Going into 2021, gold has plenty of support from major drivers such as government debt, real yields and a weaker U.S. dollar. Thus, even though this year’s gold price rally has hit the pause button, it appears that downside for the yellow metal is limited going into the new year.

HSBC Chief Precious Metals Analyst James Steel said in a report that monetary and fiscal policies are both bullish for gold, and they’re at unprecedented levels due to the economic and social disruptions caused by the pandemic. He added that it’s unusual for gold rallies to see both in such a large measure at the same time.

All the monetary and fiscal stimulus create high levels of debt and liquidity, which are both bullish for gold. Steel noted that low real and nominal interest rates, growing balance sheets at the world’s central banks, economic intervention by central banks and massive fiscal packages are all good for gold individually, but when occurring together, they are “decidedly bullish.”

Yields and Interest Rates Are Positive for Gold

Interest rates are expected to be low for years, which should provide support for gold prices. The progress on Covid-19 vaccines has been negative for gold prices, but it was already a likely scenario for next year. Thus, the fundamentals haven’t changed that much.

Bond yields are also expected to be low, and Steel notes that they may be supported by the difference between the potential growth rate of the economy and the current growth rate. HSBC estimates this output gap to be over 2% looking as far out as 2023. Since inflation will have to average more than 2% for a while to trigger tightening by the Federal Open Market Committee, interest rates should remain low for at least five years, according to Steel.

Government Debt on the Rise

One other big factor that should provide support for gold prices is the rising government and public debt. Steel believes government debt patters are “especially bullish” for the yellow metal and offers several reasons why debt supports the gold price.

These factors include limits on economic growth, negative impacts on the financials markets, and limited fiscal response to slowdowns. All of them stimulate safe-haven demand for gold in the long term, although safe-haven demand has temporarily downshifted due to news about the Covid-19 vaccines.

HSBC Chief Global Economist Janet Henry expects the federal debt-to-GDP ratio to rise over 50% this year. She expects it to increase to between 55% and 60% in the next two fiscal years. Dallas Federal Reserve President Robert Kaplan and Fed Chairman Jerome Powell have both expressed concern about the economy in the near term.

Fiscal Support Needed

However, Steel notes that limits on monetary policy place the burden on fiscal policy. Unfortunately, lawmakers have been unable to reach an agreement on a stimulus package, even as news headlines tease the markets with claims that Republicans and Democrats are moving closer to a deal.

Steel adds that high unemployment and monetary policy limits require more fiscal spending. He expects debt-to-GDP ratios around the globe to rise due to infrastructure spending by many nations. He looks for this ratio to rise to levels not seen since World War II.

Debt Overhang Is Still Building

Gold should benefit from the debt overhang that has been building in recent decades, especially now that this debt overhang is accelerating due to the pandemic response. The Congressional Budget Office in the U.S. expects the federal budget deficit to reach $3.3 trillion, triple last year’s deficit.

That doesn’t even include another round of stimulus to boost the economy during the pandemic. Whether or not Congress reaches a deal on stimulus, the federal deficit as a percent of GDP will be at the highest level since 1945. Over a decade, the deficit is expected to reach $13 trillion.

Federal debt held by the public is also on the rise. It’s projected to increase to 98% of GDP this year and 104% next year. That compares to 79% at the end of last year and 35% in 2007 before the previous recession started, according to the Congressional Budget Office.

High debt levels should support the gold price in the long term, especially since it isn’t just the U.S. with soaring debt. Many people think once the new year hits, the pandemic will recede, but that doesn’t seem to be the case. Debt is likely to keep rising, which will continue to provide support into next year. The only question now is just how long nations will have to keep adding to their debt to support their economies.

Dollar Also Supportive for Gold in the Near Term

The U.S. dollar has also exerted pressure on gold historically, and it has been pressured recently due to the debt and economic conditions. In most cases, the dollar trades inversely to gold prices, although Steel points out that the inverse relationship sometimes breaks down. It did earlier this year when the dollar was strong, and yet, gold prices reached new heights.

Since gold prices reversed course due to the vaccine news, more recent weakness in the dollar has provided support to the yellow metal. That suggests the inverse relationship is still holding right now. Steel believes that if the dollar weakens even more next year, like due to increased confidence of a global V-shaped recovery, gold could find support.

He adds that loose monetary policy will probably feed loose global financial conditions, which may mean investors won’t want to own dollars for safe-haven reasons. Steel also points out that the opportunity cost of lower-yielding currencies is diluted by the low rate outlook. That could also contribute to a softer dollar and might even counteract the negative implications of a vaccine on gold prices. In the medium term, the dollar’s impact on gold could depend on whether investors take on cyclical or structural movements.

Trade and Politics

Trade has also been supportive for gold this year, although it might not continue to be in 2021. According to Steel, history suggests that when trade flows are low or shrinking, gold prices usually rise, although usually with a lag. Trade tensions, especially between the U.S. and China, weighed on trade flows this year, but with a new president in the White House, this could change next year. Although trade tensions may be less of a positive for gold next year, geopolitical risks around the globe will likely continue.

The International Monetary Fund recently said geopolitical risks could grow next year, citing weakening ties among OPEC+ producers, which presents risks for the world’s oil supply. Further, social unrest increased around the globe last year and again this year, and the IMF warns that it could increase further next year, complicating reform efforts.

While gold prices may not stay near the record highs achieved this year, there is clearly support for the yellow metal heading into the new year. It’s unclear whether this year’s record highs can be achieved again in 2021, but the ingredients necessary for another run at the record are certainly intact.

On the date of publication, Michelle Jones did not have (either directly or indirectly) any positions in the securities mentioned in this article.  

Michelle Jones is editor-in-chief for ValueWalk.com and has been with the site since 2012. Previously, she was a television news producer for eight years. She produced the morning news programs for the NBC affiliates in Evansville, Indiana and Huntsville, Alabama and spent a short time at the CBS affiliate in Huntsville. She has experience as a writer and public relations expert for a wide variety of businesses. Email her at Mjones@valuewalk.com.