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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chair of Rockefeller International. His latest book is ‘What Went Wrong With Capitalism’
A strange twist is playing out in global markets. Gold is partying like it’s 1979, and stocks are partying like it’s 1999. But those two eras could not have been more different, the first marked by rampant inflation and geopolitical turmoil, the second by the dotcom mania and relative calm.
Most analysts think gold is soaring amid a new stock boom because investors want to hedge against rising policy uncertainty, particularly in the US. This theory implies, however, that global investors have an extraordinary tolerance of cognitive dissonance in fully embracing artificial intelligence-driven optimism for US stocks and the caution associated with gold. It also just seems a bizarre choice — why hedge with gold at a time when more direct forms of protection (such as buying put options on stocks) are cheap by comparison?
I think there is another explanation for the gold-stock duet: massive liquidity. Governments and central banks rolled out trillions of dollars in stimulus during and after the pandemic. Much of that is still sloshing around the system and continues to drive the momentum trade across many assets, including stocks and gold. On the back of it, the sum Americans hold in money market mutual funds surged after the pandemic and now totals $7.5tn, or more than $1.5tn above the long-term trend.
While the Federal Reserve says its policy is “mildly restrictive”, the fact is that nominal interest rates are still below the rate of nominal GDP growth, which keeps financial conditions loose. Governments are doing their part, led by the US with the highest deficit in the developed world. The flip side of a huge deficit is a huge private sector surplus (as the Kalecki-Levy equation shows).
Liquidity is also a function of people’s risk appetite. The more confident they feel about the upside in financial assets, the more money they are willing to pour into the markets. US households have ramped up their exposure to stocks and other risk assets in recent years, emboldened by a united government-central bank front to protect markets.
Investors have been conditioned to expect a state rescue at the slightest hint of trouble. By sharply lowering the risk premium, state support in effect opens the liquidity floodgates. For investors, the downside feels protected and the upside uncapped.
Hyper-financialisation is also boosting liquidity. The spread of new trading apps and exotic, largely commission-free investment vehicles make it much easier for anyone to buy financial assets, funnelling liquidity into multiple corners of the market.
The gush of liquidity helps explain the new tie between gold and stock prices. Historically, the correlation between them was zero. In the gold rush of the 1970s, stocks were dead in the water; in the stock boom of the 1990s, gold prices were falling. Now they’re rising together on a tide of liquidity.
I’ve long been making the bull case for gold, particularly after 2022, when the US weaponised the dollar with its sanctions on Russia and foreign central banks began buying gold as an alternative. Now I worry there is no good story that too much money can’t spoil. The centre of the buying action has moved from central banks to gold ETFs. The exchange traded fund share of gold demand has risen ninefold this year to nearly 20 per cent. The third quarter saw the highest ever quarterly ETF flows into gold.
Mainstream explanations for the AI-gold party are looking past other market prices. For example, the idea that gold is rising on fear of “dollar debasement” makes sense long term but can’t explain why it is having its best year since 1979. The dollar has been flat in recent months as gold went parabolic.
In fact, many assets do not reflect the fears of the 1970s, including that of inflation. If inflation is the worry, that should be reflected in long-term bond yields and classic inflation hedges — such as Treasury inflation-protected securities. That is not happening. Bond market signals suggest investors expect inflation to remain under 2.5 per cent long term.
Meanwhile, commodities that are not typical hedges, such as silver and platinum, are also booming. High-risk assets that are basically the opposite of safe hedges are up sharply, too. These include leveraged ETFs, unprofitable tech stocks and bond prices of low-quality companies.
The Fed is oblivious to asset-price inflation. But if traditional consumer price inflation accelerates further, and the central bank is forced to tighten, it’s going to end with an unpleasant surprise for many. Investors who bought the yellow metal as a hedge are going to find it was anything but, as gold falls along with AI stocks.
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