However, before prices move into a significantly higher range, a drift lower is a significant risk. Somewhat higher real interest rates amid reduced systemic risk, the Fed’s commitment to positive policy rates, transitory disinflation, a firm USD, ample availability of physical metal to deliver against Comex futures (which may soften the “gold shortage” narrative, albeit misplaced) and a firm appetite for equities are all reasons why the yellow metal may straddle the lower bound of the trading range before surging higher.

The resumption of a downward trend in real rates, which remain in negative territory, along with a low cost of carry and concerns surrounding fiat currency debasement as skyrocketing debt makes various forms of debt jubilee appealing in some circles, likely mean the gold price could test TD Securities’ target of $2,000+/oz in the latter part of 2021. A normalising global economy and the fraying of global supply chains in the aftermath of the coronavirus crisis likely mean that policy rates will continue to be set below the rate of inflation. This, along with monetisation pressures, as fiscal deficits surge in the US and across the world, should see investors choose the yellow metal as protection.

Gold has rallied along with risk assets, as volatility dropped from record levels, following the end to the dash-for-cash which included aggressive selling of the yellow metal during the worst of Covid-19 market instability. The reversal came after the Fed announced measures to provide unlimited liquidity to support public and private fixed income markets and as the market was convinced the US Treasury and other governments will introduce a stimulus package worth trillions of dollars designed to provide funds to stabilise household and business balance sheets that have been beaten down by the coronavirus outbreak.

After declining for some two weeks, which prompted many investors to question gold’s safe-haven bona fides, the metal started to see a resurgence, as the pressures to grow dollar positions eased. Once the funding stresses that drove prices lower alleviated further, as the Fed and other key central banks monetise Covid-19 related market dysfunctions and major governments spend trillions of borrowed money to fortify stressed households and corporates, such that liquidity problems don’t morph into a solvency crisis, investors pivoted their focus towards gold as a hedge again.

Normalising liquidity conditions, negative real rates, low cost of carry and concerns surrounding fiat currency debasement, not unlike which were present post-global financial crisis period, were all important in generating gold’s outstanding performance to make it the best performing major asset class.

However, after a very strong March and April, which saw spot prices surge some 20% off the Covid-19 induced lows, gold has had a few bad days in late April and early May, and has now stalled in a narrow trading range near $1,700/oz. The recent market disappointments in the policy narrative by the European Central Bank (ECB) and the German Federal Constitutional Court’s landmark decision that the ECB’s current quantitative easing bond purchasing program conflicts with German basic law was one of the major catalysts prompting a pullback of investor interest away from the yellow metal.

Figure 1 : Fed policy drives gold via real rates

Source: TD Securities, Bloomberg

Figure 2 : Expanding central bank balance sheets and gold so happy together

Source: Bloomberg, TD Securities

Extremely weak economic data in the US and around the world, which suggests the economy will operate significantly below potential for a prolonged period, and all the disinflationary pressures this represents, also prompted some investors to be less enthusiastic about gold in the near-term. Real rates, which are a very powerful gold driver, may move higher given the Fed’s steadfast commitment to keep policy rates at the zero bound but firmly above negative territory, at least for now.

Continued squaring of Comex positioning, which is driving strong flow of physical gold into North America, pressuring futures against physical gold, and generating liquidity stresses after the recent exchange for physical (EFP) blowout, along with the lack of physical demand in India, China and a move into risk assets such as equities as they post unexpectedly strong performance, have all reduced investor interest. The total gold exchange activity, which fell 56% m/m to 18 kilotonnes in April 2020, with Comex volumes dropping from 32 kilotonnes in March to just 13 kilotonnes in April, along with higher implied volatility is a case in point demonstrating less appetite from trader.

The upward creep in real interest rates, risk appetite and physical market dynamics will likely prevent another 20% jump, as we saw after the initial coronavirus driven collapse. Indeed, this along with a strong presence of commodity trading advisors (CTAs) and other algorithmic traders and limited risk capital (credit) availability for prop trading by institutional funds, suggest that gold is likely to remain range-bound with a strong risk of gravitating to the lower bound for the next quarter or so.

To demonstrate this point, even statements by Bank of England governor Andrew Bailey not ruling out negative rates and the recent drift of Fed Fund futures into negative territory were not enough to precipitate a lasting breakout to the upside.

After a period of stagnation during which prices may hover in the lower bound of the recent trading range near $1,700/oz, the yellow metal should see resurgence in investor interest and move back on a path towards $2,000+/oz. This level is very near the inflation-adjusted high reached in September 2009, which was the last time the market expected central banks to keep monetary accommodation in place as the economy started to follow a path to recovery.

Assuming the funding stresses moderate and there is an orderly post Covid-19 normalisation of the economy, without any major setback that would necessitate another series of shutdowns, disinflationary pressures should start to abate and with that the appetite for gold should recover. It is very likely that the post Covid-19 world will be very different than it was just a few months ago. It will be one where the economy is functioning at below potential, with high long-term unemployment and with governments who will want to solve these problems by spending trillions of dollars, which they do not have.

