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…Just as gold was used to create money in earlier eras, sovereign debt serves the same purpose today, and this constitutes a bullish outlook for the price of gold – as high as $3,000/ozt. over the next 18 months.
…The price of gold (XAU) and the U.S. dollar index (DXY) tend to have a negative correlation while the price of gold and the money supply (M2/GDP) have a positive one. This largely held true from 2000 to 2020 and reflects how U.S. dollars and gold have served as central banks’ official reserves and how in the Bretton Woods system, gold was denominated in U.S. dollars.
When U.S. monetary policy loosens and the return on risk-free dollar assets falls, the DXY tends to decline too while M2/GDP rises, causing the XAU to increase. The ongoing rally in gold prices is consistent with the rapid growth in the U.S. money supply following the resumption of quantitative easing (QE) in response to the COVID-19 shock…
Gold Prices (XAU) and the Dollar Index (DXY)
Gold Prices (XAU) and the US Money Stock (M2/GDP)
Where Do We Go from Here?
…The inverse relationship between gold and the dollar should hold firm in the long run. For example, real and potential liquidity crises (GFC) tend to cause gold prices to fall as banks and investors convert the metal into cash but then the central banks step in and flood the system with liquidity and prices recover…Whatever happens, the dollar will move based on the relative strength of European and US economy and policy frameworks. At times like these when monetary and fiscal policy have never been looser, gold may continue to climb to new heights.
Three Scenarios
What might this mean for the price of gold? To find out, we applied simple econometrics to estimate a quarterly “error-correction” model for the price of gold as a function of its main fundamentals: DXY and M2/GDP in the United States. [For mathematicians only: The long-term equation, which is estimated from the first quarter of 1981 to the first quarter of 2020 and constitutes 160 observations, is presented in the original article.]…
From this model, we constructed three scenarios for the price of gold through the final quarter of 2021 based on projections for the fundamentals. Although the model predicts the deflated price of gold, we can anticipate the implied nominal price via a projection for the CPI, which we anticipate will increase by 2% annually.
Three Scenarios for the Price of Gold
1. No Change in Fundamentals
This scenario assumes that M2/GDP and DXY remain at their last observed quarterly level. So the price of gold would rise slightly to ~$1,900 and stabilize there in 2021. This is likely a low-probability outcome if, as expected, QE-fueled monetary growth continues.
2. Continued Monetary Expansion
The money supply to GDP ratio has generally increased by approximately 1 percentage point per quarter through 2019 and early 2020. If this trend holds into 2021, leaving everything else unchanged, gold could reach $2,400 by the final quarter of 2021. This seems the much more likely scenario and may, in fact, be relatively conservative. If anything, money creation will only accelerate.
3. A Weaker Dollar
The DXY has strengthened somewhat since early 2019. More recently, as the ECB relaunched QE in response to the pandemic, the euro has weakened against the dollar but, depending on how the pandemic plays out, the DXY’s upward trend may reverse. By the fourth quarter of 2021, it could even approach its 2008 low. Our calculations, which assume continued QE, suggest that a price of $3,000 per ounce is possible.
Conclusion
All in all, this constitutes a bullish outlook for the price of gold. We see little in the way of downside risk and anticipate gold will fall within a bandwidth of $1,900 and $3,000 over the next 18 months…
Editor’s Note: The original article by Yvo Timmermans, CFA and Paul van den Noord has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy read. The authors’ views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.
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