New year, same risks drive gold

Gold support holds in December

The Thanksgiving holiday attempt by short speculators to drive gold prices below the technically important US$1,800 per ounce level failed, as gold rebounded to end the month at US$1,898.36/oz. 

News of vaccine shipments and shots had no impact on gold, which suggests the vaccine excitement was fully priced into the gold market weakness in November. Gold trended to its monthly high of US$1,906/oz on December 21, when Congress reached a final agreement on US$900 billion of deficit spending for a new coronavirus relief package. Gold was also supported by a weakening dollar, which fell to new 30-month lows brought on by “risk-on” trading with new highs in the stock market. Importantly, the heavy gold bullion ETF outflows seen in November also stopped in December.

Silver sprang to life in the second half of the year, outperforming gold by 38% and gaining 16.6% in December. As both a monetary and industrial metal, silver is enjoying the best of both worlds—one of systemic risks in which gold thrives, and the other of post pandemic growth expectations and green initiatives in which copper thrives. As reference, copper ended the year at US$3.52 per pound, its highest price in nearly seven years.

Looking back On 2020…

Gold closes the decade strongly

Gold gained 25.1% or US$381/oz in 2020, its largest annual percentage gain in ten years. A myriad of pandemic-related drivers moved gold beginning in January with the outbreak in China. Gold advanced to seven-year highs in February as COVID spread to South Korea. However, in the last week of February, news of infections in Italy, Iran and the U.S. caused markets to crash and gold fell to its low of the year of US$1,451 on March 16. Gold stocks also tumbled as investors sought to raise cash for margin calls, redemptions and risk-off positioning. Once the panic abated, gold and gold stocks snapped back, returning to their pre-crash levels in early April. Gold reached new long-term highs in April, May and June. On July 27, it surpassed the US$1,921/oz all-time high set in 2011 and went on to its ultimate high of US$2,075/oz on August 7.

Since August, gold has taken a breather, consolidating between US$1,800 and US$2,000/oz range. News of positive COVID vaccine test results in early November brought hopes for a return to normalcy, causing gold to fall and test long-term technical support at US$1,800/oz. Support held and gold trended higher in December as the US Dollar Index (DXY) made new lows, ending the year at US$1,898/oz.

Gains highlighted by market uncertainty, systemic risks

The gold bull market in 2020 had a number of drivers, including:

• Uncertainty and risks caused by the pandemic
• US Federal Reserve Bank (Fed) interest rate target cuts (to 0%), falling bond yields and negative real rates
• Massive and unprecedented government deficit spending
• Fed quantitative easing (to buy treasuries and mortgage backed securities at $120 billion/month)
• Unprecedented expansion of Fed programs to purchase securities and extend credit across the economy
• Soaring debt levels among businesses
• Dollar weakness beginning in July
• Trade and other tensions with China

Record inflows into gold bullion exchange traded products are a testament to how investors are using gold to protect their portfolios from currency debasement, systemic collapse or inflation that may come as the unintended consequences of zero-rate policies, massive debt loads and the trillions of dollars of liquidity being pumped into the global economy.

Miners outpace the metal

Gold miners’ performance outpaced gold for most of the year, despite some consolidation towards the year-end. And while, broadly speaking, investors should expect gold equities to outperform the commodity in a rising gold price environment (due to the inherent leverage miners have to the metal), it is not uncommon to see companies underperform when carrying elevated risks. A majority of the gold miners we invested in proved adept at handling COVID protocols, while production and costs were not significantly impacted. The most successful producers remained focused on controlling costs, free cash flow, disciplined capital allocation and returns to shareholders. As well, according to quarterly reports, many of these same companies increased their dividends throughout the year and now have yields that, on average, exceed 2%.

More of the same for Gold in 2021?

We expect the same drivers that propelled gold in 2020 to continue in 2021. Later in the year, the world will become a very different place once the US and other nations achieve herd immunity. Here we try to identify the remaining risks that might drive gold once the virus has been tamed:

• Negative Rates & Asset Bubbles – Foremost is the risk from the distorting influence negative nominal rates, negative real rates and zero rate policies have on the markets. The Fed has indicated it will maintain a zero rate policy at least through 2023. Nano-yields force investors into riskier segments of the investment spectrum. Markets are further distorted by massive government interventions to purchase assets and inject liquidity into the economy through loans, spending and grants. As a result, we are seeing the same asset price inflation as seen after the global financial crisis, but this time it is on steroids. Incredibly, while still in the throes of an epic health crisis, bubbles or manias have formed in stocks, corporate credit, bitcoin and residential housing. Margin debt and call options are at record levels. The greater fool theory is in full force, while another crash is a possibility.
• Debt – A second risk is the huge debt load carried by governments and corporations. No one knows what the debt capacity limits are, but it is surely a finite number that might be crossed at any time. Also, anything that causes a surge in interest rates might make debt service an overwhelming liability.
• New Administration – Expected policies of the incoming Biden Administration are a third risk. Campaign promises of tax increases on corporations and individuals, along with increased regulations on many parts of the economy are likely to hinder economic growth. Deficit spending, possibly in the trillions, will add to the debt load. More spending by government on favored industries, state and local governments and various federal programs will stimulate the economy, however, government spending is probably the least productive use of capital. 
• Inflation – Inflation is another risk that may take many investors by surprise. We expect annual inflation to surge above 2% beginning in March when the 2020 pandemic recession becomes the new basis for year-over-year measures. Later in the year, warmer weather and the proliferation of vaccinations may usher in the new roaring twenties - a surge in demand and virtually unlimited spending made possible by the massive government sponsored liquidity sloshing around the financial system. Inflation may transform from a year-over-year aberration to a lasting problem.
• Weakening US Dollar – The DXY fell 6.8% in 2020. This weakness might morph into a longer bear market for the dollar in 2021 for several reasons. With the Fed’s zero-rate policy, the dollar no longer enjoys superior sovereign rates. In fact, real (inflation adjusted) treasury yields are now less than those on Japanese and German government bonds. As the economic recovery gains momentum, emerging economies with higher growth rates will attract capital from the US Also, the fiscal position of the US is likely to deteriorate further under the Biden Administration.

Tracing gold’s past

Gold has been in a bull market since December 2015 (Chart 1). The chart pattern of this market looks similar to the first five years of the 2001 to 2011 bull market (Chart 2). It will be interesting to see if the chart similarities continue. After 2006, the former bull market found catalysts in the 2008 global financial crisis and the European debt crisis in 2010. The current bull market will certainly need further catalysts to realise similar gains. The risks we have outlined along with the dollar’s trend could provide such catalysts.

Gold’s recent bull market run (from 2015 to present)

Gold following its 2001 to 2011 bull market trend?

Source: Bloomberg, VanEck. Data as of January 4, 2020.