The document discusses whether interest rate increases in 2021 could cause gold prices to plunge. It notes that real interest rates have a strong negative correlation with gold prices. While real rates could normalize somewhat as the economy recovers, there is also potential for inflation to rise due to money supply growth and pent-up demand, which could keep real rates low and support gold prices. The document concludes that several factors, including inflation expectations, money supply growth, and a dovish Fed, make higher inflation and continued gold price support more likely in 2021 than a 2013-style plunge.

1. Interest Rate Increase
Cause Gold To Plunge In
2021

2. Points To Be Covered Today:
• Will Interest Rate Increase Cause Gold to Plunge in 2021?
• Gold Prices & Real Interest Rates
• Gold Prices & U.S. Dollar
• Will Inflation Make Gold Shine in 2021?
• US Money Supply & Bank Credit Growth
• Good News For GOld

3. Will Interest Rate Increase Cause Gold To
Plunge In 2021
• The decline in the real interest rates is the most important
downside risk for gold. Will it materialize, plunging the price of
the yellow metal?
• The rise in inflation is the most significant upside risk for gold
this year, but there are also a few important downside risks.
• The most disturbing for us is the possibility that the real interest
rates will increase.
• Why?

4. Gold Prices & Real Interest Rates

5. Strong Negative Correlation Between
The Real Yields And Gold Prices
• When the interest rates go up, the yellow metal falls, and when
the rates go down, gold rallies.
• Indeed, the real interest rates peaked in November 2018 at
1.17 percent, just one month before the last hike in the Fed’s
last tightening cycle.
• Since then, they were falling, reaching their historical bottom
below -1.0 percent in the summer of 2020. Not coincidentally,
gold was experiencing a bull market during this period, reaching
its record high of almost $2010, just when the rates bottomed.
• And, as the rates normalized somewhat, the price of gold
corrected to the level below $1,900.

6. Further Room For Real Interest Rates To
Go Down
• The obvious question is whether there is further room for real interest rates to go
down.
• In 2019, they were falling amid
• the economic slowdown and the dovish Fed cutting the interest rates. Last year, they
plunged even further (with a short spike because of the surge in the risk premium), as a
result of the COVID-19 related economic crisis and the U.S. central bank slashing
the federal funds rate to practically zero.
• However, the Great Lockdown and resulting deep downturn are behind us. When we face
the second wave of the pandemic and people become vaccinated, there will be an
economic recovery.
• As well, the Fed has already brought the interest rates to zero – meaning that without the
U.S. central bank implementing NIRP, the nominal policy rates reached their lower bound.
• So, assuming that the Fed will not cut interest rates further and that investors will not
expect a further slowing down of the economy, the room for further declines in the real
interest rate is limited.

7. Further Room For Real Interest Rates To
Go Down - I
• The only hope lies in the increase in inflation expectations, which is
actually quite probable, as I explained in the previous part of this
edition of the Gold Market Overview.
• Given the surge in the broad money supply, the pent-up demand,
and some structural shifts, reflation in 2021 is more likely than it was
in the aftermath of the great financial crisis.
• However, gold investors should also be prepared for a negative
scenario of low inflation.
• After all, the Fed has repeatedly undershot its annual inflation target.
• In this case, the real interest rates may stay roughly the same or
they could even rise.

8. Gold Prices & Real Interest Rates

9. Important Differences Between That
Period And Today
• First, as I’ve already emphasized, there is now a higher risk of an increase in
inflation. Second, in 2013, there was a taper tantrum, while today, the Fed
maintains an ultra-dovish stance and does not signal any interest rate hikes in the
foreseeable future.
• Although the U.S. central bank didn’t expand its quantitative easing in December,
showing that it feels comfortable with some increases in the bond yields, it’s not
going to accept substantial rises in the interest rates. The dovish Fed’s bias is
one of the main factors behind the downward trend in the real interest rates (even
if they normalize somewhat, they reach further lower peaks and bottoms over
time).
• Third, the U.S. dollar looks different. As the chart below shows,
the greenback started to appreciate in 2011, pushing gold prices down.
• But today it is more likely that the U.S. dollar will weaken further due to a
changing administration in the White House, the economic stabilization and cash
outflows into developing countries, soaring public debts, a zero-interest rate
policy, and the risk of an increase in inflation.

10. Gold Prices & U.S. Dollar

11. Normalization Of The Real Interest
Rates
• If so, the normalization of the real interest rates (if it
happens, which is far from being certain) doesn’t
have to plunge the yellow metal.
• In other words, there are important downside risks to
the bullish case for gold this year, but 2021 does not
have to look like 2013 in the gold market.

