Positive outlook for gold as low interest rates could last years

Apr 6, 2021

By David Duval

As recently seen on the charts, price volatility for gold ranks among the highest in the metals sector because it’s a tradable commodity and a medium of exchange. The price downturn since mid-2020 is hardly anything new or surprising and pales in comparison to some of the recent pullbacks in bitcoin which often drops over 10% in a week.

Unlike Bitcoin, gold’s losses are generally not restricted to the unit of exchange itself. There’s always plenty of collateral damage to producers and junior explorers which we are seeing in the latest pullback. Yet gold producers reported record high margins last year and 2021 also looks good. More often than not, gold equities outperform the metal and a repeat of this scenario is likely in store for gold stocks before year end.

Nonetheless, gold was one of the best performing major assets of 2020, driven by, among other things, a combination of financial and geopolitical uncertainty, low interest rates and positive price momentum – especially during late spring and summer when it reached a record of US$2,058.40 per ounce.

Why was gold bid up to this level and will the metal achieve that lofty performance again? The answer is more than likely “yes” as its main price drivers are beginning to awaken after a half year slumber.

Gold has always been seen as a safe haven in times of crisis and uncertainty. And heaven knows, there’s plenty of that around these days. For one thing, markets appear to be heavily overbought and the global financial system is precarious at best following the economic downturn that resulted from the Covid-19 pandemic whose economic consequences will be felt for generations.

Since the 1930s, the U.S. dollar has lost 99% of its value against gold while other reserve currencies such as the British pound and Japanese yen did even worse.

One of the most important things impacting gold is the bond market as the spike in yields have worked against the value of gold as it’s much easier to simply clip coupons in the bond market than it is to pay for storage of gold. Investors generally see gold as a good inflation hedge and the metal has proved to be relatively stable over the long haul and not easily depreciated by outside factors or other currencies.

As a rule, when the value of the dollar increases relative to other currencies around the world, the price of gold tends to fall in U.S. dollar terms. The reason for this is because gold becomes more expensive in other currencies. As the price of any commodity moves higher there tend to be fewer buyers, reducing demand for the metal. Conversely, as the value of the U.S. dollar moves lower, gold tends to appreciate as it becomes cheaper in other currencies, increasing demand at the lower prices.

The U.S. Federal Reserve has kept interest rates near zero to keep financial markets stable and make borrowing costs as low as possible to shore up the economy. It also decided to buy hundreds of billions of dollars in bonds which brought yields down, making gold and its lack of yield more attractive to investors.

The gold market suffered a major sell-off that began late last year and only began to reverse itself in mid-March of 2021 after gold futures ended below the US$1,700 mark when the U.S. dollar index touched its highest level in over three months. Treasury yields briefly topped 1.6% as the U.S. employment report showed larger-than-expected job gains in February. Higher government bond yields and a stronger dollar can make gold less attractive to investors seeking a safe-haven.

Jason Teed, co-portfolio manager of the Gold Bullion Strategy Fund QGLDX, recently told MarketWatch that gold has been pressured by “a continued increase in interest rates, making the metal a less attractive store of value relative to bonds,” adding that “interest rate pressure is likely a larger and nearer-term factor than the positive pressure of expected inflation.” As a caveat, he believes that should interest rates continue to move up on positive U.S. economic news, gold may continue to come under some selling pressure but that pressure may “abate somewhat if yield movements take a breather.”

One of the most important things investors need to pay attention to is the bond market as the spike in yields have worked against the value of gold as it is much easier to simply clip coupons in the bond market than it is to pay for storage of gold.

As the global economic recovery gathers momentum, analysts expect the U.S. dollar to weaken which will serve to increase safe haven demand for gold. Investors should remember that real interest rates are much more important for the gold market than changes in nominal interest rates, including the federal funds rate. Generally, real interest rates are negatively correlated with the price of gold (i.e. rising real rates adversely impact the yellow metal).

Recent statements from U.S. Federal Reserve Chairman Jerome Powell indicated that any interest rate hike is unlikely through 2023. The U.S. economy remains fragile and the post-pandemic recovery will be gradual at best, meaning a low-rate environment and an elevated gold price environment is here to stay at least for the next few years!

The World Gold Council believes that investment demand will remain well supported while gold consumption should benefit from the nascent economic recovery, especially in emerging markets. The WGC also sees gold investors navigating potential portfolio risks including: ballooning budget deficits, inflationary pressures and market corrections amid already high equity valuations.

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