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Gold's 2021 drivers: Ballooning deficits, inflation and overvalued equities – WGC

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(Kitco News) Gold will remain an attractive investment in 2021 due to ballooning budget deficits, inflation risks, and market corrections, according to the World Gold Council (WGC).

The WGC's analysis suggested that gold's trading pattern might be "more subdued" this year but still remain very positive. More specifically, 2021 will see a mix of risk-on sentiment amid growing portfolio concerns.

"Investors will likely see the low interest rate environment as an opportunity to add risk assets in the hope that economic recovery is on the immediate horizon. That said, investors will likely also be navigating potential portfolio risks including: ballooning budget deficits, inflationary pressures, and market corrections amid already high equity valuations," the report said. In this context, we believe gold investment will remain well supported while gold consumption should benefit from the nascent economic recovery, especially in emerging markets."

Looking at high equity valuations, the WGC said that the S&P 500 price-to-sales ratio is at unprecedented levels.

"Going forward, we believe that the very low level of interest rates worldwide will likely keep stock prices and valuations high. As such, investors may experience strong market swings and significant pullbacks," the WGC said in its Gold Outlook 2021.

Some risks to watch out for in terms of equity performance this year include vaccinations taking longer-than-expected due to logistical complexities or increased number of COVID-19 strain mutations, the report added.

In terms of expanding budget deficits, the concern is inflationary pressures combined with low interest rates and a growing money supply.

"This concern is underscored by the fact that central banks, including the U.S. Federal Reserve and European Central Bank, have signaled greater tolerance for inflation to be temporarily above their traditional target bands," the WGC said.

Gold is a winner in an inflationary environment, the report pointed out. "Gold has historically performed well amid equity market pullbacks as well as high inflation. In years when inflation was higher than 3%, gold's price increased 15% on average … Further, gold has been more effective in keeping up with global money supply over the past decade than U.S. T-bills, thus better helping investors preserve capital," the report stated.

In 2020, gold was one of the best-performing assets, rising to a new record high of $2,067 and August and gaining 25% in 12 months.

In the new year, gold will remain very relevant as a hedge in light of the low-rate environment. On top of that, economic recovery in emerging markets will boost physical demand, which was weak in 2020.

"The economic recovery may particularly realize in countries like China, which suffered heavy losses in early 2020 before the spread of the pandemic was controlled more effectively than in many western countries. Given the positive link between economic growth and Chinese demand, we believe that gold consumption in the region may continue to improve," the WGC noted. "Similarly, the Indian gold market appears to be on a stronger footing. Initial data from the Dhanteras festival in November suggest that while jewelry demand was still below average, it had substantially recovered from the lows seen in Q2 of last year."

In other regions, however, consumer demand for gold is likely to remain subdued due to slower economic recovery and gold prices still trading at much higher levels than last year, the WGC highlighted.

Central bank demand will remain well below its record 2018 and 2019 levels, but it is not going away entirely.

"Central bank demand became more variable in the second half of 2020, oscillating between monthly net purchases and net sales. This was a marked change from the consistent buying seen for many years, driven in part by the decision of the Central Bank of Russia to halt its buying programme in April," the report described. "There are good reasons why central banks continue to favor gold as part of their foreign reserves, which, combined with the low interest rate environment, continue to make gold attractive."

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.