Precious metals remain one of the most interesting areas of the market. To be clear, in the near-term, there are much better opportunities - whether it's in the growth stocks that are breaking out to new highs or the "reopening" trade as investors price in a world that will see pent-up demand for various experiences and services with the vaccine's distribution.
However, precious metals should remain on investors' radar screens. And, if prices fall further, it could be a fantastic entry point. Before making the case for being bullish on precious metals in the intermediate-term, it's necessary to review the major driver of the asset class.
Real Interest Rates
When real interest rates move higher, precious metals move lower. After all, there's no dividend or return for gold and silver. So, if the risk-free return on money goes from 1% to 3%, gold is less desirable. However, the demand for gold will increase if real interest rates go from 2% to -2%.
Currently, real interest rates are at -0.9%. The Federal Reserve has signalled that it won't "even think about" hiking until 2022 and even then, it won't until inflation hits its 2% target "symmetrically". This is a new framework for Fed policy in which it will attempt to let the economy run hot for a period of time to balance out the period when the economy ran below capacity.
Reasons to Expect Lower Real Interest Rates
Therefore, interest rates are going to remain at zero. However, there's increasing signs of inflationary pressure building. Due to the coronavirus, we have a combination of pent-up demand and potential shortages and supply-chain disruptions. This is certainly going to be inflationary in the near-term.
So, it's likely that real interest rates will trend lower, barring some unexpected reversal in Fed policy. Rates will remain at zero, while inflation will keep moving higher. Normally, the Fed would tighten or signal it is going to tighten under these circumstances. However, in the near-term that isn't the case.
Outlook
In many ways, there is a clear analogue between the current situation and precious metals from 2008 to the top in 2011. During this period, gold
That period saw the economy coming out of a recession which led to massive pent-up demand which caused inflationary pressures to rise. Despite this, the Fed kept rates at zero and QE going which led to major gains in precious metals. The bull market in precious metals ended when inflation never materialized, and the Fed began to adjust its policy.
This time, there's a much higher chance of inflation, since the economy has less excess capacity than last time in terms of housing, labor, and manufacturing.
