On precious metals 2021 price forecast

The LBMA Webinar "2021 Price Forecast Review" took place on 1 April 2021. Moderator Frederic Panizzutti (MKS Switzerland) hosted Rhona O'Connell (Stone X), René Hochreiter (Sieberana Research) and Thorsten Polleit (Degussa) for a discussion of the key factors and drivers underpinning their precious metals price forecasts for 2021. 

In this context, we would like to add some remarks on the relationship between the price of gold and interest rates. In general, one would expect a negative relationship between the two. That is, if interest rates rise (fall), the price of gold should go down (go up). The reason being is that interest rates represent (one type of) opportunity costs: When you are holding gold, you forgo income you could possibly earn from holding coupon-bearing securities. In a world where people are not fooled by "money illusion", real (i.e. inflationadjusted) rather than nominal interest rates matter.

Because what people are interested in is real rather than nominal income. If the interest rate is, say, 10 per cent, and price inflation is 20 per cent, the real interest rate is a negative 10 per cent; if, however, the interest rate is, say, 2 per cent and price inflation is 0.5 per cent, the real interest rate is 1.5 per cent. 

If you own gold: Do short-term or long-term interest rates (in real terms) matter? Once you consider gold as a substitute for short-term bank deposits (as a monetary substitute), short-term rather than long-term rates should represent your relevant opportunity costs. What about the argument that gold is a "longterm play", and its relevant opportunity costs being represented by long-term yields (in real terms)?

Suppose today's ten-year nominal yield on government bonds is, say, 2 per cent. Current CPI inflation is, say, 1.5 per cent, so the bond's real yield is 0.5 per cent. Does that mean that you lock in a 0.5 real return per annum if you buy the bond today? The answer is no. Because such an assumption actually implies that you can re-invest all the coupon payments at a real rate of 0.5 per cent. But is that a reasonable assumption?

But is this a reasonable assumption? No, it is not. Because CPI inflation could rise in the years to come, which would reduce your real rate of return, and it could even turn it into a negative real return. Also in this context, one can have serious doubts that CPI is the "correct" measure for the decline in the purchasing power of money. This is, for instance, because CPI does not include asset prices and therefore ignores asset price inflation, which contributes to the erosion of the purchasing power of money.

What is more, the central bank may not set its short-term rate in the future as it is expected today. It may reduce the short-term interest rate, or it may not raise it to the level implied by today's nominal bond yields. This, in turn, would also result in an ex-post real interest rate that is perhaps (much, much) lower than what today's bond yield implies. In other words, you are well-advised to question current spot interest rates as an unbiased predictor of future long-term (real) interest rates.

The experience in recent years has demonstrated that bond markets have virtually always overestimated the level of the Fed's short-term interest rates: While markets expected short-term interest rates to rise, the Fed had actually cut them. That said, bond investors can be expected to have been widely disappointed as far as their ex-post real yields were concerned. Reality may even have delivered them negative real yields.

We argue that there are good reasons for precious metals investors to focus on short-term real interest rates as their relevant, their "true" opportunity cost factor. US real short-term yields, calculated on the basis of CPI, averaged minus 0.40 per cent in the period January 2000 to February 2021. >From August 2008 until today, the average was minus 1.2 per cent.

Given the grave problems in the international financial architecture and economic system, chances are that short-term interest rates in real terms will remain negative or fall even further into negative territory.

This, in turn, is a strong argument for holding physical gold and silver as part of your portfolio. At current prices, holding physical gold and silver is a great way to reduce your portfolio risks while contributing to a higher portfolio return.

Thorsten Polleit. Chief Economist at Degussa