December 16 2020

6 Factors that Shape the Future of Gold

According to the World Gold Council (WGC) and UBS bank, the future of Gold is likely to be promising and to witness a positive and strong investment trend in 2021. Spot price hit the level of $2,000 an ounce by August 2020. On August 6, gold hit $2,070 an ounce, rising 35%, compared with the year-start.

Investors may likely rely more on gold in the near future. According to WGC, they will increase their exposure to safe-haven assets like gold to hedge their portfolios. In the points below, we will discuss the main factors that shape the future of gold, the expansion of its demand through important channels, and the major forecasts of top institutions regarding gold price.

Negative Yield on Bonds

Investment options

The world is facing now a negative interest rate environment. Negative rate, which is a tool used by the Monetary policy that sets the nominal interest rate below zero percent, had been enabled after COVID-19. Bond is a fixed income paper that gives promised interest. In this environment, bonds should be replaced to achieve returns. Gold will be the alternative diversifier to government bonds given negative to low-interest rates.

Bloomberg Business Week revealed that in the traditional investment portfolio of 60 percent stocks and 40 percent fixed income (Bond is the popular type), bonds should be replaced with gold, as it couldn’t hedge against losses from equities.

Opportunity Cost

The cost of holding gold is relatively low compared with other assets. In an environment of negative yield on bonds and higher interest rate risks, the cost of holding bonds is high. Global uncertainties, like that resulted from the Coronavirus, tend to shake the markets of bonds and equities, and in return increase the brightness of precious metals.

Gold doesn’t have credit risks. Although it doesn’t pay fixed income regularly as bonds, it is a safe-haven asset that achieves returns on the longer term. Opportunity cost is one of the key reasons that support holding and investing in gold. It is what the investor misses out on when choosing one alternative over another.

Second Coronavirus Wave and Vaccine

One of the factors that will shape the future of gold is the coronavirus itself. The second wave of coronavirus already hit many countries along the world. The number of cases is rising daily and many countries imposed lockdowns; thus leading negative impact on economies. Bank of England has decreased interest rates to a record low of 0.1 percent. The Federal Reserve had decreased its benchmark interest rate to zero in March 2020 and launched a new round of QE (Quantitative Easing).

In case big countries launch new fiscal stimulus and Quantitative Easing tactics; thus yellow metal may continue to benefit from the COVID-19. Although, there is much news concerning vaccines against COVID- 19, rather than approving their last effectiveness, approvals, and distribution among countries could take more time. No wonder that the Bank of Canada has announced the Coronavirus vaccine would not be broadly available until mid-2022.

High Levels of Debt

There is a positive correlation between public debt and gold prices. The debt is eventually paid from the taxes, collected from the citizens. This fear from higher taxes in the future encourages the need for safe-haven investments like gold. Global debt increased to reach a record of $258 trillion in the first quarter of 2020 as countries around the world had to shut down to cover the coronavirus pandemic, and debt levels are continuing to rise, according to the Institute for International Finance. This continuing positive trend of debt inspires the demand for gold; and hence, good performance of prices in the future. The US Public Debt has increased by 20% in June 2020 compared with June 2019, as shown in the following chart.

Source: Statista 2020

UBS forecasts the percentage of government debt from Gross Domestic Product (GDP) to be higher by a range from 15-25ppt by the end of 2021 compared with 2019 across much of Europe and the US. Once the Coronavirus comes to an end and the emergency spending is over, budget deficits will fall. Although, public spending is not expected to decrease after the crisis, according to UBS. The bank expects, however, that governments will use three means to finance the debt, as follows:

  • Financial Repression

Financial Repression means the methods used by governments to increase tax income and domestic debt. Coronavirus hit the global economy aggressively. The fears from these methods from the largest developed economies in the future after COVID-19 is a big incentive for the increased demand for gold.

  • Higher Taxation

UBS bank expected that governments might increase taxation on large, transitional companies and especially on technology firms. Also, some other countries may increase taxation on the wealthy to help finance debts.

  • Moderately higher inflation

It is a popular means of reducing debt. Printing money to finance debt will eventually increase inflation. Federal Reserve has announced during September 2020 that it will give more flexibility to inflation; allowing it to move beyond the 2% target.

Weakening US Dollar

The U.S. Dollar in early June 2020 performed to be in full free fall. Through the period of (May 14– June 8) 2020, the Bloomberg Dollar Spot Index faltered 4.6%, effectively wiping out all of its appreciation throughout the foulest of the coronavirus crisis. A commentary by Stephen Roach, former chairman of Morgan Stanley Asia, declared that “A crash in the Dollar Is Coming”. COVID-19 adds more pressure on USD. The negative relation between the dollar index and gold appears to increase the brightness of precious metals.

Geopolitical Risks

Uncertainty and risk historically benefit safe-haven demand in assets like gold. The aggravated trend of the geopolitical risks in 2020 supports the positive trend of increasing demand and hence increase the gold prices. With rising political and economic uncertainty, gold will be the asset used by many investors to reduce the risks and diversify their portfolios.  There are many political top-up events that were opened and may impose difficulties in the future. Failure to strike a post-Brexit trade deal is an example. It was expected that this could cut the UK’s economic growth rate by more than half next year in 2021.

Major Forecasts about the Future of Gold

Having said that and analyzed the current situation that favors the rising trend of Gold, allow me to address the latest forecasts issued by major financial institutions. In this context, Goldman Sachs announced its price target at $2,300 per ounce in 2021. Citibank’s outlook is also optimistic, as, on its recent updated predictions of gold prices, it declared $2,400 per ounce in 2021. By the end of April, Bank of America raised its 18-month price target for Gold to $3,000 an ounce.

There are many factors that determine the future of the yellow metal. Among many, negative bond yield, geopolitical risks, high level of debt have a great influence on the gold trend in the upcoming years. The current situation, as well as recent forecasts, indicate positive returns on gold in 2021, and investors are expected and encouraged to increase their gold holding in investment portfolios.

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