Gold kicked off 2021 strongly before dipping below US$1,800/oz, levels last seen in late November 2020, in the aftermath of positive vaccine announcements. However, we still see further upside price risk for gold in the coming months. The roll-out of the COVID-19 vaccine has given rise to optimism that economic and social confidence will be restored, but most of the population across the U.S. and Europe is unlikely to receive the vaccination until Q3 2021, delaying the post-pandemic recovery to H2 2021.
Broadly in line with our own expectations, the annual LBMA survey revealed a positive outlook for gold, expecting prices to gain 11.5% year on year on an annual-average basis, which is up around 8% from current prices. We expect prices to surpass US$2,000/oz in 2021 given the conducive macro backdrop. However, compared with last year, market views on gold are vastly divided. The poll reveals a difference of US$650/oz in the annual average forecast, with the most bullish forecast at US$2,300/oz and the most bearish at US$1,650/oz.
Similarly, there is a wide trading range forecast for gold this year of over US$1,000/oz, with the highest intra-year high forecast at US$2,680/oz and the lowest low at US$1,488/oz, over US$300/oz wider than last year. While there is little disagreement on the physical drivers for the market, such as central bank activity or jewellery demand, there is a wide range of expectations on the macro front and policy response.
Some believe COVID-19 inoculation effectiveness will restore social and economic confidence, boosting the economic recovery, and any inflationary pressures will be delayed beyond 2021. This would create an environment where gold will become less attractive compared with other asset classes and push gold prices lower. In contrast, others think easy monetary policy is here to stay for some time, interest rates will remain low, the economic recovery is uncertain given COVID variants, and fiscal stimulus will push up inflation and boost gold prices to new highs.
The key factors here are whether 1) real yields remain negative given how far five-year real yields have fallen already and gold remains correlated to real yields; 2) the U.S. dollar resumes it weakening trend; and 3) inflation will be high enough for gold to be an effective inflation hedge.
Vaccination outperformance in the U.S. has led to a combination of U.S. dollar strength, U.S. equity market outperformance, and U.S. rates ticking higher. This is reminiscent of 2018, when a confluence of factors weighed on gold prices. While we continue to believe U.S. real rates will return as the main driver of gold price action, in the near term the U.S. dollar continues to set the tone of trading, with the three-month rolling correlation above 50%.
We maintain a medium-term U.S. dollar bearish view. The newfound yield support is driven by inflation expectations rather than real rates, while fiscal stimulus is likely to result in large U.S. twin deficits.
Markets have been focused on U.S. inflation data and our macro strategists note that the Fed seems to be raising the bar for what constitutes “troubling” inflation. If it hits 2%, the policy response will depend on how fast inflation is accelerating. Gold tends to outperform during periods of high and unexpected inflation rather than around 2%.
Despite the vaccine, the start of 2021 is more supportive for gold than the start of last year, given the unprecedented scale and speed of the policy response globally to the pandemic. Interest rates were cut, balance sheets expanded, and stimulus packages introduced, which limited downside economic risk in 2020 but increased debt at the start of 2021. This scenario also means fewer policy tools may be available this year if there are economic setbacks.
Risks at play
We expect upside risk to linger in the coming months as real yields remain negative, the U.S. dollar weakens further and economic uncertainty likely supports continued interest in gold. The broader macro backdrop – that propelled prices to new highs in 2020 – is unchanged for gold.
As a barometer for risk, the recent price action signifies strong pull and push forces: on one side are the vaccination outperformance in the U.S., a stronger U.S. dollar, signalling of QE tapering and anticipation of a U.S. recovery buoyed by sizeable fiscal stimulus. On the other side are the hefty U.S. twin deficits, rising inflation expectations, record debt, expectations of a slow economic recovery, COVID-19 mutations potentially outpacing the inoculation progress, and low and negative real yields persisting for a prolonged period.
Both forces are strong and credible and have resulted in gold ETP inflows slowing. We continue to believe the U.S. dollar is likely to resume its downtrend and real yields will remain low or negative; and as the physical market recovers (albeit from a weak base) the downside risk for gold prices should be cushioned.
However, as the economic recovery gains momentum, other commodities are likely to gain favour; while this may not necessarily result in hefty net redemptions in gold, allocation into gold may slow. The physical market will therefore be key, as it tends to cushion prices by setting the floor. But gold still has a role to play in portfolio diversification. There is less dispute over the physical flows in the gold market. Jewellery demand is expected to recover from a low base, and central banks to remain net buyers, albeit at a slower pace.
Signs of demand recovery?
The latest World Gold Council Gold Demand Trends report flagged that annual global demand fell to an 11-year low. The physical market started to recover in Q4 2020, led by growth in China and India; however, with the COVID variant and slow vaccine rollout, the recovery appears fragile in Q1 2021, suggesting that investor demand still has to do most of the work to drive gold prices higher.
On a positive note, India has reduced its import duty to an effective 10.75% from 12.875%. India’s gold imports fell by 47% year on year in 2020 to less than 400 tonnes and are down 60% when compared with more than 1,000 tonnes 10 years ago. Imports were broadly on a downtrend even before the pandemic but higher prices mean tax revenue has risen. While we do not think the duty cut will exponentially boost the gold demand recovery, we do think it will help to limit the downside risk, suggesting better support for gold prices. We had been expecting India’s consumer demand to recover in 2021, but to remain below 2019 levels. The duty cut poses upside risk to our 2021 forecast, but we still expect India’s consumer demand to remain below 2019 levels, albeit to a lesser extent, with the gap narrowing to 20%.
Not just jewellery demand, but also central bank buying slowed last year. Although central banks stayed net buyers, purchases fell to their lowest since 2010, which was the first year that flows swung back to net demand since the 1980s. Net buying fell to 272.9 tonnes from the 52-year high of 668.5 tonnes in 2019, and while a number of the large 2019 buyers were absent or scaled back buying, seven central banks became net sellers, including some notable gold producers. However, a greater number of returning central banks made sizeable additions. Turkey replaced Russia as the largest buyer in 2020. We expect central banks to remain net buyers in 2021 with volumes closer to those in 2020 rather than 2019, given the continued desire for diversification; but the need for liquidity may prompt selling and cap net buying.
This means there will still be a substantial gap that needs to be plugged by investment demand to drive prices higher. Market positioning in gold was scaled back into year-end 2020, and gold net fund length is almost half the level it was a year ago, primarily on reduced gross long positions.
Tactical positioning in gold has been nimble. Net fund length is down as a percentage of open interest to 20.4% from 26.7% at the start of the year, just below the long-run average. While open interest and volume traded in Comex gold is lighter than one year ago, volume traded in the London OTC market is higher YTD year on year. On a regional basis, ETP flows diverged in January; Europe continued to add to holdings, while the largest redemptions materialized across North America. Premature concerns around QE tapering pressured regional demand, while a slower vaccination rollout across Europe has raised concerns over its economic recovery. Globally, holdings are down 6.4 tonnes YTD. ETPs have swung from being a key driver of upside price risk to a source of downside pressure as the resilience of the current metal held in trust is uncertain. We expect further inflows to materialize, but at a slower pace year on year. Retail investor demand is the one pocket of strength, but the more muted investor flows generally reflect a more divided outlook for the market, in our view.
In all, price risk remains skewed to the upside in light of our expectations of further U.S. dollar weakness, negative real rates, inflation concerns, and further fiscal stimulus amid accommodative monetary policy. We expect prices to average US$1,958/oz in 2021.