What upcoming economic factors could affect precious metals?
Precious metals price performance was somewhat disjointed during January. The outlook for the complex remains positive, however.
One of the primary factors that weighed on gold and the entire precious metals complex in January was the increase in bond yields during the month. The gains in 10-year bond yields can be attributed in part to future optimism about the economy and in part to the expectation of increased fiscal spending without an immediate increase in taxes to pay for such spending. The U.S. dollar also put in a fairly strong performance during the month. This was an additional factor that weighed on precious metals prices and suggests that optimism about U.S. economic growth (both relative to other major economies and compared to its own recent performance) was more likely the reason for stronger bond yields during January.
It should be noted that while nominal bond yields rose, real yields remained firmly in negative territory, offering little by way of an attractive or competitive investment alternative. Notwithstanding any short-term weakness in gold prices when nominal yields rise, gold prices are more meaningfully impacted by real yields, which when negative have a price supportive impact on gold prices. Historically it has taken much higher real and nominal interest rates before there is a coincidental if not causal decrease in investor interest in gold and thus gold prices. Historically it has taken 3% real rates, or 5% or more in nominal rates at 2% inflation before investors have pivoted away from gold en masse to re-invest in bonds. Market expectations of inflation have risen quite sharply over the past month, with 10-year breakeven rates in January reaching levels last seen in May 2018. While inflation should be expected to rise going forward, based on improving economic conditions, pent up demand, increased savings rates, and accommodative monetary policy, it is not expected to rise to problematic levels, with still large amounts of surplus labor, manufacturing capacity, retail capacity, and commercial real estate acting as headwinds. Inflation should be expected to rise little enough to keep real yields negative, which would be positive for gold and the entire precious metals complex.
While a lot of market optimism regarding economic growth is tied to the vaccine rollouts and hopes for large amounts of fiscal stimulus in the U.S. following a Democrats sweep, the markets may have run ahead of themselves. Vaccine rollouts were expected to be a logistical nightmare and they are living up to that expectation. This likely will delay economic recovery. But more importantly, some market participants are pricing assets as if a $1.9 trillion stimulus package announced by Biden is a foregone conclusion. A large stimulus package should be expected, but it may not be as large as announced and it may not be large enough to help turn the U.S. economy around. There may not be sufficient Democratic support for a large package, which could require them to rely on Republican support.
Equity markets, which have run up sharply, are most vulnerable to a smaller than expected stimulus package, which would further enhance gold’s role as a portfolio diversifier and provide downside support for prices.