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Seeking Alpha: Gold Rush on Its Way as Hyperinflation Risks Rise

May 12, 2021
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Article by Stuart Allsopp in Seeking Alpha

The case for having a portion of one's assets in gold has never been stronger as U.S. policymakers seem intent on undermining the purchasing power of the dollar like never before. The metal is currently trading more than 10% below its short-term fair value based on current real interest rates which are likely to head even further into negative territory as the U.S.' perilous fiscal state necessitates increased Fed money printing. There is also a growing, albeit small, threat of hyperinflation as the Biden administration adopts increasingly radical policies. While a complete loss of faith in the U.S. dollar as a store of value is still only a minor risk, it is a growing one, which could be enough to cause the demand for gold to surge given the asymmetric returns that would result.

Real Bond Yields Suggests At Least 10% Gains Over Next 12 Months

For those new to gold price analysis, the most important thing to keep in mind is that the metal is primarily driven by the spread of interest rates over inflation, or more accurately, interest rate expectations relative to inflation expectations. 

As a result, inflation-linked bond prices are at new all-time highs. Despite this, gold continues to trade 13% down from its peak. Given the tight correlation between the two markets, the current deviation is noteworthy. There has been a clear tendency for gold prices to perform well following similar periods of undervaluation in the past and we see no reason to expect things to be different this time around. 10% upside is likely to be a worst-case scenario over the next 12 months if history is any guide.

The Growing Threat Of Hyperinflation

As I have argued on a number of occasions in recent years, I fully expect real (inflation-adjusted) interest rates to head even deeper into negative territory as the Fed is forced to keep rates low even as surging government spending leads to higher inflation. As government debt continues to rise relative to its ability to repay it, real interest rates will have to be deeply negative in order to prevent debt servicing costs from rising exponentially.

The problem with this policy mix, however, is that as the wedge between government debt and tax revenues rises, the Fed will be forced to create increasing amounts of base money in order to prevent bond yields rising in response to rising inflation. It should be easy to see how a Catch-22 situation may develop whereby the Fed's efforts to prevent bond yields rising amid increasing inflation causes inflation to rise further and so on.

Gold offers strong potential for gains over the coming months and years even in the absence of a continued rise in inflation given how undervalued the metal has become relative to real interest rates and the commodity complex. It also offers asymmetric upside potential in the event that .....

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