SLV may be rehypothecated, or simultaneously owned by another party.

Owning silver indirectly through financial instruments obviously doesn’t achieve true diversification out of financial assets. But Wall Street types tend to perceive financial instruments as the only game in town.

The fact that some very real demand for precious metals is being diverted into Wall Street products and away from bullion products has suppressed the physical market to some extent. That may be working to keep a lid on spot prices as well – especially as exchange-traded vehicles announce workarounds to obtaining real, physical holdings.

ETFs like the SLV depend almost entirely on the London Bullion Market Association for their physical silver holdings, such as they are. Inventories of LBMA silver bars have grown increasingly scarce throughout the demand surge we’ve seen the past couple years.

Whether that develops into a full-fledged shortage remains to be seen.

But in the event of a run on the bank for physical silver or gold, paper products linked to precious metals would not necessarily benefit in the way holders of them hope. They could even implode.

Meanwhile, in the event of a shortage of available coins, rounds, and bars, scarcity premiums could go through the roof. That gives bullion investors the opportunity to potentially benefit from both rising premiums and rising spot prices – a double play that no ETF offers.