Conversely, central banks will provide virtually unlimited liquidity and will have the willingness to buy up a significant portion of public, private and corporate debt. In their quest to bring the economy to full employment, governments will continue to deficit spend, and central banks will very likely allow inflation to move above their current targets of 2%. There will also be a risk of de-facto monetisation, should deleveraging become a threat.

Policy rates are expected to remain at zero, even as inflation expectations move higher, and with that there will be a considerable number of investors who will try to protect their wealth against a stealth currency debasement. It is a well-established fact that over the very long-term, gold has outperformed fiat currencies.

This post Covid-19 world will very likely turnout to be structurally different, with globalisation being reversed. This implies that critical and strategic supply chains will be brought closer to home for security of supply, as well as for strategic and employment reasons. This likely means higher costs due to the loss of efficiency and the use of higher cost domestic labour in the developed world. This would be a negative supply shock of sorts, which the Fed and other western central banks would no doubt accommodate. As such, above target inflation would be possible even if the economy is functioning below potential – a form of stagflation.

Figure 3 : Economic weakness suppressing inflation, lifting real rates — keeping gold in the lower bound of the range for now

Source: BEA, TD Securities

Figure 4 : Liquidity takers exacerbate intraday momentum amid shallow markets

Source: Bloomberg, TDS Commodity Strategy

Figure 5 : Ample amounts of gold in registered inventories

Source: Bloomberg, TDS Commodity Strategy

Figure 6 : Open interest continues to wane amid low volume despite bullish narrative

Source: Bloomberg, TDS Commodity Strategy

Once the post Covid-19 economic trajectory is well defined and health issues are managed with some certainty, the economy should have a good base to start a sustained recovery, albeit a prolonged one given the massive dislocation and insolvencies faced by small business and individuals. Negative real interest rates will likely be the order of the day for a long time, which make gold relatively cheap and desirable to hold in absolute and relative terms.

And, since it is no one’s liability, which is quite opposite to the government paper that will be issued to support all the spending needed by the trillions to fund the various stability programs throughout the G7, gold has a clear path towards $2,000+/oz.

There is strong evidence that gold performs well when debt is skyrocketing. And, debt is at a record high, with a very high probability it will reach much higher levels. We can only hope it does not go out of control, forcing aggressive monetisation.

To avoid sudden deleveraging, rates must be kept low and liquidity high, including central bank purchases (or quasi-monetisation). Thus far and in the post great recession central bank interventions, inflation only manifested in financial assets, but it did not move into the sphere of real goods and services as was feared – likely due to the cyclical components but also due to structural components such as globalisation, demographics and technology.

With the coronavirus fiscal response in full swing, the global debt burden is set to rise dramatically in 2020; gross government debt issuance soared to a record high of over $2.1 trillion in April, more than double the 2017–19 average of $0.9 trillion.

As social distancing and sheltering-in-place became the norm across most mature economies, the current global recession will begin with $87 trillion more in global debt than at the onset of the 2008 financial crisis driven slowdown. Based on Institute of International Finance (IIF) data, using a simple top-down projection, if net government borrowing doubles from last year’s levels – and there is a 3% nominal global economic contraction (which could be significantly worse) – the world’s debt is set to surge from 322% ($255 trillion) of GDP to over 342% ($263 trillion) this year.

To stimulate employment, it is likely that the Fed and other key central banks will keep rates low for longer and will no doubt be very pragmatic in how they respond to an inflationary drift higher in order to avoid a deleveraging. Given the massive amount of global debt, markets will worry about monetisation and purchasing power debasement via the use of negative rates for a prolonged period. Considering it has been a challenge to hit inflation targets for so long, it’s almost a given that that central bankers will not worry if core inflation moves above the 2% target touted by most central banks in some form for a while.

The current price range near $1,700/oz or a sell-off in the near-term should be considered temporary, with the previously discussed bullish macro factors eventually set to take charge. Further, the fact that some 6 million oz of annualised mining gold production is shutdown due to Covid-19 measures and lingering logistical issues making physical shipments extremely hard, will likely serve as additional catalysts moving the price toward $1,900/oz before the yellow metal reaches escape velocity toward a $2,000+ handle next year.

Figure 7 : Gold targeting historic high longer-term

Source: TD Securities, Bloomberg

Figure 8 : A bullish outlook with no bulls in sight

Source: CFTC, Bloomberg, TDS Commodity Strategy

Figure 9 : Outsized net decline in GDP implies lots of slack and a very accommodative Fed policy for prolonged period

Source: BEA, CBO, TD Securities

Figure 10 : Covid-19 to see world’s debt surge to 342% in 2020

Source: TD Securities, IFI