Investment management consultant MATTHEW FEARGRIEVE considers the challenges that lie ahead for gold prices in the spring and summer of 2021 and beyond, and asks whether investors should trim their exposure to gold and gold producers, or keep faith with the world's most trusted precious metal.
The world’s most trusted precious metal hit a record high of US$2,069.40 per ounce in August 2020, driven by weakness in the value of the US dollar as low interest rates and government economic stimulus during the Covid-19 pandemic sent investors toward precious metals.
At the height of the pandemic in 2020, when investors were flooding into safe-haven assets, many professional investors optimistically predicted gold would head towards, and smash through, US$3,000.
But it was not to be. As vaccine roll-out got underway, and stock markets sustained their buoyancy, investor confidence returned. Gold being a traditional flight-to-safety asset in turbulent times, investors began to trim their positions, and the price of gold has fallen by 9.6% in US dollar terms over the first three months of 2021.
The price dropped to a one-year low of US$1,678 per ounce on March 8, then rebounded to US$1,743.90 per ounce, before slipping back to US$1,686 per ounce on March 30. It managed US$1,728.40 per ounce on April 1 as the Biden administration announced its US$2trn infrastructure spending plan.
Gold price forecasting for 2021 has been adjusted downwards somewhat, with many estimated averages hovering around the US$2,000 mark. Some players predict lower. Citibank, for example, posit that the bull market cycle for gold has ended. They have cut their average gold forecast for 2021 from US$1,900 per ounce to US$1,800 per ounce.
Gold has been conspicuously absent from the recent commodity rally, suffering US$1.1bn of outflows in the last week of March.
And figures released this month by the World Gold Council do not improve the 2021 outlook for gold. The figures show central bank gold purchases, one of the key drivers of demand, have tumbled in 2021.
Collective net purchases totalled 8.8 tonnes, with India buying around 11.2 tonnes, Uzbekistan 7.2t, Kazakhstan 1.6t, and Colombia 0.5t. But offsetting this was Turkey which sold 11.7t, putting central bank net sales at 16.7t year to date, which is the weakest start to a year in a decade.
If gold is a safe asset in hard times, why did its price rise on news of Biden’s stimulus measures? The question can be answered in one word: inflation.
The more the US government spends on stimulus packages, the more the prospect of increased spending by hundreds of millions of locked-down, frustrated consumers, the greater the market’s expectation of higher levels of inflation.
At its March 16-17 meeting, the Federal Open Market Committee (FOMC) forecast inflation running to 2.4% this year, ahead of its previous estimate of 1.8%. It also stated that interest rates in the US are to stay on the floor, with no rate increase likely until 2023 at the earliest.
Here we have two market dynamics that impact gold prices: high(er) inflation and low(er) interest rates.
Higher inflation (combined, in an ideal scenario for gold investors, with higher unemployment) is broadly good for gold.
Low interest rates mean that gold, a non-income generating asset, can in principle stay competitive.
Post-the FOMC meeting, there is now in the US a low-interest rate, low-inflation environment.
There is, however, the spectre of inflation on the horizon. The Fed acknowledged this by raising its 2021 inflation target to 2.4%. In so doing, it signalled the US government’s continuing commitment to spending its way to post-pandemic economic recovery and that it is prepared to tolerate a short-term rise in inflation in the process.
The Fed is determined to run the US economy hot. A highly-stimulated reflationary economy, combined with the unleashing of pent-up consumer demand, is a recipe for higher inflation.
So why are gold prices dropping when inflation could be making a comeback? The answer lies in the bond markets.
The potential for higher inflation has, in part, driven bond prices down. Inflation effectively reduces the returns of bonds over time, and the price that the US government can demand from buyers of its long-maturity debt instruments (aka US Treasuries) has accordingly fallen.
Read more: Why Bond Yields will Continue to Climb.
