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The big story in Q2 was the jump in CPI numbers as lockdown restrictions eased across many parts of the world. Our ITV report examines the performance of gold and other major asset classes during the second quarter and year-to-date, along with a review of the conditions that could impact precious metals in the second half of the year.

Gold in Q2: Price Rebound

After taking a hit in Q1 from spiking yields, gold responded to headlines of spiking inflation in Q2. Here’s how gold and other major asset classes performed in the second quarter.

Despite falling 7% in June—its worst monthly drop since November 2016—gold ended the quarter 4.3% higher. Silver outperformed gold, gaining 7.4%. Platinum underperformed, while palladium gained. Oil prices stole the spotlight, shared by commodities and real estate prices. It’s also noteworthy that the S&P 500 ended the quarter at a record high.

On the negative side, Bitcoin (BITCOMP) fell over 40% recently, once again highlighting its volatility.

Gold YTD: Just Below the Zero Line

Despite a 13% run mid-quarter, gold ended the first half of the year negative. Gold struggled last month when Fed officials indicated an increased likelihood of interest rate rises in 2023. Higher inflation could push the Fed to raise rates.

While the kneejerk reaction may be to sell gold if nominal rates rise, the real rate (10-year Treasury minus the CPI) has the most influence on the price. Negative real rates look to remain indefinitely, even if the Fed raises the nominal rate.

What Does 2H Bring?

As we begin the second half of the year, to state the obvious, this will be no ordinary summer. Much of the world is slowly exiting the pandemic, the easing of restrictions accompanied by an eagerness to travel. Meanwhile, reflation remains a dominant driver for many asset prices. This and more are some of the factors that could impact economies and markets. Here’s what we’re watching that will likely have the most effect on precious metals.

The “Transitory” Question

When inflation spiked, the Fed stated it would be transitory. Most investors and economists seemed to agree at the time. But now doubt has started to creep in.

• Fed Chair Powell acknowledged that a “lasting period of uncomfortably high inflation is a possibility.”
• St. Louis Fed president James Bullard said the “pickup in prices might persist.”
• The Bank of England stated, “It is possible that near-term upward pressure on prices could prove somewhat larger than expected.”
• Larry Summers said Biden's spending plan could overheat the economy and “set off inflationary pressures of a kind we have not seen in a generation.”
• Noriel Roubini wrote that “today’s extremely loose monetary and fiscal policies, when combined with a number of negative supply shocks, could result in 1970's-style stagflation (high inflation alongside a recession). In fact, the risk today is even bigger than it was then.”

It’s not just government officials and economists. According to a Harvard CAPS/Harris poll in late June, 85% of Americans are “concerned about inflation.” Perhaps for good reason.

General Mills (GIS) recently announced it is raising prices across nearly all its grocery categories, citing the “highest costs in a decade.” Campbell Soup (CPB) and J.M. Smucker made similar announcements, and the Costco (COST) CFO said on their recent quarterly call that “the feeling is that this [inflation] will continue for the most part of this calendar year.”

Meanwhile, the Producer Price Index (a measure of wholesale costs) rose 6.6% in May (latest data available), the fastest increase on record. Input costs also rose at the fastest pace since data collection began in 2007, weighed down by ongoing and severe supply-chain disruptions and labor shortages. Delivery times for suppliers also lengthened to the greatest extent on record in June.

And despite the selloff in lumber prices, most other commodity prices remain elevated. Oil is now above around $75 a barrel, a three-year high, pushing the average price of unleaded gas to $3.12 per gallon, a 43% increase over last year.

And now record temperatures and a nationwide drought are piling on to the woes. Climate scientists report that 9.8% of the U.S. is currently in an “exceptional drought,” the most severe designation, which includes widespread crop and pasture losses. Roughly 44% of the nation is experiencing some level of drought. This condition could push food prices higher.

While the transitory question may not be answered immediately, if elevated inflation rates persist, investors are bound to look for hedges -- gold and silver being obvious choices.

Fiscal Spending

The Democrat-controlled House approved a $715 billion surface transportation and water infrastructure bill, an early step in President Biden’s $1.2 trillion infrastructure deal, which also has reached tentative agreement with Republicans and is to be finalized by September. These funds would represent a direct injection into the economy, as opposed to QE efforts that tend to inflate asset prices.

In light of the multiple stimulus measures, the Congressional Budget Office projects the deficit will reach 13.4% of GDP this year. That would be the second-largest level since 1945, exceeded only by 2020 spending. This level of fiscal spending is likely to weigh on the U.S. dollar, which would support gold prices.

Stock Market

In light of high stock valuations, the Skew Index—a measure of the difference between the cost of derivatives that protect against large market declines and the right to benefit from such—reached record highs. Gold has historically acted as a buffer against stock market weakness.

Housing Prices

The boom in home valuations is largely global, reaching from the U.S. to the U.K. to China. Bloomberg Economics reports that global valuations are now rising at the fastest pace since 2006.

Many drivers, however, appear to remain in place: mortgages below 3%, a post-pandemic desire for more space, newly-remote workers relocating, and perhaps FOMO—the fear that one might need to buy now before it gets even more expensive. As with stocks, gold can hedge against reversals in real estate prices.

Higher Taxes

In addition to the prospect of higher tax rates in the U.S. to fund new spending plans, a group of 130 nations recently agreed to a global minimum tax on corporations, part of a “broader agreement to overhaul international tax rules.” Higher tax rates could depress company earnings, or add to inflationary pressures if costs are passed on to consumers.

Silver Outperformance

Part monetary metal like gold, but also an industrial metal whose uses will climb in the infrastructure spending plan, this dual role could push silver to advance more than gold. It’s noteworthy that silver rose more than gold in Q2, and is down less YTD.

The gold/silver ratio (gold price divided by silver price) ended Q2 at 68.5; despite the decline from its record high of 123 in March 2020, the ratio is still 24% above its long-term average of 55, showing it remains undervalued relative to gold. The ratio fell to 32 in 2011.

Black Swans

The environment remains ripe for an unforeseen event. Potential candidates include a spread of COVID-19 variants, fallout related to the Fed's reverse repo facility now near $1 trillion, or issues surrounding the deadline for reinstatement of the federal debt ceiling at the end of July. Another shock to the global economy or markets would underscore the importance of gold’s hedging abilities.

The Precious Metals Hedge

The circumstance of rising inflation, large fiscal stimulus plans, and elevated stock and real estate prices creates an ideal scenario for gold. The most likely scenario for the second half of 2021 is one where gold continues to offer a meaningful and necessary hedge, along with the distinct possibility of yet another set of record high prices.