February 09, 2021
Stepping into the new year, the markets were cheering vaccines and a return to normal life.
The medical solutions have raised hopes of a turnaround in the global health and economic situation in the second half of the year. But one month into 2021, renewed waves and new variants of the virus pose concerns for the outlook. The return to normal life was prone to setbacks, and we are now seeing some of those risks emerge. Several European countries and states in the US have extended their restrictions. In the US, December was the first month of job losses since April, consumer spending dropped for the third straight month and jobless claims went up. This further confirms the theory that beyond the initial V shaped recovery, it's going to be a slow grind.
In addition, supply shortages and safety concerns have slowed the vaccine rollout. This is further slowing down the pace of the economic recovery. Global stock markets seem to have gotten a bit of a reality check as timing of recovery gets pushed further down the road.
Amid the market volatility, the dollar gained strength due to its safe haven appeal. This was despite all the talk about the additional US stimulus. Gold lost ~3% in the month in dollar terms, even though it is viewed as a counterbalance against currency devaluation and inflation which are expected with further economic stimulus.
Biden's presidency looks promising for gold
Expectations of a rally in gold had been building since Democrats, aligned with Biden, won control of the White House in early January. They have a big spending and borrowing plan to help the United States economy. Incoming Treasury Secretary Janet Yellen has also said the White House will go “big” on deficit spending to avoid a long-lasting economic downturn. This essentially is the start of an extended period of weakness in the US dollar due to the never seen before economic stimulus and currency devaluation. Biden and Yellen seem set to push the dollar down in the long-term, especially because a weak currency is good for the economy during a period of economic recovery. This notion of race to the bottom, rising deficits and high levels of government debt should ideally increase demand for sound money alternatives. This will be bullish for gold.
But for now, the dollar isn’t weakening despite Biden’s $1.9 trillion fiscal plan to fight Covid-19. Typically, when massive spending like this is announced, risk appetite improves. This sends investors to stocks and commodities, including gold, while the dollar weakens.
But with the Democrats being supporters of further fiscal spending, the stimulus announced by the president isn't necessarily the last for the year. Hence any strength in the dollar will be short lived. With more money trickling down to the real economy, the market is expecting higher inflation going forward. This will fuel a deeper drop in real or inflation-adjusted bond yields in the medium-to-long term. This will increase the portfolio relevance of gold.
Biden also aims to boost America's vaccination campaign. If progress is made on that front it could boost growth and hurt gold prices as it would mean reduced government funding.
The Fed renews commitment to easy money
Anticipation of big stimulus measures by the incoming administration in the US led to 10-year Treasury yields spiking up in the month, hurting gold. Larger government borrowing and concerns about stimulus tapering by the Federal Reserve were the main drivers.
But in its latest policy meeting in January, the world's most powerful central bank acknowledged a slowdown in activity and employment and predicted modest inflation this year. Referring to a cautious outlook, and to avoid derailing the recovery with taper talk, Chair Powell said the economy is still a long way from meeting inflation and employment goals. He denied any reduction in its $120 billion/month bond buying or hike in interest rates any time soon. He added that any exit from the easy money policy will be gradual. These comments too should ideally be pulling the dollar down. Gold, which tends to do well in times of low nominal and negative real interest rates, will continue to be a preferred asset for investors in search of higher returns.
While Powell put an end to concerns about stimulus unwinding, future policy of expanding the debt purchases to enable four more years of trillion-dollar deficits would benefit gold. Such central bank monetization of government borrowing will hurt confidence in the US dollar and the dollar will resume its slide.
The optimism that vaccines would heal the global economy in just a few months has been dampened by the outbreak of new variants and problems with the vaccine rollout in the developed world. Given the current risks, uncertainty and commitment to easy money policies, gold prices seem stretched to the downside. Now is a good time to build your gold allocation.
Source - Bloomberg, World Gold Council
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