Falling bond prices drive bond yields higher, and higher yields make borrowing more expensive for the government that issues the bonds. So we can expect some intervention by the Fed if bond yields continue to climb. But at the moment the Fed is determined to persevere with its stimulus spending programme, and US Treasuries are still being issued in large quantities.
Read more: Rebalancing the Bonds in your Portfolio.
Because bonds are sensitive to the effects of inflation, they are the one asset that acts as an early-warning system when inflation is on the horizon. So low bond prices mean better times for gold prices, right?
Well, not quite. Downward pressure on bond prices has the opposite effect on bond yields. Higher yields on US Treasuries are bearish for precious metals, because investors can earn guaranteed returns from the yield at lower investment cost (the bond price), unlike metals which unlike bonds fluctuate in price and do not pay interest or dividends.
Higher yields also attract foreign investors, supporting a higher US dollar, which in turn has a depressive effect on metal prices.
We explained in our blog Why Bond Yields will Climb Higher that it may be unwise simply to assume that the Fed intends the current inflationary phase to be purely transitional. We know nothing about the extent of the Fed’s capacity to tolerate prolonged inflationary pressures before it will feel compelled to take normalising action. More than a year of economic lockdown has left the world economy in need of massive stimulus and spending programmes to help it reflate. Inflation may be higher and longer-lived than we may think.
Longer-lived inflation will, we think, keep bond yields high. The Fed has not shown itself particularly willing to curtail rising yields by buying back US Treasuries. There is some repurchasing going on, but this is outweighed by the volume of bond issuances.
In short, we think the 2021 challenge for gold prices is twofold: economic recovery (with or without an attendant investor influx into equities, which we are already seeing) and higher than normal bond yields, which will be attractive to both to institutional investors, who can realise more income from US government debt than from precious metals, and to retail investors, who have trimmed their gold exposure in Comex and ETFs.
One thing that could keep gold in the game is the absence of consensus on the likelihood and degree of inflation risks. Investors are aware that worldwide policymakers like the Fed have been downplaying the risks, so as not to spook consumers into curtailing their post-pandemic spending. If inflation overshoot expectations, risk-conscious investors will return to gold.
On balance, we do not consider that this is the time to exit gold completely from your investment portfolio. True, many savvy investors consider gold an "in and out" asset. But the lingering - and possibly strengthening - whiff of inflation, combined with the potential for higher unemployment on both sides of the Atlantic once furlough schemes are withdrawn, are strong dynamics that tend towards retaining some exposure to gold.
There is also, of course, a bullish argument for buying while prices are (relatively) low compared to last year's highs. When timing your purchase you will need to keep an eye on any step-up in the Fed's bond repurchase programme, which will be designed to limit further rises in bond yields. Once government bonds, in particular US Treasuries, begin to pay lower returns, institutional allocators will trim their bond holdings and move money back into gold and other precious metals, which will drive prices up.
There is also a historical paradox that comes into play here, just to complicate your gold outlook a little. If yields continue rising toward higher levels, however, the uncertainty surrounding inflation, and its impact on a fledgling post-pandemic economy, may also increase, which historically has triggered a shift from the dollar to gold as a safe haven. This was seen in the 1980s when yields soared upwards toward 14% and gold also spiked.
Our sense is that you might have to wait for most of 2021 or even longer for bond yields to drop. See our blog Why Bond Yields will Stay High. On the plus side for gold and gold fund buyers, continuing economic recovery and sustained investor enthusiasm for global equities throughout 2021 will help to keep gold prices lower.
Meanwhile, of course, Bitcoin continues to surge, notwithstanding its own historical sensitivity to high bond yields. It is fascinating to speculate how long this will last and how far cryptocurrencies will become accepted, in a post-pandemic economy, as “mainstream” assets.
MATTHEW FEARGRIEVE is an investment management consultant. You can read his investing blog here and see his Twitter feed here.
IMPORTANT: the views expressed in this article are a matter of the author's opinion only, and are not intended to constitute financial advice on which any reliance should be placed. Always consult your own professional financial advisers for financial advice.