Relative Underperformance Likely to Continue
Our 1Q’21 forecast for gold prices was both incorrect, insofar as gains were expected, and correct, with other metals, precious or otherwise, pacing the field ahead of bullion. But the source of the error in our fundamental forecast was easily pinpointed early in the quarter: the composition of the US Congress changed. At the time the 1Q’21 forecast was written, there was no ‘blue wave’; the Georgia Senate elections had not flipped to Democrats yet.
Recommended by Christopher Vecchio, CFA
Download the full Gold 2Q forecast!
And thus, there is a significantly different background for gold prices as we enter 2Q’21 as compared to 1Q’21. Instead of a world of low interest rates and a slow-but-steadily improving economy cultivating a near-term environment of persistently negative real US yields, the Biden administration’s first stimulus package brought forth a jump in both nominal US Treasury yields and inflation expectations, the net-result of which was rising real US yields.
If Real US Yields Keep Rising and Volatility Drops, Gold is in Trouble
It’s important to view recent price action across asset classes through the lens of asset allocation and risk-adjusted returns. Gold, like other precious metals, does not have a dividend, yield, or coupon (as noted earlier), thus a jump in both US nominal and real yields presents a problem. Moreover, rising US Treasury yields, narrowing the gap with key metrics like US S&P 500 dividend yield (and above that, the earnings yield), are provoking reallocation not just in commodities, but equities and FX as well.
Bond markets are the ‘tail that wags the dog,’ and while longer-term fundamentals matter, a rapid advance in yields can provoke short-term havoc that runs counter to longer-term expectations. In this case, which is a steady erosion in real yields due to the combination of loose monetary policy and expansionary fiscal policy, instead catering to a rise in real yields in the short-term.
Historically, gold prices have a relationship with volatility unlike other asset classes. While other asset classes like bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – gold tends to benefit during periods of higher volatility. The problem? As the global economy moves towards reopening, volatility across the financial system has been steadily falling. But for a ‘black’ or ‘grey swan’ type event (e.g. a resuscitation of the US-China trade war), gold volatility likely retains a downtrend into 2Q’21.
Gold Prices Still Not as Shiny as…
In the 1Q’21 forecast it was noted that, “traders shouldn’t be surprised if platinum, alongside base metals like iron, nickel, and copper, all outpace further growth in gold prices in Q1’21 as financial markets remain ever-forward looking. In a future where the pandemic has been contained, growth is on the march, and substantial support is still being provided by central banks and sovereigns globally; metals are likely to rise but with an upended leaders table.”
The broad strokes of the fundamental view remain the same as at the start of the year. Rising government deficits and persistently low interest rates, akin to the period following the global financial crisis, against a global economic backdrop of significant growth post-pandemic, mean that other metals are likely to outperform gold in 2Q’21.