Last week, I discussed how the specter of inflation could make what has been a relatively fertile environment for gold and silver even more ideal. Since the end of 2018, when U.S.-China trade war concerns knocked financial markets for a loop and re-energized precious metals, gold and silver have risen 54% and 97%, respectively. During almost all of that time, meaningful inflation was nowhere to be found. However, the Labor Department announced last week the April Consumer Price Index (CPI) jumped 4.2% on a year-over-year basis. The news raises the distinct possibility that the historically metals-favorable factor of inflation could become a key component of an existing pro-gold/silver environment.
As it turns out, the good news might not be at an end yet for precious metals. Indeed, the Biden presidency may prove to be a sort of “gift that keeps on giving” to gold and silver.
In conjunction with an ambitious spending agenda expected to push the federal deficit to an all-time record this year, President Biden last month announced plans to seek a historic increase in the capital gains tax.1 Specifically, the president says he wants to see the top rate of the capital gains tax effectively double – from 20% to 39.6% – for households making more than 1 million dollars per year. Add that to that the 3.8% Medicare surtax on investment income for higher earners introduced as part of the Affordable Care Act, and the combined long-term capital gains tax rate for households earning more than one million dollars could reach a whopping 43.4%.
As you may know, capital gains tax is assessed on profits realized from the sale of capital assets such as stocks, bonds and real estate. That means the potential negative impact of such an increase on financial markets could be substantial. However, if markets do take a hit from a higher capital gains tax, there could be a silver lining for precious metals. In fact, experts suggest metals potentially could benefit two ways: 1) as market-uncorrelated assets with the capacity to thrive on the back of suffering equities, and 2) as assets seen by long-term savers as having more potential for appreciation in a climate that offers diminished prospects for interest-bearing assets as well as equities.
The proposed leap in the capital gains tax is unlike any we’ve seen previously. Some analysts suggest the impact of the higher tax would be minimal based on the historical record of markets largely shrugging off previous capital gains increases.2 But I’m not so sure. The proposed near-100% increase over the current rate is the biggest single jump in modern U.S. history.
But the news may not be all bad. It’s sometimes the case that challenges faced by one or more asset classes can help create opportunities in other asset classes. That could be the situation here if precious metals are seen as a refuge from the market volatility that might arise from a big jump in the capital gains rate. Sean Lusk, vice president at Chicago commodities brokerage Walsh Trading, made this straightforward argument for Kitco News. “Changes in tax policy could create a drawdown, where major stock indexes go negative of the year,” Lusk said. “If that should occur, we should get a bid on gold.” Gold is fundamentally uncorrelated to equities, an important feature for an asset one might consider using to help effectively diversify their overall holdings.3
But there could be another opportunity for precious metals to strengthen beyond their potential as “risk-off hedge assets” to which some may flee if markets sink. They could also thrive on the basis of being seen as one of the more promising asset options in an environment that potentially becomes adversarial for both interest-bearing assets and equities.
Heightened economic uncertainty, as well as expansionary monetary and fiscal policies, have helped sustain a precious metals bull market now well over two years old. While the economic outlook does appear to be improving, the monetary and fiscal regimes are expected to remain decidedly interventionist. With the significant year-over-year jump in April’s Consumer Price Index (CPI), I won’t be surprised if we see inflation – another potentially pro-metals condition – become a component of the current climate.
So it’s anticipated the near-term environment will be characterized by at least a measure of real inflation, interest rates hovering near zero, and continued high levels of deficit spending by the Biden administration. That’s a promising scenario for those hopeful to see the precious metals bull continue to run. And the prospect of a massive increase in the capital gains tax potentially adds still another metals-favorable dimension.
“Money goes where it is treated best,” Kevin Grady of Phoenix Futures and Options LLC told Kitco News in the same article referenced earlier. “Right now, people are chasing yields. They want to find the higher yield.”
Translation: The Fed’s commitment to keeping rates near zero makes interest-bearing vehicles largely unappealing for long-term savers. Many of those savers essentially have felt forced into risk assets (equities) to try to realize a measure of growth. Now there’s talk of a whopping increase in the capital gains tax, which could provide a major headwind to stocks. So there’s a chance equities could become less appealing. It is possible, therefore, that in an environment with reduced potential in fixed-income and equities assets that also shows signs of dollar weakness and inflation, precious metals could be viewed by some as one of the more appealing asset options available.
After a 2020 in which gold and silver appreciated roughly 25% and 48%, respectively, both metals declined modestly from January through April. But experts have been suggesting the overall climate for precious metals remains strong and that gold and silver would resume their upward momentum as a metals-friendly environment reestablished itself. Sure enough, in the wake of announcements of massive spending plans and tax hikes by the Biden administration as well as the first sign of real inflation in a long time, gold and silver have enjoyed a particularly strong May so far. Since the beginning of this month, gold is up 6.5% and silver has jumped 8.5%.
For retirement savers who’ve been watching the performance of gold and silver against the backdrop of pro-metals conditions they’ve been told are in place, it likely is reassuring to see the assets respond favorably. Does that mean it’s certain they will continue to do so? No. But all things considered, it’s reasonable to think we could see the continued development of ideal conditions for metals. This apparently includes the possibility we’ll see the single biggest jump in the capital gains tax in modern history. In a climate so fertile for gold and silver, it’s difficult to imagine the precious metals bull market grinding to a halt anytime soon.
1 Kimberly Amadeo, The Balance, “What Is the Current U.S. Federal Budget Deficit?” (May 9, 2021, accessed 5/20/21).
2 Brian Sozzi, Yahoo News, “Biden’s capital gains tax hike may not bury the stock market: strategists” (April 26, 2021, accessed 5/20/21).
3 Portfolio Visualizer, Asset Class Correlations (accessed 5/20/21).
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