As the year draws to a close, this edition of Gold Heartbeats looks ahead to the possibilities of 2021 and the implications for Gold.
With less than half a month to go Gold is up over 25% in 2020. The Covid-19 pandemic and the consequent unprecedented stimulus packages in the Western world were the key drivers for the move.
Looking ahead to 2021 will the rather sluggish price action of late continue or will Gold resume the multi-year uptrend? While certainty is always lacking there several unlikely potential scenarios to be examined. These are certainly not in any consensus view.
So, what is the consensus? Equities will rise, the Covid-19 will come to an end, and everything will return to normal, along with some stronger than usual inflation, while Central Bank policy remains unchanged. Additionally, almost all commentators and investment banks think the US Dollar will continue its decline.
Scenario 1: Drastic Reversal in Government and Central Bank Policy
Probably the most unlikely scenario on the list, unless inflation really starts to move higher and does so quickly. The global consensus that began in 2008 shows no sign of being challenged. Governments and Central Banks will continue to intervene in markets and the economy in major ways. Just look at the comment below from Pictet, in the FT, regarding the firepower the ECB has ready to buy bonds of eurozone governments. There is little, if any, pushback on this from any major quarter. It will continue unchallenged until it precipitates the next crisis.
While the word unprecedented is overused, the chart below demonstrates the scale of “balance sheet expansion” by Central Banks:
Only aggressive inflationary statistics will move the Central Banks to raise interest rates. And the move would have to be strong, fast, and sustained. One month’s inflation data would not be sufficient, it would need to be a quarterly move for any sustained shift into a rate rising environment. If rates had to rise quickly then, with the huge amount of indebtedness globally, there could be a danger of another financial crisis, especially with valuations in many sectors at eye-wateringly high levels. Gold, in this case, would initially fall, due to its high liquidity “sell what you can, not what you should”, and the fact that higher rates usually mean lower Gold prices. However, the threat of real damage from rising rates would see investors then flock to Gold as a safe-haven.
Scenario 2: Covid-19 Vaccine Disappoints
The turnaround in sentiment regarding the pandemic has been swift. Optimism abounds, with many commentators now saying that the crisis will be over by the summer. But there are several scenarios that could prevent this from happening.
Firstly, there could be negative headlines linking the vaccine to injury or death, whether true or not, which could put the whole programme in jeopardy. Secondly, the actual efficacy may not be as strong as hoped. Thirdly, there are distribution and production delays pushing out the timetable of a return to normalcy.
Additionally, the economic consequences have yet to be really reflected in employment numbers, savings, and future behaviour of consumers. Also, the knock-on effects from deflation in commercial real estate needs to be carefully followed.
Scenario 3: Geopolitical Tensions Rise
With Trump gone, the assumption is that the US will return to a more dovish and less confrontational foreign policy. While that may be true, the key flashpoints remain the same. Biden will not want to be seen as weak on Iran or China, especially as the latter gains increasingly hostile press in the West. China’s ambition and drive have shown it is unafraid to take controversial decisions as seen in Hong Kong and now with the current spat with Australia. Western policymakers will be looking frantically to diversify supply chains away from China after becoming so hooked in the last decades. This could put further pressure on China and increase its volatile behaviour.
Scenario 4: Stock Market Bubble and Crash
For years it has seemed that there has been a tech bubble. However, it has never popped. Not yet. 2021 could again disappoint the bears but there are the first signs of “irrational exuberance” like below:
Of course, this time interest rates are near zero so this can go on even longer. But at some point, companies have to start making money, or show they are close to making money. The other difference this time compared to the late 1990s is that, as shown below, Central Banks, are deeply involved in the stock market.
Why would the Bank of Japan ever let the stock market go down if it can buy stocks out of thin air?
Even with the milestone like above being hit, it is very difficult to see Central Banks turning off the taps and not supporting markets if the drop is more than 20% once the next panic comes.
After so many years of being conditioned to believe the Central Banks would come to the rescue, it takes a huge leap of imagination to perceive a future where they cannot or will not come to the rescue once again. Only hyperinflation or civil strife spring to mind.
So as long as that continues, expect to see examples like this become the norm. Valuations will continue to take on a surreal or nonsensical perspective as long as this current liquidity situation remains.
The world has changed drastically in the last ten years. Attitudes to risk, failure, unemployment have shifted profoundly. Bailouts are expected, and Central Banks are literally buying stocks, ETFs, and Bonds. With this not looking likely to change, then Gold should continue to benefit into 2021.