The fate of gold in 2021 will be determined primarily by inflation and the Fed’s reaction to it.

In the epic struggle between chaos and order, chaos has an easier task, because there’s usually only one proper method of getting a job done – the job you can mess up in multiple ways. So, although economists see a strong economic expansion with cooling prices and a normalization of monetary policies in 2022, many things could go wrong. The Omicron strain of coronavirus or its new variants could become more contagious and deadly, pushing the world back into the Great Lockdown. The real estate crisis in China could lead the country into recession, with serious economic consequences for the global economy. Oh, by the way, we could see an escalation between China and Taiwan, or between China and the United States, especially after the former country’s recent hypersonic missile test.

That said, I think the main forces that will affect the gold market in 2022 will be – like last year – inflation and the Fed’s response to it. Looking at things in isolation, high inflation should support gold prices. The problem here is that gold prefers high and rising inflation. Although the inflation rate is expected to continue its upward trend for some time, it is expected to peak this year.

Indeed, based on very simple monetarist reasoning, I expect the peak to be somewhere in the first quarter of 2022. Indeed, the lag between the acceleration in money supply growth (March 2020) and CPI growth (March 2021) was one year. The peak in the former was in February 2021, as seen in the chart below. You can do the math (this is the exercise that proved too difficult for Jerome Powell and his “smart” colleagues at the Fed).

This is – as I said – a very simple reflection that assumes the stability of the lag between monetary impulses and price reactions. However, given the Fed’s passive reaction to inflation and the fact that the pace of money supply growth did not return to pre-pandemic levels, but remained twice as high, the peak of inflation could come later.

In other words, more persistent inflation is the major risk to the economy which many economists still play down. The consensus expects inflation to return to a level close to the Fed’s target by the end of the year. For 2021, the predictions were similar. Instead, inflation rose to around 7%. So, never underestimate the power of the dragon of inflation, especially if the beast is unchecked! As everyone knows, dragons love gold – and this feeling is mutual.

Saxo Bank, in its annual “Outrageous Predictions,” sees the potential for U.S. consumer prices to rise 15% in 2022, as “companies raise wages in an effort to find willing workers and skilled, triggering a wage-price spiral unparalleled since the 1970s. In fact, given the fact that millions of Americans have left the workforce — something the Fed doesn’t understand and still expects them to return — that prediction isn’t as extreme as it is. one might expect. I still hope that the inflationary pressure will ease this year, but I fear that the drop may not be substantial.

On the other hand, we have the Fed with its hawkish rhetoric and its gradual reduction in quantitative easing. The US central bank is expected to begin a tightening cycle, raising the fed funds rate at least twice this year. Doesn’t sound good for gold, does it? A hawkish Fed implies a stronger greenback and rising real interest rates, which is negative for the yellow metal. As shown in the graph below, the normalization of monetary policy after the Great Recession, with the famous “taper tantrum”, was very supportive of the US dollar but deadly for gold.

Graphic

However, the price of gold hit a low in December 2015, exactly when the Fed raised interest rates for the first time after the global financial crisis. Markets are always forward-looking, so they often react more to expected events than to actual events. Another thing is that the Fed tightening cycle from 2015 to 2018 was dovish and the fed funds rate (and the Fed’s balance sheet) never returned to pre-crisis levels. The same goes for the current situation: despite all the hawkish reactions, the Fed is terribly behind the curve.

Finally, history teaches us that a tightening of the Fed is synonymous with problems for the markets. As a reminder, the last tightening cycle led to the yield curve inversion in 2019 and the repo crisis, which forced the US central bank to cut interest rates, before anyone had even heard of it. of covid-19. The Fed is therefore in a very difficult situation. Either it stays off the curve, which risks letting inflation slip, or it tightens its monetary policy decisively, just as Paul Volcker did in the 1980s, which risks a correction in commodity prices. already high assets and the next economic crisis. . These expectations have driven gold prices higher since December 2015, and they could also support the yellow metal today.


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