COVID – 19, Gold and Equities

During the last two severe economic contractions and recessions in which the Federal Reserve intervened to help stabilize the economy a new paradigm occurred in which both U.S. equities and gold would move in tandem to the upside. The explanation is fairly straightforward in the case of U.S. equities they are reacting in a bullish manner due to the fact that there is tremendous liquidity and inexpensive money in terms of borrowing costs. In the case of gold, it is also fairly straightforward and that every time the Federal Reserve increases their balance sheet they in essence increase the money supply and devalue the U.S. dollar.

At some point the positive correlation between rising equities and rising gold reverses. We saw that during the middle of 2011. Gold and equities had been rising since 2009 due to the factor stated above. However, the disconnect occurred when gold began to plummet from its all-time record high above $1900, and U.S. equities continued to gain ground.

Although one day does not make a trend, today we witnessed U.S. equities trade sharply lower, while gold had moderate gains. The relationship which is typically in inverse correlation between the two asset classes has returned to this traditional relationship. Market participants and traders tend to move the majority of their investment capital into equities when the stock market is rising, avoiding a major percentage of their capital to gold holdings. Inversely when U.S. equities are trading under pressure traders tend to move that capital into a safe haven asset group, gold being one of the most prominent places to park their capital. Especially when interest rates are at the lowest points seen in quite some time bonds become less attractive.

As for today’s activity it is certainly feasible that investors and market participants have actively moved money from the risk on asset class (stocks) to the safe haven asset class (gold).

It has been the belief of many economists and advisors including myself that the recent climb in U.S. equities was a bear market rally. This assumption is based upon the dramatic and destructive effects of the coronavirus pandemic which is resulted in a global economic contraction. Whenever you get worldwide declines in GDP, global equity seems to react by trading lower.

Another important potential outcome of the current pandemic is the unknown factors. Since the virus has never before been encountered, medical professionals have only models and assumptions to determine whether or not a second, third or even fourth wave will follow after this first wave has run its course.

Another variable which is possibly the largest wildcard is the creation of a vaccine. Because even after the effects of the pandemic diminish and individuals worldwide attempt to return to a more normal lifestyle one question is most important, what is the new normal without Covid-19’s eradication or vaccination.

How long will it take before individuals are willing to attend large sporting events, large social interactions as well as other activities that revolve around social activity of large groups of individuals. This could take years not months if a vaccine isn’t forthcoming by then.

While it is easy to ponder potential outcomes of the pandemic, truth be told no one can answer that question with any modicum of assurance. With that in mind depending on how this pandemic plays out could see gold move substantially higher over the next 12 months.

Wishing you as always good trading and good health,