What are the common drivers and signals for the end of the simultaneous rise of gold and U.S. stocks?

In the Past 2 Years, U.S. Stocks and Gold Have Risen in Sync

Since 2023, U.S. stocks and gold have risen in sync. There have only been 6 instances in history since 1968 where U.S. stocks and gold have risen together for at least 2 years: May 1970 - January 1973, April 1978 - September 1980, February 1985 - August 1987, March 2003 - October 2007, March 2009 - September 2011, and February 2016 - August 2020. If we categorize the state of the U.S. economy based on the year-on-year changes in GDP and CPI, during this round of synchronized rise in U.S. stocks and gold, both U.S. GDP and CPI have resonated downward, resembling the economic state of February 1985 - August 1987.

Common Driver Behind the Synchronized Rise of U.S. Stocks and Gold: Liquidity Surge

During the past 6 periods of synchronized rise in U.S. stocks and gold, the U.S. dollar index has declined. This indicates that the commonality behind the synchronized rise is a weak dollar rather than low interest rates. Why is liquidity still loose during the Fed's interest rate hike and balance sheet reduction phase in 2023? We believe there are two possible reasons: (1) Non-U.S. central banks have cut interest rates ahead of the Fed, leading to a global liquidity spillover effect that boosts U.S. stocks and gold. (2) Liquidity released through other channels in the U.S. offsets the Fed's balance sheet reduction, resulting in substantial liquidity easing.

U.S. Debt Issuance Shrinks, U.S. Stocks and Gold May End Synchronized Rise with Resonance Adjustment in 2025

When will the synchronized rise of U.S. stocks and gold end? Three important observational variables: (1) The end of the synchronized rise of U.S. stocks and gold is often accompanied by a turning point in the U.S. core CPI. (2) A reversal in the downward trend of the U.S. dollar index. (3) The potential labor productivity in the U.S. often rebounds after hitting a bottom.

Future Outlook: As U.S. debt issuance shrinks, U.S. stocks and gold may end their synchronized rise with a resonance adjustment in 2025. If we consider the states of GDP and CPI, this round of synchronized rise in U.S. stocks and gold is similar to February 1985 - August 1987, but the state after the synchronized rise will differ. The U.S. unemployment rate continued to rise in July this year, triggering the Sam Rule, and the U.S. fiscal deficit in September was the lowest level for the same period in the past 4 years. The U.S. Treasury's latest announcement predicts that the net debt issuance scale for Q4 2024 will decrease to $546 billion, and the net debt issuance scale for Q1 2025 is expected to be $823 billion. The pattern of fiscal expansion in the U.S. since 2023 is difficult to sustain.

Therefore, the core factors that drove the rise of U.S. stocks in the 1990s will no longer hold this time. The U.S. economy and inflation are maintained by borrowing and spending, and after losing fiscal support, we expect the U.S. economy to accelerate its decline in 2025, with a reversal in dollar liquidity. The resonance rise of U.S. stocks and gold driven by liquidity expansion over the past 2 years will reverse. We suggest monitoring the net issuance of U.S. bonds and changes in the U.S. labor market for corresponding right-side confirmations. From the perspective of potential labor productivity, the CBO predicts that U.S. potential labor productivity will reach its lowest point in 2025, at which point U.S. stocks and gold may also end their synchronized rise. Combined with our judgment that the U.S. fiscal expansion model is difficult to sustain, the output gap in the U.S. is expected to turn downward in 2025, ultimately leading to a wave of resonance adjustment in U.S. stocks and gold The text is as follows:

1. The simultaneous surge of U.S. stocks and gold over the past 2 years

Since 2023, U.S. stocks and gold have surged simultaneously. As of October 29, 2024, both the S&P 500 and COMEX gold have risen by 52%. It is rare in history for a risk asset and a traditional safe-haven asset to rise together for nearly 2 years. We have compiled cases since 1968 where U.S. stocks and gold have risen together for at least 2 years, and historically, there have only been 6 instances: May 1970 - January 1973, April 1978 - September 1980, February 1985 - August 1987, March 2003 - October 2007, March 2009 - September 2011, and February 2016 - August 2020.

