Search ForexCrunch
  • Spot gold prices have traded as flat as a pancake on Tuesday around the $1880 mark as traders take a pre-year end breather.
  • Real yields are likely to again be a crucial determinant of gold price action in 2021.

Spot gold has traded within tight parameters around the $1880 level over the past 24 hours or so. At present, the precious metal trades higher by about 0.3%, but in truth is hardly moved from levels this time on Monday. Volumes have dropped right off, and the precious metal has struggled to advance back towards recent highs around the $1900 level, despite weakness seen in the US dollar, to which XAU/USD has a negative correlation, and downside in equity markets, to which XAU/USD also typically has a negative correlation.

It seems as though month, quarter and year-end portfolio rebalancing flows are distorting the price action, and this may continue to be the case for the rest of the week. Indeed, USD and stocks aren’t typically seen trading lower together (given their usual negative relationship), implying that there is no clear risk bias in the market right now; instead, equity traders might be feeling inclined to take some profit before the year-end, while those betting on a weaker dollar in 2021 might be attempting something of a front-run of such a move.

How real yields might impact gold in 2021

The main driver of gold in 2020 was a steep decline in real yields, particularly in the US. The yield on US 10-year TIPS dropped from around 0.15% to lows in August and September under -1.1%. The sizeable decline in the return investors got from the US bond market thus drove them into other asset classes such as equities and precious metals. Indeed, spot gold rallied from just above $1500 to highs around $2080 by August.

From August to November, 10-year TIPS yields rose back towards -0.7%, hurting precious metals, with their woes further compounded by strong risk appetite and vaccine optimism. Spot gold dropped to lows under $1800 in late November. However, since early December, rising inflation expectations (which is in itself a precious metal positive, given they are seen as a hedge against inflation) has driven real yields lower and the 10-year TIPS is back under -1.0%. Spot gold has thus recovered back towards $1900. Meanwhile, USD is limping into the end of the year, with a weaker USD another big positive for gold in 2020.

What happens in 2021 will largely be a function of what happens with US real interest rates, as well as (to a lesser extent) the US dollar. Many investors expect nominal US yields to rise in 2021, but if this is being driven by higher inflation expectations, then real yields will remain in place close to recent lows.

Of course, the Fed is keen to maintain its ultra-accommodative monetary policy stance into the foreseeable future. Therefore, one key question in 2021 will be to what degree does the Fed allow real interest rates to rise; as the US and global economies recover in 2021 (as is expected to be the case), investors might start to demand a higher real yield if they are to lend to the government, given a preference to invest money in higher yielding assets (such as equities) elsewhere. Does the Fed allow some tightening in monetary conditions? This would be negative for gold and a probable dollar positive.

Or does it act to keep real yields close to lows? (Perhaps by signalling that QE is to continue for longer or at a higher monthly pace). If they do the latter, this is likely to keep real interest rates low and, given the comparatively higher levels of monetary stimulus present in the economy, is likely to further increase inflation expectations, a bullish cocktail for gold.

What if the Democrats win the Senate?

Another key factor to how 2021 will go down for gold will be decided by the end of next week; do the Democrats win a majority in the Senate in the Georgia run-off elections (they need to win both seats that are up for grabs to do so)? If yes (which looks likely given both Democrat candidates lead in the polls), then expect significant further fiscal stimulus, perhaps to the tune of a further $3T in spending. A Democrat victory will likely be good for risk appetite given expectations all this stimulus will boost the economy and probably be a USD negative, which could be a short-term precious metal positive.

But they the key question for gold returns to the Fed; do they allow all this tsunami of additional US government borrowing to drive up US nominal and real yields, thus tightening monetary conditions (probably gold negative), or do they stick to their pledge to keep conditions accommodative and perhaps tweak their asset purchase programme with the aim of keeping a lid on real interest rates (probably a gold positive)?

What if inflation surprises?

All this stimulus, which has come in quantities that dwarf that seen in the aftermath of the global financial crisis at the end of 2000s, has got many an analyst betting on the return of inflation in 2021. Indeed, US 10-year breakeven inflation expectations are at their highest levels since Q1 2019 in the 1.90s%. With mass vaccinations and stimulus in the first half of the year, followed by (hopefully) herd immunity and a roaring global economic recovery later in the year, it is not hard to imagine US 10-year breakeven inflation expectations surpassing Q2 2018 highs around 2.2%. One thing is for sure; higher inflation expectations ought to pump the precious metals market, which is seen as the ultimate inflation hedge.