Gold has outperformed many assets in 2020, playing true to its historical role as a safe-haven asset.
It is often a port of call in times of turbulence – and this pandemic-driven market and economic disruption we have lived though in 2020 has been a period of turbulence like no other.
Gold’s year-to-date gains of over 24% are impressive relative to other major asset classes. Even in a world where cyclical assets are now recovering strongly, we believe the outlook for gold remains very strong for the coming year and beyond.
That is partly because gold tends to rise with inflation, which in turn tends to rise in periods of strong economic growth.
In fact, it is this asymmetric behaviour that makes gold a perfect companion to an investment portfolio, as it gives rise to a low correlation with other assets.
We are in an economic recovery, and central banks like the US Federal Reserve have altered their inflation targeting regime to look at average inflation.
In practice, what that will mean is the Fed will allow inflation to be elevated in coming years to make up for periods of low inflation in past years.
Elevated inflation will support the price of gold. Historically, periods of high monetary growth have been followed by periods of high inflation, with a lag of roughly three years.
Today we are seeing monetary growth at levels we have never experienced before. This indicates we may be set up for a period of elevated inflation for several years.
Even in the coming year, a rebound in energy prices from ultra-low oil prices in April 2020 is likely to drive up general inflation.
An uncertain economic recovery
We expect an economic recovery to continue, but it is likely to be mired with uncertainty. Resurging counts of virus cases; not knowing when a Covid-19 vaccine will be available; the unknown efficacy of current stimulus in boosting economic growth; and the direction of the world’s largest importers and exporters are all sources of concern and investor anxiety.
Gold is an asset investors have historically used to hedge against both financial and geopolitical uncertainty, and we do not doubt that it will continue to play this role in the coming year.
Once again, gold’s asymmetric traits – doing well in times of strong inflation and doing well in times of turbulence – will favour the asset class over the coming years.
We believe rising sentiment towards gold could account for more than $500/oz increase in gold price over the coming year.
Inflation and dollar depreciation are also gold catalysts
That forms the basis of our outlook for gold in 2021. We expect inflation to rise to 2.9% around the middle of 2021, providing over $250/oz lift to gold prices.
We also expect sentiment towards gold to continue to strengthen with investors building positions in both futures and exchange traded commodities.
In addition, depreciation in the US dollar that has already started this year is likely to continue for several years. A depreciating dollar tends to lead to higher gold prices – in dollar terms.
The US dollar typically goes through long cycles. Historically, rising indebtedness – which is evident in the escalating twin deficit – has been the trigger for a return in the cycle (with a three-year lag).
After close to a decade of dollar appreciation, we seem to be in the middle of a turn in the cycle.
In the coming year, we expect a 4% dollar depreciation to lift gold prices by $50/oz.
Strength in gold likely to carry into 2021
Gold prices could rise by over $520/oz in the coming year, taking the gold price to over $2410/oz in Q3 2021 from under $1,890/oz today.
This is despite the headwinds from rising Treasury yields. Gold historically has a negative correlation with Treasury yields.
Rising indebtedness may not only drive the dollar lower and increase the appeal of gold as an alternative defensive asset to government debt securities, but may also drive Treasury yields higher. Our forecasts factor in these headwinds.
London, the centre of gold liquidity
If we head into another period of lockdowns, which may affect the ability to move gold from one place to another as we saw in March 2020, we could see another disruption to the gold market.
However, size and scale of liquidity in the London over-the-counter market that underpins most of Europe’s gold exchange traded commodities is unrivalled.
In addition, there are many mitigants to the disruptions to the New York gold futures market that now exist including significantly higher futures exchange inventory of gold compared to March 2020.
The smooth functioning of both these markets will likely see gold moving from strength to strength, underscored by sound fundamentals.
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