2021 has been a disappointing year for gold bugs with a year-to-date (YTD) loss of 4.2%. In contrast, the S&P 500 is up nearly 17%. Other commodities such as copper and oil have also been quite strong in 2021 with gains of 27% and 53%, respectively.
Gold’s underperformance is puzzling, especially as it’s hard to imagine a more bullish set of circumstances for the yellow metal. Over the last 2 years, we’ve had massive deficits due to the coronavirus leading to lower tax receipts and substantially higher spending. In total, 2020’s deficit was $3.1 trillion, and it’s estimated to be $3 trillion this year. Additionally, central banks all over the world slashed rates and purchased assets to ensure that the financial system remained solvent and liquid. On top of this, inflation has also been quite strong and has reached multi-year highs.
I believe that gold’s underperformance, during a period of strong fundamentals, is an ominous harbinger for its near-term outlook. On top of this, there are some bearish catalysts that could lead to more selling.
Here are three reasons to be bearish on gold for the remainder of 2021:
- Divergence with real interest rates
- The Federal Reserve is laying the seeds for tapering
- Bitcoin is now an alternative asset to protect against monetary debasement
Real Interest Rates
In the same way that earnings ultimately drive stock prices, gold prices are largely driven by real interest rates. This is clear from the chart above.
It also makes sense from a logical perspective. When real interest rates are rising, holding gold is less appealing as investors can earn a positive, risk-free return in short-term Treasuries. At the same time, when real rates are falling, gold demand increases as it provides a store of value, while the return on short-term Treasuries erodes due to inflation.
Currently, we have a divergence with real interest rates making a lower low, while gold makes a lower high. In late-2018, we saw a similar divergence, in the opposite direction, as gold made a higher low while real rates made a higher high.
This also marked an important inflection point for gold prices as it climbed from $1,200 to above $2,000 in the next 20 months.
The Federal Reserve is Laying the Seeds for Tapering
Another reason to be bearish on gold is that real interest rates are likely to move higher. One factor is that the Fed is clearly laying the seeds for tapering. Tapering is when the Fed slows down the pace in large-scale asset purchases.
At its last meeting, Fed Chairman Jerome Powell said that the economy has made progress towards its goals. He also didn’t seem to be significantly concerned about the rise in Covid cases due to the Delta variant in regards to the economy.
In turn, Fed funds futures markets responded to the decision as the odds of a 25 basis point hike by the September 2022 Fed meeting increased from 10% to 23%. Odds for a 25 basis point hike by the December 2022 meeting increased from 19% to 38%. Most expect that Fed tapering will begin about a year before the first rate hike.
Of course, the Fed’s current slow and gradual path of removing accommodation is also contingent on the recent rise in inflation being “transitory”. While there remains considerable disagreement on this matter, recent evidence indicates that the Fed’s judgement is correct as some of the components most responsible for the spike in inflation are starting to cool off. Notable examples include lumber prices, housing, and used cars.
This combination of falling inflation and tighter monetary policy would result in higher real interest rates which would lead to selling in gold.
I believe that bitcoin’s emergence is another reason to be bearish on gold. In fact, many investors are buying bitcoin as it’s considered a “store of value” given that its total supply is fixed.
It’s not a coincidence that this mirrors the argument that gold bulls have been making for decades. Both camps point to the Fed’s growing balance sheet, the long-term debasement of the dollar, and the expanding money supply as reasons for why people should invest in hard assets.
Given the strong performance of bitcoin over the past decade, especially relative to gold, it has more appeal to younger investors. Further, while gold has been an asset class that institutions have invested in for decades, bitcoin is in the early innings of being embraced by investors.
Due to these factors, I believe that bitcoin may be cannibalizing some portion of gold demand and could be one factor in its recent underperformance relative to its fundamentals.
Gold’s performance in 2021 should certainly raise red flags, especially since it’s hard to imagine a more favorable set of circumstances. I believe the demand could decline with real interest rates rising and the Fed gearing up to taper asset purchases. Finally, the strong performance and growing institutional interest in bitcoin is another factor that could dent gold’s appeal as a ‘store of value.’
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GLD shares were trading at $169.39 per share on Tuesday afternoon, down $0.22 (-0.13%). Year-to-date, GLD has declined -5.03%, versus a 18.56% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles. More...
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