Gold gained around 25% in 2020. However, after hitting an all-time high of US$ 2,075/oz in Aug 2020, it is now down around 17% and back to pre-Covid levels. We expect the precious metal to bounce back into the remainder of 2021.
Gold in the context of diversified portfolio
Gold as a separate asset class that deserves its allocation within a diversified portfolio. However, the yellow metal also has a unique investment case during current times.
We regard gold as an alternative global reserve currency but with a negative yield. It should likely act as hold of value against depreciating fiat currencies. Central Banks globally have injected unprecedented liquidity into the financial systems. We expect this to continue till end-2021(and probably longer). This will likely put downward pressure on US Dollar and test its efficacy as a reserve currency over the coming years.
Also, gold has historically acted as a hedge against uncertainty.
Reasons for Underperformance since Aug – Dec 2020
1. Supply demand mismatch
Demand: Improving physical demand not enough to offset falling investment demand
Demand for gold fell from 1,018 metric tonnes in 2Q20 to 784 metric tonnes in 4Q20. Several factors led to a reduction in demand
- Improving Physical demand : The physical demand for Gold has started to pick up in the key economies such as India & China but this improved physical demand was enough to offset the declining investment demand for gold.
- Reduced investment demand : due to vaccine announcements and Strong US economic recovery which resulted in strong risk on rally. As a result, there was a strong outflow from Gold ETFs in last few months of 2020.
Supply, on the other hand, has increased from 1,025 metric tonnes in 2Q20 to 1,269 and 1,185 metric tonnes in 3Q20 & 4Q20, respectively.
The stable supply and falling demand for gold resulted in significant demand- supply mismatch in last few months of 2020. Demand as a percentage of supply fell from 99% in 2Q2020 to 66% in 4Q2020.
Physical Demand has started to pick up but is still not enough to offset the fall in investment demand
Investment Demand has fallen significantly in last few months of 2020
2. Rising Real Yields
Gold is also seen as an alternative Global reserve currency but with a negative yield. It is also a hold of value against depreciating fiat currencies. However, with the US 10Y rates rising from a low of 0.84 in Dec to 1.65% currently, the real yields increased – this has led to another leg down.
Prospects for 2021
We think following factors may result in improved price performance for gold
- Physical demand to pickup due to economic recovery in key emerging market economies like India and China
- Investment demand picking up: We expect the investment demand to pick up from the current levels. Central banks were not a major participant in the gold market through 2020 but we expect the central bank demand to pick up in 2021.
- Inverse Relationship with Real Yields: Real Yield are increasing. This should have a negative impact on gold initially. However, we expect inflation to pickup in coming months which will result in real yield to fall and hence we can see strong performance from Gold in coming months.
Gold does not generate any cashflow and hence benefits whenever real yield goes down and vice versa
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