Although Covid-19 vaccines have given people greater hope for 2021, the path to recovery is likely to have many bumps in the road, according to WisdomTree’s Nitesh Shah, who highlighted the emergence of new more contagious variants as a headwind.
“It is unlikely that the UK is the only country to have an adversely mutated form of the virus,” said Shah, director – research at exchange-traded product provider WisdomTree.
“So, we start the year 2021 with a lot of uncertainty as to how many more bumps in the road will face. As in 2020, gold is likely to serve as a strong hedge against these uncertainties.”
Shah said the size of fiscal stimulus packages in the US and the ongoing monetary policy support could have a “highly distortionary” effect on the economy.
“We have seen the largest fiscal and monetary response to an economic shock seen in history,” said Shah.
As such, the potential for elevated inflation in the coming years has been heightened and the burden of increased government indebtedness could fall on the younger generation, driving further social unrest, he noted.
Therefore, the precious metal could continue to have a role to play in investor portfolios.
Gold had a strong 2020, as investors sought out ‘safe havens’ for their cash as the first truly global pandemic in a century took hold.
Performance of Bloomberg Gold Sub index in 2020
Source: FE Analytics
As the above chart shows, the Bloomberg Gold Sub index ended the year up by 20.95 per cent, in US dollar terms.
Below, Shah presents three scenarios for gold in 2021.
Consensus
The first scenario is based on consensus forecasts for macroeconomic indicators and assumes sentiment towards gold remains flat.
“Consensus has adjusted to the Federal Reserve’s new inflation targeting regime, where the central bank looks at average inflation and thus will let inflation rise above 2 per cent to compensate for periods when it has been below,” said Shah, adding that it could hit 2.6 per cent by the middle of the year to reflect rising energy costs.
“Consensus is [also] looking for interest rates to remain on hold for more than a year.”
As such, gold could rise to $2,130 per ounce – a fresh high for the yellow metal and surpassing the $2,075 per ounce level reached in August 2020.
Continued economic uncertainty
Under the ‘continued economic uncertainty’ scenario there could be further monetary intervention, weakening the US dollar and strengthening investor sentiment towards gold.
“The consensus view appears to be pricing in a straight-line recovery with very few bumps along the road,” said Shah. “However, on the ground in the UK we are witnessing a substantial bump in the road which is echoed throughout Europe as stricter social distancing rules and lockdowns in various forms have been put in place due to a more infectious mutation of the virus spreading.
“The consensus surveys were largely taken before this came to light.”
While many will receive a vaccine in 2021, the operational challenge to get an entire population inoculated cannot be underestimated, he noted.
“With this in mind, we doubt that central banks will be in any hurry to communicate a path towards tightening rates or broader policy any time soon,” said Shah.
“One potential avenue is for the Fed to undertake yield curve control. That is likely to constrain Treasury yields – relative to what consensus is expecting.”
In this scenario, inflation could peak at around 2.8 per cent, as the Fed actions generate greater economic demand while supply remains constrained.
He added: “The looser monetary policy could also weaken the US dollar further than in the consensus case.”
The WisdomTree director said gold could rise to $2,340 per ounce if this were to happen, close to a 24 per cent upside from December 2020 levels.
Hawkish Fed
Finally, in a ‘hawkish Fed’ scenario, economic conditions improve and the central bank begins to raise rates.
In this scenario, inflation remains below 2 per cent and rates increase to 1.8 per cent. This could see the US dollar also appreciate more aggressively.
Should this happen, gold could fall to $1,595 falling to levels last seen in April 2020.
Source: WisdomTree
Shah concluded: “We generally believe that economic uncertainty will persist during this unusual pandemic crisis that hasn’t been fully resolved yet.
“We can’t rule out a scenario where the economy improves considerably. However, we are sceptical that the Fed would behave in a very hawkish fashion and, therefore, put a low probability to the hawkish Fed scenario.”