Gold Price Fundamentals - Still on the Yellow Brick Road

Unprecedented actions by central banks and governments to prop up economies amid a raging pandemic pushed gold to record highs last year. But by no means does that mean that the gold story has run its course. With the Fed pledging to stick to ultra-soft monetary policy, investors will be looking to move out of yielding assets and into gold. Meanwhile, massive fiscal spending carries inflationary risks, making gold, a traditional hedge against inflation, more appealing. Also, gold will not only maintain its traditional safe-haven properties but will continue to behave like a risk asset, especially when upbeat economic data pushes real yields even lower and boosts inflation expectations. With new US fiscal support likely forthcoming and the Fed set to stay dovish even as the global economy normalizes, the dollar will likely weaken, which will provide further support for gold.> Central banks, ultra-soft monetary policy and inflation. The return to low-to-negative yields after central banks slashed rates to prop up the global economy - thus mitigating gold's traditional disadvantage of being a non-interest-bearing asset - is the single most important factor that propelled bullion to an impressive 25% gain last year. Meanwhile, inflation expectations are running higher thanks to ramped-up QE programs, the Fed's pledge to keep rates near zero until at least 2023 and its decision to allow inflation to run over its previous and firm 2% target for some time. > Factoring in the dollar. Another key factor for gold is the dollar. A weak dollar makes holding gold more attractive for investors operating in other currencies. How the dollar performs will be largely dependent on the global economic recovery, the pace of which we believe will be quite solid. This suggests a resumption of dollar depreciation, especially against the euro, which we believe could appreciate to 1.28 this year once the European economy turns the corner with the virus.> Vaccine breakthrough was short-term negative but long term positive. The gold price dynamic in 4Q20 was dominated by upbeat vaccine news that caused bullion to surrender most of its Covid-19 safe-haven premium, falling to $1,765/oz. However, we argue that longer-term, progress on the vaccine front is positive for gold as a hedge against inflation, given that successful vaccination would boost consumer spending - and therefore inflation expectations - and push real yields lower.> Decoupling from the physical gold market. Investor demand for gold surged last year, but physical demand in Asia has recently been weak, which is providing headwinds for gold.