Hit the rewind button a year ago. Gold was trading at $1,850 an ounce and the iShares TSX Gold ETF was around $19.50. Now, how would you have answered if you were asked how gold and gold stocks would perform in a year that would see:

1. The pandemic is getting worse.
2. Core consumer prices in the United States and Canada are rising 5.5% and 2.9%, the fastest pace since the early 1990s, making inflation a hot topic.
3. Real yields remain pinned below zero.
4. Meanwhile, the expansion of the global money supply would continue to grow.

As humans, we love x → y, or simply, causality. It makes our life easier – simple rules to help the decision-making process. As if there were inflation, gold is good; everyone knows this one. Unfortunately, causality rarely has a single variable in the world and especially in the financial world. It was the long version of “it’s complicated”. Gold is not broken, and there are many other variables at work. So let’s review some of the big ones to help put 2021 into perspective and see if we can get a sense of the outlook for gold in 2022.

Gold Price Influencers

CPI: Gold has a good long-term track record as a real asset that retains its value during times of high inflation (currency losing purchasing power). This was cemented most recently in the 1970s when inflation really took off, and so did gold. It should be noted though that many years in the 1970s saw the CPI accelerating and gold falling. This may be a strong overall relationship, but other variables may become the driving force for periods. Maybe 2021 was one of those times.

Nonetheless, the highest CPI since the early 1990s has undoubtedly been a positive for gold in 2021. The big question is what will happen in 2022. The bottlenecks contributing to the CPI inflation should gradually subside. Covid supply disruptions, high demand and sudden changes in behavior should all subside. But so much stimulus has been pumped into the global economy that will continue to impact prices for many quarters to come. The headline CPI is expected to normalize in 2022, but this new normal will likely be higher than before the pandemic. And the longer it lasts, the more expectations about the future change. This is positive for gold.

Real returns: The advantage of discussing real returns is that it incorporates nominal returns and longer-term inflation expectations (not to be confused with headline CPI data). Taken in isolation, higher nominal yields are not good for gold. Bonds are a competing asset class, and more yield increases the opportunity cost of holding gold, which has no yield. As a result, rising nominal yields have been a headwind for gold over the past year.

Fortunately, longer-term inflation expectations (measured by break-even points) also rose, which kept real (nominal minus inflation) yields negative. It was good for gold, but only marginally. The variation in real returns matters more than the absolute level. Gold really likes it when real yields are falling versus when they’re flat.

Welcome real yields as a positive contributor for 2021 as they remained negative. For 2022, it becomes a bit more uncertain. We believe nominal yields will continue to rise in 2022, but do not believe they will accelerate significantly. Simultaneously, inflation expectations are likely to rise and we see prices for sticky items starting to rise, business intentions remaining high for further price increases and wages rising. Put it all together and actual returns will likely remain below zero. But we’ll give it a  for 2022. Part of that is due to the negative starting point, and we could see nominal yields potentially rising faster than longer-term inflation expectations.

US Dollar – This one is pretty straightforward: Gold is quoted in US dollars. Thus, if the US dollar rises, the quoted price of gold tends to fall.

In 2021, the US dollar appreciated against most currencies. If you only look at the Canadian dollar, you may have missed this, given the strength of the loonie over the same period. It held steady against the US dollar, but rose against many others.

The rising US Dollar has been a headwind for gold in 2021; it’s a  in our gold influencer board. As 2022 approaches, with central banks expected to pivot at different times and speeds, currency volatility will likely increase. More major currencies are undervalued against the US dollar than overvalued, with a number expected to raise rates sooner than the Fed. And while periods of dollar strength are expected in risk-free periods, the longer-term trend is likely to the downside. We will give the motto a .

Risk-on / Risk-off: Thus, gold behaved rather badly during a year when the North American indices rose by more than 25%. I’m sure a raging bull run is not when the gold shines. It’s a safe-haven asset, and in a year when investors were looking for outsized returns, gold is blunting. If your defensive assets have increased by 15-25% in the last year, better check your ratings, as these are probably not really defensive.

2022 has a lot of important moving parts for the market to digest. Changing the pace and, in some cases, the direction of monetary and fiscal stimulus will be important. Add to that the potential for leadership change that is currently being debated in the markets, and this year is likely to be a bumpier one. This could lead to periods of risk aversion and, given the advance in markets over the past twenty months, safe-haven assets could be opportune. So  this is for 2022.

Flow: As with any asset, net inflows tend to help the price and outflows to hurt. In this case, our proxy is the evolution of gold held by ETFs (chart). We might wonder if it is a price change that drives the net ETF flows (classic performance hunting), the flows causing the price change, or a combination of both. This link has grown stronger over the past decade.

After strong inflows in 2020, gold has seen gradual outflows in 2021. If you take a step back, that makes sense. Much of the entries in 2020 were driven by the extreme uncertainty of the pandemic; call it a safe place to park capital. As uncertainty diminished and markets rose, money was reallocated to where it came from. It sounds simple, but often things are.

Have digital assets stolen streams? (aka bitcoin and friends). Perhaps some who dislike the gradual (sometimes a little faster than gradual) decline in the purchasing power of fiat currencies have chosen to switch from gold to digital assets. But we’re pretty confident that their flows are due to risky behavior. Gold is a real safe haven asset. Digital assets might be one day, but they remain a high risk/reward asset for now.

Flows in 2022 could go either way. Digital assets may continue to attract some capital out of gold. On the bright side, more than half of the money that piled up in gold as the pandemic scare peaked has been withdrawn, and the pace of outflows has slowed to a trickle in recent months. We will rate our flow outlook as neutral for the coming year.

Price: Unfortunately, trying to price gold is difficult. An old economist friend used to say that gold was valued at 1/T, where T is the confidence in the system. We’ve also heard that an ounce of gold should always buy a nice man’s suit in Savile Row. Neither is exactly hard data for analysis. It also brings down the level of uncertainty. We could even simplify further, as gold rose 18% in 2019 and 25% in 2020. In other words, it started 2021 at a high price level with big gains to digest. We don’t know if gold is cheap or expensive heading into 2022, but we do know that after falling 4% over the year, it may have digested or consolidated after these big comebacks. of the previous calendar year.

Investment implications

Anyone who has invested in gold for more than a few years has probably been frustrated at one time or another. Gold has many moving parts, and sometimes one factor or influencer matters more than others, and those that matter most change over time. Maybe real yields will be the main driver this year, maybe the US dollar or maybe flows. What we do know is that more of these factors are better positioned to contribute positively to gold as we head into 2022.

And let’s not forget that owning gold is generally a safe-haven asset. What if we get a period of risk aversion, which could be driven by slowing growth, the outbreak of conflict in the Eurasian Plain, or some other reason? If bottlenecks in the supply chain persist, this could cause nominal yields to decline while inflation does not. The US dollar would rise, offsetting some of the positive impulses for gold, but the net impact would likely be quite good.

Gold is not broken. It performed as a safe-haven asset should, in a mostly risk-driven year. Given our outlook on the input factor allocation, we continue to believe that an allocation to gold is a prudent part of a portfolio.

Sources: Unless otherwise noted, charts are from Bloomberg LP, Purpose Investments Inc. and Richardson Wealth.

Twitter: @ConnectedWealth

Any opinions expressed herein are solely those of the authors and do not represent the views or opinions of any other person or entity..