Recent weeks have brought encouraging news with respect to several successful COVID-19 vaccines that will hopefully herald a return to a more normal way of living... sooner rather than later.
The first of these announcements, by Pfizer on November 9, triggered a huge “risk-on” move in markets, with investors favouring more risky assets like equities, in the belief that something closer to business as usual is in sight. Given gold’s reputation as a safe haven some might be wondering how it will perform in an extended risk-on period.
Moving in sync
After all, it is currently up over 17 per cent on the year (in dollar terms, as at November 30). Yet, contrary to perception, gold can rally in a risk-on environment, and we saw this in 2019 when gold and the MSCI World Index of global equities rose in tandem, advancing 18 and 25 per cent, respectively.
Far more important for the direction of the gold price than risk sentiment is the path of real interest rates (nominal rates adjusted for inflation). Over meaningful periods of time, gold price has an inverse relationship with real interest rates, such that lower real interest rates make for a higher gold price. And higher real interest rates make for a lower gold price.
This is entirely logical given that gold, which does not yield any income, competes with other assets classes for invest or capital.
Stretch those forecasts
The economic damage that COVID-19 has reaped means the US Federal Reserve, which has cut rates to zero, will need to support the economy with zero interest rates for quite some time. By its own projections, the Fed will not be raising rates until 2023, and I would not be surprised if its first rate hike fails to materialise before 2025.
It is worth remembering that after the Fed cut rates to zero in 2008, in response to the Global Financial Crisis, it subsequently left them unchanged for seven years.
To me, it seems inevitable that the Bank of England will also maintain zero interest rate policy for years to come. The UK was the hardest hit by COVID-19 among major economies, and it seems quite likely that it will see a slower recovery than the US in the years ahead, just as it did after the Global Financial Crisis.
Fine with zero?
Investors certainly aren’t discounting the notion of the BoE cutting rates even further during this cycle. It is noteworthy that the bank recently wrote to a number of firms to request information about their operational readiness to implement a zero or negative bank rate.
So, nominal rates on both sides of the Atlantic are unlikely to move higher anytime soon, but what about the other side of the real interest rates equation? Inflation?
For the last decade or so, inflation in both countries has fluctuated within a narrow range and has been persistently low. There are no signs that this is about to change, but it is well understood that both the Fed and BoE are keen to see higher inflation on a sustained basis, having seen inflation in their respective countries below their targets for so long.
It follows that unless inflation moves significantly above their targets, or becomes problematic, both central banks will be reluctant to act to suppress it with higher interest rates. This tolerance for higher inflation was reflected in the Fed changing its target for inflation this summer from an upper bound of 2 per cent to an average of 2 per cent over time, which could allow for a lot of observations above 2 per cent.
Extend the glitter
All else being equal, higher inflation makes for lower real interest rates, which is conducive to a higher gold price.
It seems probable that real interest rates in both the US and the UK will move lower by virtue of lower nominal rates and/or higher inflation before they move higher - and so, risk-on or risk-off, I believe gold will continue to shine.
- Chris Mahoney is a Gold and Silver Fund Manager at Jupiter Asset Management.