Gold, which is priced in dollars, would be a big beneficiary if a crisis of confidence plagues the world’s reserve currency.
With plenty of liquidity sloshing around and also seeping into the real economy, unlike 2008 where liquidity remained bound to banks and financial institutions, the probability of inflation looms large.
In 2020, lakhs of lives and livelihoods were lost to the Covid-19 pandemic. The health crisis snowballed into an economic one and the global economy plunged into recession. Stock markets lost about a quarter of their value only to end the year at all-time highs. Real interest rates plummeted, the world’s reserve currency lost its muscle and gold yielded spectacular returns.
For all the hope spurred by the breakthroughs on the vaccine front, we believe that most of 2021 will be a bumpy journey from vaccine to vaccination. What will this mean for gold?
Gold prices to move up Gold is expected to initially move up riding on the back of additional fiscal stimulus from the US government and improving investment demand as well as consumer demand from India and China. But the optimism surrounding the economic rebound and the cheap liquidity backdrop is expected to encourage further risk taking. The continued optimism on the economic recovery and surging risk assets could be a headwind for gold that could limit its rise next year. However, the economic rebound has been losing steam. For example, the US economy has recouped half the jobs lost due to the pandemic but is now adding jobs at a much slower pace. When the liquidity led momentum recedes and markets start reflecting ground reality, gold should reprice on back of constructive fundamentals.
Let’s remember that gold was already on an upward trajectory before Covid-19, with the pandemic being only one of the tailwinds for its incredible rally. And most of the macroeconomic conditions that supported gold are now being carried forward to 2021.
Gold as store of value With plenty of liquidity sloshing around and also seeping into the real economy, unlike 2008 where liquidity remained bound to banks and financial institutions, the probability of inflation looms large. The vaccine breakthrough could bring back pre-Covid-19 spending habits. Such pent-up demand, magnified by cash handouts and high savings rate, will mean consumers return to fewer goods and services—with many businesses having shut down for good. This will drive up inflation and take wealth away from savers and devalue their wages. This not only means the erosion of purchasing power but also the erosion of trust in the reliability and sustainability of the current monetary system. This is incredibly bullish for gold—the currency of last resort and the ultimate store of value as real rates continue to dip further.
Gold, which is priced in dollars, would be a big beneficiary if a crisis of confidence plagues the world’s reserve currency. One way in which governments are expected to tackle these high debt levels is currency devaluations. As economies compete for the weakest currency, gold, being a monetary asset will be more valuable.
Global policy makers will continue to resort to monetary inflation, credit expansion and government spending to tackle the economic fallout of the pandemic. Use of monetary policy will mean failure to normalise the world economy as central banks will be trapped in a state of perpetual policy manipulation, financial systems will continue to walk on fiscal crutches, and the system will be marred with vulnerabilities. This will ensure that gold remains a preferred portfolio asset in 2021 and beyond.
The writer is senior fund manager, Alternative Investments, Quantum AMC