In Q1 2020, asset markets were whipsawed. Demand destruction from the sudden stop in global activity as countries deal with the Covid-19 pandemic led to abrupt declines in cyclical asset prices from equities to credit to base metals and oil.
There appeared nowhere to take cover. Even gold was not initially immune to the selling pressure.
But that was for a very specific reason: the large equity drawdowns gave rise to a thirst for liquidity.
Steep declines in risk assets led to investors selling gold to generate funds to meet margin calls. That was testament to gold's role as a liquid asset.
Now that central banks have injected unprecedented amounts of liquidity into the system and opened up large swap lines, the selling pressure on gold appears to have assuaged and at the time of writing, gold price is rising and has surpassed levels last reached in December 2012.
Scenarios using WisdomTree's framework
Where will gold go for the rest of this year? As the length and amplitude of the Covid-19 shock on the global economy are simply unknown, it is particularly difficult to forecast any asset price movements.
However, using our model framework, we provide some example scenarios.
There are almost an infinite number of scenarios we can paint. In the last few weeks, Treasury yields have moved in a very wide range (from as low as 0.54% on 9 March 2020 to 1.19% on 18 March 2020). That whole range is lower than when we started the crisis.
Similarly, the US dollar basket has moved from a low of 95 on 9 March 2020 to 103 on 20 March 2020. Pinning down the right path for all the explanatory variables in the model is more difficult today than it has ever been, given the volatility in asset markets.
It is likely that we will see several parameters go to levels we have never seen before. But we make an attempt with two main scenarios: a v-shaped economic recovery and a u-shaped economic recovery.
Prior crises indicate we are more likely to head into a u-shaped economic recovery, but we have contrasted the two forecasts.
V-shaped economic recovery
In the V-shaped economic recovery forecast, we assume the effects of Covid-19 on the economy are largely transitory, i.e. when social distancing practices stop and global commerce starts again, activity resumes and the policy easing applied in the first two-quarters of the forecast horizon can be reversed in the latter two quarters.
There is less downward pressure on Treasury yields initially and in the second half of the forecast horizon, yields rise. Speculative positioning in gold futures progressively falls from an elevated starting point, as the market anxiety diminishes.
In this scenario, while gold rises sharply initially, it more than gives back all its gains by the end of the period.
U-shaped economic recovery
In the U-shaped economic recovery forecast, we assume the global economy struggles to recover from Covid-19. Facilities provided by central banks and fiscal authorities are heavily utilised and expanded.
We could thus see continued policy easing. Downward pressure on Treasury yields increases with policy easing.
Speculative positioning in gold futures rises to levels we have come close to but never reached in the past and remains elevated through the forecast horizon.
That reflects market anxiety about the state of the world and the future consequences of unprecedented policy action. In this scenario, gold rises above $2,000/oz - marking an all-time high - at the beginning of the forecast horizon and then continues to rise, ending Q1 2021 at $2,200/oz.
Beyond the one-year forecast
We believe the risk of a U-shaped economic recovery is higher than a v-shaped economic recovery. So even after Q1 2021, monetary and fiscal stimulus could be in play.
While we believe that the inflationary impact in the coming year will be muted, there is risk that at some point, so much freshly minted money, tax breaks and cheques offered to the public could become inflationary. That risk increases if it is hard to wean off the policy stimulus.
Gold prices may potentially see support for years to come if inflation rises in future years as a result of the stimulus we see today.
Nitesh Shah is director of research at WisdomTree