Gold is moving higher because of rising inflation expectations and has become just another reflation trade very similar to equities, according to Mandy Xu, Credit Suisse chief equity derivatives strategist and a director in the global markets division in New York.
Xu discussed the shift in correlation between gold and equities during a video interview on “Bloomberg The Open.”
“Given the shift in correlation, gold may not be as reliable a hedge for your equity risk,” Xu said.
Reflation is a fiscal or monetary policy designed to expand output, stimulate spending, and curb the effects of deflation, which usually occurs after a period of economic uncertainty or a recession. The term may also be used to describe the first phase of economic recovery after a period of contraction.
Here’s the transcript of Xu’s answer to the question: What’s your take on things with regards to precious metals at the moment?
Mandy Xu: It’s pretty well understood by now that gold moves inversely to real yield. And it’s not a surprise that gold is making new record highs at the same time as real yield is making new record lows.
That begs the question, what’s driving real yields lower? To break it down, since June, the entire decline in real yields has come from rising inflation expectations, even as nominal yields haven’t really moved.
That divergence I would attribute to the fed and the effectiveness of the fed for guidance, driving the key rate to zero even if inflation overshoots. Against this backdrop, I think what’s interesting is gold is moving higher because of rising inflation expectations. It’s become just another reflation trade very similar to equities and you see it in the correlation between gold and equities.
This is something I want to point out because I think the traditionally gold is known as a safe haven defensive asset and that’s been true for many years, right? You look at the correlation between equities and gold, that’s been persistently negative in recent years.
However, in recent months that has turned positive so now gold is moving more in tandem with equities and shaping more like a risk assets, and it’s
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not unprecedented. The last time we saw persistent positive correlation between gold and equities was in the aftermath of the last crisis — not coincidentally, another time where the Fed cut rates to zero and we had massive amounts of stimulus coming into the system.
To me it’s really important to break down what is driving gold and right now, it’s reflation.
This is really important because as you’ve noticed, rate vol has totally collapsed because of this shift in the Fed’s reaction function and many people are thinking about pivoting away from treasuries to gold. As you’ve pointed out, if there’s a positive correlation between gold and equities, you’re not getting that inverse correlation if you go from treasuries to gold. What do you say to class about that issue right now?
Mandy Xu: In this environment with rate vol basically zero and the yields where they are, a lot of investors are looking for an alternative for a hedge for the multi-asset portfolio, because bonds are just not as effective of a hedge for their equity risk.
A lot of people have turned to gold because of this traditional negative correlation and that’s why I’m highlighting for them this shift in correlation regime. Gold may not be as reliable a hedge for your equity risk. The Fed should be more looking at equity-specific hedges rather than relying on the correlation regime that may or may not hold up.