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 yield
Amid the market volatility, the dollar gained strength due to its safe haven appeal, despite all the talk about the impending US stimulus. Gold lost 3% in January in dollar terms, even though it is viewed as a counterbalance against currency debasement and inflation which are expected with further economic stimulus.
Expectations of a rally in gold had been building since Democrats, aligned with Biden, won control of the Senate in early January. Incoming Treasury Secretary Janet Yellen has also said the White House intended to go “big” on deficit spending to stave off a long-lasting economic downturn. This essentially is the start of an extended period of weakness in the US dollar due to the unprecedented economic stimulus and currency debasement.
The Biden-Yellen duo seems set to push the dollar down in the long-term, considering that a weak currency is beneficial for economic recovery. This notion of race to the bottom, surging deficits and high levels of government debt should increase demand for sound money alternatives and thus will be bullish for gold.
With more money trickling down to the real economy, the market is expecting robust inflation going forward. This will fuel a deeper drop in real or inflation-adjusted bond yields in the medium-to-longer term and increase the portfolio relevance of gold. President Biden also aims to boost America’s vaccination campaign. If meaningful progress is made on that front, it could weigh on gold prices as it implies reduced government funding.
Anticipation of big bang stimulus measures by the incoming administration in the US led to 10-year Treasury yields spiking up in the month, hurting gold. In its latest policy meeting in January, the Federal Reserve acknowledged a slowdown in activity and employment and predicted modest inflation this year. Citing a cautious outlook, and to avoid derailing the recovery with premature taper talk, Chair Powell said the economy is still a long way from meeting inflation and employment goals and denied any tapering 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 stance 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 yield.
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 unequivocal central bank monetisation of government borrowing will hurt the credibility of the US dollar in the eyes of global investors and the dollar will inevitably resume its slide.
The optimism that vaccines would heal the global economy quickly has been dampened by the outbreak of new variants and problems with vaccine rollout. Given the current risks, uncertainty and continued commitment to accommodative policies, gold prices definitely seem stretched to the downside, making now an opportune time to build your gold allocation.
The writer is senior fund manager, Alternative Investments, Quantum AMC