If we categorize the state of the U.S. economy based on the year-on-year changes in GDP and CPI, during the past 6 periods of simultaneous rises in U.S. stocks and gold, there were 2 instances of upward resonance in GDP and CPI (overheating), 2 instances of GDP declining while CPI rose (stagflation), 1 instance of downward resonance in both GDP and CPI (recession), and 1 instance of GDP rising while CPI fell (recovery). During the current period of simultaneous rises in U.S. stocks and gold, both GDP and CPI are in downward resonance, resembling the economic state of February 1985 - August 1987.

2. The common driver behind the simultaneous rise of U.S. stocks and gold: liquidity surge

The simultaneous rise of U.S. stocks as a risk asset and gold as a safe-haven asset is primarily driven by liquidity, which does not necessarily have to be achieved through interest rate cuts by the Federal Reserve. For example, during the period of interest rate hikes from 2004 to 2006, U.S. stocks and gold still rose together.

If we measure dollar liquidity through the U.S. dollar index, during the past 6 periods of simultaneous rises in U.S. stocks and gold, the dollar index has declined, with an average drop of 15.9% and a median drop of 9.7%. It is evident that the commonality behind the simultaneous rise of U.S. stocks and gold is a weak dollar rather than low interest rates. In 2023, gold prices significantly diverged from real interest rates while maintaining a high negative correlation with the dollar index.

During the Federal Reserve's interest rate hike and balance sheet reduction phase in 2023, why is liquidity still loose? We believe there are two possible reasons: (1) Non-U.S. central banks cut interest rates ahead of the Federal Reserve, leading to a spillover effect in global liquidity that boosts U.S. stocks and gold. This round of global interest rate cuts is different from the past, as non-U.S. central banks are the first to cut rates, while the Federal Reserve is relatively lagging. If we measure global liquidity by the net interest rate cuts of central banks worldwide, the most tense period of global liquidity has passed by early 2023, with marginal easing of liquidity aligning with the starting points of U.S. stocks and gold.

In addition, over the past two years, the trend of Chinese government bond futures has been largely consistent with U.S. stocks and gold, while U.S. Treasuries have somewhat decoupled from both. This may also reflect a spillover of liquidity, as part of the ample domestic liquidity has flowed into overseas assets such as U.S. stocks and gold.

(2) Liquidity released through other channels in the U.S. offsets the Federal Reserve's balance sheet reduction, resulting in substantial liquidity easing. In 2023, the Federal Reserve is raising interest rates and reducing its balance sheet. If we follow the experience of interest rate hikes and balance sheet reductions in 2018, both U.S. stocks and gold should decline. However, asset prices are showing signs of liquidity easing in a high-interest-rate environment. Behind this divergence in liquidity and price, there may be liquidity released through other channels in the U.S. that offsets the Federal Reserve's balance sheet reduction. For example, the most discussed point is the decrease in the scale of reverse repos in the U.S., which has indirectly released liquidity into the financial market, countering the Federal Reserve's balance sheet reduction. This can be seen from the trend of base money, where the growth rate of U.S. base money rose from a low of -15.7% in December 2022 to 10.8% in February 2024.

However, after February 2024, the growth rate of U.S. base money has declined from its high, while U.S. stocks and gold continue to rise together, indicating that there are other domestic sources of funds in the U.S. driving liquidity. From the perspective of the U.S. real estate market, a loan interest rate of 6%-8% is already at a 15-year high, yet housing prices continue to rise. A similar divergence in liquidity and price was also observed during the periods in the 1970s when both U.S. stocks and gold rose together.

Additionally, the dollar share of global foreign exchange reserves is an indicator of the dollar's credit. This indicator has been largely consistent with the trend of the dollar index over the past 25 years, but in the past three years, a noticeable divergence has occurred. The dollar index has shifted upward to around 100, while the dollar share of global foreign exchange reserves has been declining. If we compare the trends of the dollar share of global foreign exchange reserves and gold prices, we can find that their trends are also largely consistent, indicating that the dollar index in recent years does not fully explain the trend of weakening dollar credit The liquidity released by the United States itself is more abundant than what is indicated by interest rates and the US dollar index.

