Half Year Gold Outlook

July 2021, half year Gold Outlook:
Interest rates will likely remain a key driver for gold in the short and medium term. Yet, the negative impact that higher rates could have, will likely be offset by the longer-lasting effects and unintended consequences of expansionary monetary and fiscal policies created to support the global economy. These may include inflation, currency debasement, and higher exposure to risk-on assets in portfolios. Combined with attractive entry levels, this could prompt strategic investors to add gold to their allocation strategies and support central bank demand during the second half. However, while consumers may also benefit from the economic recovery and recent price pullback, new COVID variants may limit the uptake in gold jewellery in key markets.

The first half of 2021 proved to be a good example of how gold’s diverse sources of demand and supply interact. The gold price dropped by 6.6% in H1, as gains during most of Q2 were thwarted by a significant pullback in late June. Gold’s price also underperformed in most key currencies except for the Japanese yen and the Turkish lira, as these weakened against the US dollar. Overall, gold’s performance was driven primarily by higher interest rates, especially during Q1 and then again in late June on the back of a more hawkish-than-expected statement by the US Federal Reserve. Gold was also influenced by upbeat investor sentiment as the global economy started to recover from the impact of COVID-19.

However, there were also supporting factors for gold.
Concerns of higher inflation offset part of the drag that interest rates brought. And the strong response from governments to aid economic recovery through monetary and fiscal policies has made some investors worried about currency risks and capital preservation. In addition, gold benefited from a recovery in consumer demand in Q1, although second waves and new lockdowns presented challenges in Q2.

Risk for gold to continue but there will be also opportunities through the following developments:
- an accelerated economic recovery
- a consumer-led economic boom
- an environment where rapid rate rises offset inflation in later years
- a more cautious economic recovery
- an environment where new COVID variants severely impact the global economic recovery.

These results suggest that there is still upside potential for gold’s implied hypothetical performance during the second half of the year based on the conditions under consideration However, this is unlikely to come without challenges.

Gold’s performance will probably be heavily influenced by the movement of interest rates and the success of vaccination campaigns.
For example, a further rise in interest rates could continue to create headwinds for gold. This is also consistent with gold’s historical behaviour in periods when monetary policy becomes tighter, often resulting in price pullbacks.

However, central banks will be cautious in terms of the speed at which they start to remove asset purchase programmes or increase interest rates. A hasty move could result in large market swings and potentially destabilise the economic recovery.

In addition, the ultra-low interest-rate environment that investors have experienced for a prolonged period is creating structural changes in asset allocation. Investors are adding more risk to their portfolios in search for returns which, in turn, has required them to revisit their risk management strategies. This will likely increase the need to hold assets such as gold for downside protection and diversification.

This not only applies to private individual and institutional investors. Central banks have steadily increased their allocation to gold so far in 2021 and they’ll likely continue.

Inflation could come in different flavours. Inflation has become a key concern for many investors. But while inflation has been on the rise, there are mixed views as to whether the increase in consumer prices will be temporary or more sustained. If price inflation becomes persistent, history shows that gold could perform well. For example, gold had an annual average return of 15% in years when the US Consumer Price Index (CPI) was higher than 3%. Gold may not only respond to higher CPI inflation. Gold is highly correlated to broader inflation metrics such as money supply which continues to rise and that could later result in inflation bubbles, currency debasement and potential market volatility around the world.

This may prompt global investors to consider gold as a means to protect against the erosion of capital. Following the significant price pullback in late June, the gold options market showed interesting dynamics. The so- called ‘put skew’ suggested that some of the selloff could have been softened by buyers. The price selloff also pushed gold’s relative strength index down significantly.
And while some investors could remain concerned about downside risks, these metrics signal that others could see it as an entry opportunity, whether as a tactical opportunity or as a means to build strategic positions.

Overall, the global economic recovery and the recent price pullback should continue to support gold consumer demand. In China, for example, government stimulus, sales promotions, and seasonal patterns suggest stronger gold consumption during H2. In contrast, however, surges in COVID-19 cases due to some of the new variants are significantly impacting key markets such as India.

The performance of gold responds to the interaction of the various sectors of demand and supply, which are, in turn, influenced by the interplay of four key drivers. In this context, we expect that the need for effective risk hedges will keep investment demand well supported, but gold’s performance will also be influenced by the direction of interest rates and the robustness of the economic recovery.