Quantitative Easing

Gold’s appeal boosted by rate and inflation outlook

Summary

If inflation remains elevated for several years, the financial system will not return to normal for an extended period, creating an environment where gold and gold stocks could shine.

Monthly overview of the gold market and economy from Joe Foster, portfolio manager and strategist, and Imaru Casanova, assistant portfolio manager, presenting their unique insights into the benefits of the mining and gold portfolio. An expanded PDF version of this commentary, including fund-specific information, can be downloaded here.

Markets react to rate hike expectations

Gold continued to consolidate throughout the year in a range centered around $1,800 per ounce. US interest rates, the US dollar and the US Federal Reserve (the “Fed”) remain the dominant drivers for gold. Based on US interest rate futures prices on January 3, the market was pricing in the Fed’s first rate hike in May, with a 77 basis point (bp) tightening expected by the end of the month. end of the year. During the month, markets priced in an increasingly hawkish Fed following the release of minutes from the December Federal Open Market Committee (FOMC) meeting, Fed Chairman Powell’s confirmation hearing in Congress and the FOMC policy meeting in January. As a result, expectations are now for a US rate hike in March and hikes that would total at least 100 basis points of tightening this year. This drove interest rates and the US dollar higher, with 10-year US Treasuries hitting new two-year highs.

The gold price meter moves for a relatively short time

All of this is ostensibly negative for gold prices. However, the gold market hit its peak for the month at $1,853 on January 25 in choppy trading. Gold’s resilience did not last when, on January 26, President Powell’s comments following the FOMC meeting sent the US dollar index to near-term highs and gold fell, ending the month at $1,797.17 for a loss of $32.03 (1.8%) . Gold stocks mimicked gold’s uptrend, then fell to end the month with losses of 5.7% for the NYSE Arca Gold Miners Index (GDMNTR)1 and 8.6% for the MVIS Global Junior Miners Index (MVGDXJTR).2

Gold market tides could change

One of the defining features of the lackluster gold market over the past year has been exchange-traded product buybacks of gold bullion. The outflows indicate a lack of investment demand, especially from institutional investors. However, on January 21, SPDR Gold Shares (GLD), the world’s largest gold ETF, recorded its largest ever dollar inflow, worth $1.63 billion. In terms of tonnage, this was the largest inflow since September 21, 2020. The deceleration in outflows shown on the chart suggests that most of the selling pressure has passed, while the recent large inflow could mean as investment demand picks up.

Inflation finally attracting investors to gold?

Source: Bloomberg. Data as of February 2, 2022. This is not a recommendation to buy or sell any securities. Past performance does not represent future results.

More to Watch Beyond Gold Investment Demand

While investment demand for bullion ETFs has been lackluster, the World Gold Council’s (WGC) Gold Demand Trends Report for 2021 shows that all other sources of gold demand have increased.

  • Jewelry – Jewelry consumption grew 52% in 2020 to match the 2019 total. Indian demand nearly doubled in 2021 to a six-year high with a strong fourth quarter driven by pent-up demand during festival seasons. U.S. jewelry demand grew 26%, the strongest in 12 years. The WGC attributes this to a lack of competition for discretionary spending, given the current lull in travel and entertainment spending.
  • Bars and coins – Demand for bars and coins grew 31% annually to an eight-year high. This was driven by China, the United States and Germany. Demand for bars and coins in China rose 44% to a three-year high. The United States and Germany both set new records. The demand for bullion and coins contrasts sharply with the outflows of bullion ETFs. Each is carried by different types of investors. Demand for coins primarily represents retail investors, while demand for bars reflects high net worth investors. These investors are closer to “Main Street”, where inflation and pandemic-related risks are at the forefront. Bullion ETFs are dominated by institutional investors who are closer to “Wall Street”, where gold is weighed against a myriad of investment choices that have risen to prominence.
  • Industrial manufacturing – Gold used in technology rose 9% to a three-year high. Electronic applications include LEDs, circuit boards, dynamic random access memory (DRAM) chips, and wireless technology which includes automotive, satellites, 3D imaging sensors, and smartphones.
  • Central banksCentral bank demand rose 82%, lifting global reserves near a 30-year high. The biggest buyers in 2021 were Thailand, India, Hungary, Brazil, Uzbekistan and Singapore. The trend of increasing gold in foreign currency reserves is truly global.

The Fed Easing Party is over…

Soon, the quantitative easing (QE) will be over and the Fed will start raising rates. While Washington will still spend copious amounts of other people’s money, it looks like the multi-billion dollar stimulus packages are also over. Through QE, the Fed has crowded out the private sector, funding more than 50% of all government borrowing needs since 2010. The Fed also owns more than 30% of all mortgage-backed securities insured by the federal government. All of this stimulus has distorted the markets and the price signals they send to investors. For example, the yield curve flattened at a time when inflation expectations were rising, which is the opposite of what has happened in past inflationary cycles. The last time real rates were as deeply negative as 2021 was in 1974, a year when the S&P 500 Index (SPXTR)3 fell 37%. However, in 2021, the same stimulus-fueled index gained 29%.

Markets may need a shoulder to lean on

The achievement of an economy without stimulus caused many major stock market indexes to decline in January. New Year’s volatility looks like a precursor to a year of extraordinary uncertainty as the financial system attempts to return to normal. The transition, if successful, will take years of 25 basis point rate changes and the disposal of trillions of Treasuries and mortgage-backed securities. We doubt the system can return to normal without increased and possibly extreme market volatility and unintended consequences.

So far, gold has avoided market volatility. Its January performance was boring, trailing only around $1,800, as it has for over a year now. In such a market, perhaps boredom is good. However, we expect to see more gold in 2022. We expect it to outperform as Fed tightening risks materialize and other drivers of inflation continue to rise .

No shortage of supply shortages

The Wall Street Journal reports port congestion is spreading to the East Coast as the queue of ships waiting to enter Southern California ports hit a record high in January. Inventory of semiconductor chips from US companies fell further to less than five days. McDonald’s Corp. said he expects the rate of cost increases for food, paper and other materials in the United States to roughly double this year. Moreover, most foreign business investment is not used to increase production. The United Nations Conference on Trade and Development showed that the number of new capacity expansion projects falling in 2021 remains well below their 2019 level. Foreign investment is used to buy existing companies, rather than entirely new projects that expand manufacturing.

Pandemic History Lesson: Inflation

The last comparable pandemic in terms of lethality broke out more than a century ago and was accompanied by the First World War, but it is arguably the only pandemic we have for comparison. War spending can probably be roughly equivalent to spending fighting the coronavirus pandemic. Inflation soared to 18% in 1918, 14.6% in 1919 and 15.6% in 1920. Although we do not expect double digit inflation in this post-pandemic cycle, if inflation remains simply high for several years, the financial system will not be able to return to normal for an extended period. This could become an environment where gold and gold stocks can shine.

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Originally published by VanEck on February 9, 2022.

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