Will Inflation Make Gold Shine in 2021?
The comments below are an edited and abridged synopsis of an article by Arkadiusz Sieroń
Inflation will be one of the greatest upside risks for gold this year. Will it materialize and make gold shine?
Many believe that inflation is dead. After all, the only way to justify the Fed’s dovish actions is believing in low inflation. And the only way to justify the buoyant stock market is the expectation of a return to the Goldilocks economy.
Could they be correct? We haven’t seen double-digit inflation since 1981, and the last time the CPI annual rate was above 3% was in January 2012. In the last ten years, inflation was below the Fed’s 2% target most of the time.
Moreover, the US Covid-19 pandemic has seen inflation fall. So, given the strength of the negative demand shock and the following plunge in inflation, why should we worry about higher inflation?
First, the broad money supply has surged because the banks haven’t been hit so far (in contrast to the financial crisis where banks suffered greatly), so they have been lending freely.
Second, people aren’t spending money. But when the health crisis is over, spending will soar. The realization of pent-up demand may overwhelm firms’ capacity, leading to an increase in prices.
Third, there may be structural shifts in the global economy, which will reverse the current disinflationary forces. The era of low inflation, caused by globalization, is now ending.
Last, politicians and central bankers have become more complacent. Politicians are tempted to inflate away the public debt. The Fed has embraced the inflation bomb. In 2020, it announced that it would tolerate overshooting of inflation above its target for an undetermined period of time.
All of this is good news for gold. The case for reflation in the global economy is stronger than after the financial crisis of 2007-2009. The risk of higher inflation should support the demand for gold as a hedge. And the increase in inflation expectations lowers real interest rates, thereby positively affecting the yellow metal. Although gold will face headwinds this year, inflation expectations are likely to outpace the increase in nominal bond yields, which will put downward pressure on real interest rates and support the gold price.