12. Will Inflation Make Gold Shine in 2021?
• Inflation will be one of the greatest upside risks for gold this year. Will it materialize and
make gold shine?
• The report about gold in 2021 would be incomplete without the outlook for inflation. We
have already written about it recently, but this topic is worth further examination. After all,
higher inflation is believed to be one of the biggest tail risks in the coming months or
years, and one of the greatest upside risks for gold this year.
• Most economists and investors still believe that inflation is dead. After all, the only way to
justify the central banks’ unprecedentedly dovish actions is the premise of low inflation.
• And the only way to justify the buoyant stock market amid the new highs in the number of
Americans in hospital with COVID-19 is the expectation of an inflations economic
recovery this year. In other words, many people forecast the return to the Goldilocks
economy after the end of the pandemic.
• On the surface, it seems that they might be right. We haven’t seen double-digit inflation
since the end of 1981.
• And last time the CPI annual rate was above 3 percent was in January 2012. Actually, in
the last ten years, inflation was below the Fed’s 2-percent target most of the time

13. CPI & Core CPI Inflation Rates

14. CPI & Core CPI Inflation Rates - I
• Moreover, the inflation rates dropped significantly during the
U.S. epidemic and the Great Lockdown when people distanced socially
and limited their spending. So, given the strength of the negative demand
shock and the following plunge in inflation, why should we worry about the
risk of higher inflation?
• Well, shouldn’t it be obvious after experiencing a pandemic, i.e., an
improbable but impactful event?
• Even a small probability of a surge in inflation should be worrying,
especially given the pile of debt and, thus, limited room for central banks to
hike interest rates to prevent inflation.
• Moreover, the likelihood of an increase in inflation is not so small. As
I’ve explained several times, the case for higher inflation is stronger today
than in the aftermath of the Great Recession.
• The first reason is that the broad money supply has surged.

15. US Money Supply & Bank Credit Growth

16. US Money Supply & Bank Credit Growth - I
• Second, in contrast to the previous economic crisis where people did not
spend money because they had no income or they decided to repay their
debts, this time, people didn’t spend money because they were stuck at
home.
• But when the health crisis is over and people get vaccinated, some
consumers may go on a spending spree. The realization of pent-up
demand may overwhelm the firms’ capacity, leading to an increase in
prices.
• There are already some signs of bottlenecks, or supply falling behind
demand, such as the increase in prices of some commodities like iron ore.
• In other words, when the world returns to normality, the private sector will
find itself flush with cash.
• And I bet that some households will try to make up for all the time not
spent in movie theatres, restaurants and hotels during the last year.

17. US Money Supply & Bank Credit Growth - II
• Third, there might also be some structural shifts in the global economy, which will reverse
the current disinflationary forces.
• As Charles Goodhart and Manoj Pradhan argue in their book The Great Demographic Reversal1,
the era of low inflation, caused by globalization, is now ending. You see, in the 1980s and 1990s,
China, India and post-communist countries from Europe and Central Asia, entered the global
economy. As a consequence, the global labor supply for production of tradeable goods rose
enormously, leading to weak inflationary pressure. But all this is going into reverse. Globalization is
now weakening and there are no big countries in the queue to enter the global economy. Actually,
ageing in China and other countries reduces the global labor supply, thus strengthening inflationary
pressure.
• Last but not least, the politicians and central bankers have become more complacent. The
thoughtless and irresponsible stance of politicians is unsurprising, especially given the temptation to
inflate away the public debt. However, the central banks also stopped worrying and embraced the
inflation bomb. For example, the Fed has changed its monetary regime in 2020, announcing that it
would tolerate overshooting of inflation above its target for a undetermined period of time.
• The bottom line is that inflation should return in the coming months (more precisely, in the
second half of the year, when the distribution of vaccines will be widespread). We shouldn’t
experience double-digit rates, but the markets don’t expect a deflationary crisis either.

18. 5 & 10 Year Inflation Expectation

19. Good News For Price Of Gold
• All this is good news for price of gold. The case
for reflation in the global economy is definitely stronger than
after the global financial crisis of 2007-2009.
• The present risk of higher inflation should support the demand
for gold as a hedge against inflation.
• And the increase in inflation expectations lowers the real
interest rates, thereby positively affecting the yellow metal.
• Although gold will face some important headwinds this year,
inflation expectations are likely to outpace the increase in
nominal bond yields, which would put downward pressure on
the real interest rates and support gold prices.

20. Interest Rate Increase
Cause Gold To Plunge In
2021

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Interest Rate Increase Cause Gold To Plunge In 2021