A Global Market Crossroads: Gold and Stocks in a Bizarre Dance

The global market is witnessing a unique phenomenon: a frenzied surge in gold prices reminiscent of the 1979 fever, and a stock market boom mirroring the state of 1999. However, the two eras are fundamentally different. In the past, rampant inflation and geopolitical turmoil prevailed, while the second era was characterized by internet bubble mania and relative geopolitical stability.

Why is Gold Rising Amidst a Stock Market Boom?

Most analysts believe that the rise in gold prices in conjunction with the stock market boom reflects investors' desire to hedge against political uncertainty, especially political risks in the United States. But this argument contains a contradiction: investors are required to simultaneously accept "optimism about US stocks driven by artificial intelligence" and "cautious hedging represented by gold." This cognitive dissonance is surprising. Even more surprising is the choice of the hedging tool itself. More direct hedging instruments, such as buying put options on stocks, are currently cheaper than gold. So why do investors choose gold?

Massive Liquidity: The Hidden Engine Behind the Simultaneous Rise

Ruchir Sharma, the current Chairman of Rockefeller International, believes there is another reason for the rise of gold and stocks together: massive liquidity. During and after the COVID-19 pandemic, governments and central banks around the world launched stimulus packages worth trillions of dollars. These funds are still flowing into the markets, driving upward trends in stocks, gold, and other asset classes. As a result, the volume of money market funds held by Americans has increased significantly after the pandemic, currently reaching $7.5 trillion, more than $1.5 trillion above the long-term trend.

Government and Central Bank Policies: Additional Fuel for the Markets

Although the Federal Reserve describes its policy as "moderate tightening," the reality is that nominal interest rates are still lower than nominal GDP growth, which maintains easy financial conditions. Governments are making matters worse, with the United States leading the list of developed countries in terms of financial deficit levels. According to the Kalecki-Levy equation, the other side of the huge deficit is the huge surplus in the private sector.

Expectations of Government Intervention: A Safety Net for Investors

Liquidity has also been linked to people's propensity to take risks: the more confident they are in the potential for financial asset prices to rise, the more money they pump into the markets. In recent years, and with the support of "joint market protection" by the US government and the Federal Reserve, American households have significantly increased their allocations to stocks and other risky assets. Investors have entrenched the expectation that "the government will intervene to save the market when any sign of danger appears." This government support significantly reduces the risk premium, effectively opening the gates of liquidity. For investors, downside risks seem to be supported, while upside potential is unlimited.

Excessive Financialization: Facilitating Access to Markets

Excessive financialization also contributes to increased liquidity: the proliferation of new trading applications and the availability of complex and virtually free investment tools make it easier for the general public to buy financial assets, leading to huge amounts of liquidity flowing into all corners of the market.

Liquidity Drives the Relationship Between Gold and Stocks Off Its Historical Course

Massive liquidity explains the new relationship between gold and stocks. Historically, the correlation between them was zero: during the gold rush in the 1970s, the stock market stagnated, and during the stock market boom in the 1990s, gold prices fell steadily. Today, in the midst of the liquidity wave, they are rising simultaneously.

Concerns About Excessive Money Flows

Sharma has always been optimistic about gold, especially after 2022, when the United States used the dollar as a weapon to punish Russia, and central banks began to increase their holdings of gold as an alternative. But he is now concerned that no sound logic can withstand the excessive flows of money. The main driver of gold purchases has shifted from central banks to gold-backed exchange-traded funds (ETFs). This year, the proportion of ETFs from gold demand increased by 9 times, reaching nearly 20%, and inflows to gold-backed ETFs in the third quarter recorded their highest level ever in the same period.

Other Price Signals: Reading Between the Lines

Interpreting the current market as "artificial intelligence mania" and "gold hedging" ignores other asset price signals. For example, the statement that "gold is rising due to concerns about the devaluation of the dollar" seems logical in the long term, but it does not explain why gold prices recorded their best performance since 1979 this year, especially since dollar exchange rates have been stable in recent months. In fact, the prices of unconventional hedging commodities, including silver and platinum, are rising sharply. High-risk assets (such as leveraged ETFs, unprofitable technology company stocks, and low-rated corporate bonds) that are completely contrary to the concept of "hedging" are also rising significantly. The prices of these assets do not reflect concerns similar to those of the 1970s (such as panic from inflation).

What Do Bond Markets Tell Us?

If the market is really concerned about inflation, it should be reflected in long-term bond yields and traditional inflation hedging instruments (such as US Treasury Inflation-Protected Securities TIPS), but the actual situation is not the case. Bond market signals indicate that investors expect long-term inflation to remain below 2.5%.

The Federal Reserve Ignores Asset Price Inflation

The Federal Reserve is currently ignoring asset price inflation. But if traditional consumer price inflation accelerates further, and the Federal Reserve is forced to tighten monetary policy, many investors will face an unexpected shock: those who bought gold as a hedging tool will discover that gold may fall alongside artificial intelligence stocks, and will not play a hedging role at all. This article presents the point of view of Ruchir Sharma, Chairman of the Board of Rockefeller International.