The simultaneous rise of US stocks and gold often accompanies a potential decline in labor productivity and an increase in the output gap. The saying "buy gold in troubled times" often occurs in the later stages of the previous generation's technological dividend, where the global pie becomes smaller, and conflicts are more likely to escalate. Therefore, the price trend of gold is generally inversely related to the potential labor productivity in the US. The rise of US stocks relies on the economic cycle, which is the increase in the output gap. Thus, the simultaneous rise of US stocks and gold often accompanies a decline in potential labor productivity and an increase in the output gap. The simultaneous rise of US stocks and gold since 2023 is a combination of declining labor productivity and an increasing output gap.

3. The scale of US bond issuance is shrinking; US stocks and gold may end their simultaneous rise through resonance adjustment in 2025

Historically, the way US stocks and gold end their simultaneous rise is not uniform. Out of six instances, three ended with both declining, two ended with gold prices falling while US stocks rose, and one ended with gold prices rising while US stocks fell.

So when will the simultaneous rise of US stocks and gold end? Three important observational variables: (1) The end of the simultaneous rise of US stocks and gold often accompanies a turning point in the US core CPI, which can be either a bottom or a top. (2) A reversal in the downward trend of the US dollar index. The end of the simultaneous rise of US stocks and gold often accompanies a transition of the dollar index from a downward trend to an upward or sideways trend, in short, a reversal of the downward trend. (3) The potential labor productivity in the US often rebounds after hitting a bottom.

From the perspective of inflation, during this round of simultaneous rise of US stocks and gold, the inflation state in the US is similar to that of 1970.5-1973.1. In 1970, the US entered the first wave of a major inflationary downturn, and the turning point of the core CPI downward corresponded to the beginning of the simultaneous rise of US stocks and gold. This time is similar; at the beginning of 2023, the US core CPI established a downward turning point, and US stocks and gold rose simultaneously.

If we refer to the experience of 1970.5-1973.1, the second wave of major inflation in the US began in 1973, and US stocks and gold ended their simultaneous rise. This indicates that during periods of high inflation, a decline in inflation means marginal liquidity is loosening, while the opposite indicates marginal liquidity is tightening. Therefore, when will the two end their simultaneous rise? An important observational indicator is the trend of inflation in the US.

Future Outlook: The Scale of U.S. Bond Issuance Shrinks, U.S. Stocks and Gold May End Their Correlation in 2025.

As mentioned earlier, if we consider the state of GDP and CPI, the current correlation between U.S. stocks and gold is similar to that of 1985.2-1987.8, but the state after the correlation ends will differ. From the perspective of U.S. dollar liquidity, based on the experience of liquidity spillover in the 1990s, the reversal of liquidity spillover from Japan to the U.S. occurred when the U.S. economy began to weaken significantly, as the relative advantages of the U.S. economic fundamentals started to narrow, leading to a reversal of the core logic of liquidity spillover. U.S. economic data has remained resilient since 2023, while other economies have shown weakness. However, the unemployment rate continued to rise in July this year, triggering the Sam Rule, and the U.S. fiscal deficit in September was at its lowest level for the same period in the past four years. The U.S. Treasury's latest announcement predicts that the net bond issuance scale for Q4 2024 will decrease to $546 billion, and the net bond issuance scale for Q1 2025 is expected to be $823 billion. The pattern of fiscal expansion in the U.S. since 2023 is difficult to sustain.

Therefore, the core factors that drove the rise of U.S. stocks in the 1990s will no longer hold this time. The U.S. economy and inflation are being maintained by borrowing and spending, and after losing fiscal support, we expect the U.S. economy to accelerate its decline in 2025, leading to a reversal of U.S. dollar liquidity. The resonance-driven rise of U.S. stocks and gold over the past two years, fueled by liquidity expansion, will reverse. We recommend observing changes in U.S. bond net issuance and the U.S. labor market for corresponding right-side confirmations. Additionally, from the perspective of potential labor productivity, the CBO predicts that U.S. potential labor productivity will reach its lowest point in 2025, at which point U.S. stocks and gold may also end their correlation. Combined with our judgment that the U.S. fiscal expansion model is difficult to sustain, the output gap in the U.S. is expected to turn downward in 2025, ultimately leading to a wave of resonance adjustment in U.S. stocks and gold.

Author: Ding Luming (S1440515020001), Chen Yunyang, Source: CITIC Construction Investment Securities Research, Original Title: "What are the Common Drivers and Ending Signals of the Correlation between U.S. Stocks and Gold?"