After reaching an all-time high in the summer of 2020, gold has struggled in 2021. Gold prices have fallen close to 10 per cent in Q1 2021. Falling bond yields, dollar depreciation and strength in investor sentiment that were all helping gold in 2020, have gone in reverse in the first quarter of 2021. 
At the time of writing, US 10-year Treasury bond yields have risen to a 14-month high while the US dollar basket (DXY) is close to a five-month high. Meanwhile, inflation has been very tame, with the US consumer price index (CPI) inflation reading for February 2021 at only 1.7 per cent.
Investor sentiment towards the metal, unsurprisingly has cooled. Net speculative positioning in gold futures is now close to 180k contracts net long, down the considerably from over 300k contracts net long last year.
As we look to the year ahead, we do expect the tactical interest in gold to remain cool. After all, demand for defensive assets like gold are likely to be muted in a moderate recovery.
However, gold has demonstrated its strategic credentials throughout 2020, helping counter the drawdowns in cyclical assets in the first half of year. Therefore, we expect gold as a strategic asset to remain firmly in place, especially as the path to recovery will continue to be bumpy.
Our models indicate that, if economic consensus is correct, gold prices will resume on an upward path. Gold prices may fall a little further in the near future, but we are approaching the end of this drawdown.
What has surprised the markets the most in the past quarter, is rising bond yields. Consensus opinion is that bond yields will stabilise. If that’s not the case, we could see gold prices come under renewed pressure.
However, it is difficult to see how the government’s fiscal outlays can be met with the sharply increasing cost of servicing their debt. If putting a brake on fiscal spending becomes a real threat and if that starts to cool down the recovery, we could see the US Federal Reserve (Fed) engaging yield curve control. That would indeed be gold price positive.
Three potential scenarios
There are three potential scenarios for gold prices forecast until Q2 2022.
Source: WisdomTree Model Forecasts, Bloomberg Historical Data, data available as of close 31 Mar 2021
Consensus opinion is that US 10-year Treasury bond yields will hit 1.8 per cent in Q1 2022 and dip below 1.6 per cent temporarily before we get there. With current bond yields at 1.72 per cent, the market is clearly expecting the worst of the bond sell-off to be behind us. Also, consensus opinion is for the US dollar to resume its depreciating trend that started in 2020.
Inflation could peak at 2.9 per cent in Q2 2021, largely reflecting the base effect of very weak energy prices this time year ago. Inflation is expected to moderate to 2.2 per cent by Q1 2022.
Investor sentiment towards gold clearly been dented by weak prices and tactical investors refocusing on cyclical assets, to the detriment of defensive assets like gold. We think this trend is likely to persist and therefore we reduce the speculative positioning in gold futures assumption to 100k net long, down from close to 170k net long today.
Factoring these assumptions into our model, we get to a gold price of $1,860/oz by Q1 2022, essentially recouping all the losses in gold so far this year.
Source: WisdomTree, data available as of close 31 Mar 2021
Beyond Q1 2022
While we have acknowledged earlier that inflation is likely to remain in a ‘tame’ territory in our 1-year forecast horizon, we can see that inflation expectations have risen to the highest level in eight years, based on the 10-year breakeven rate.
This is what the market is pricing-in as an expectation over 10 years and thus indicates that inflation is likely to head structurally higher. Gold tends to perform well in higher inflation scenarios (which is often coupled with strong economic growth that generates the ‘demand-pull’ inflation).
Source: WisdomTree, Bloomberg. Data available as of close 31 Mar 2021
Nitesh Shah is research director at WisdomTree. The views expressed above are his own and should not be taken as investment advice.