The equity market rally that began from the bottom of the crisis back in late March has been driven by plentiful liquidity from central banks: rate cuts, quantitative easing (QE), support for credit markets and overall highly accommodative forward guidance. Under that environment, gold was positively correlated with equities because they both benefit from ample liquidity provision; equities because money is cheap, and gold because real rates were falling.
Given positive vaccine news in November, the main driver of equity markets shifted from liquidity to growth. That is, equities were able to continue to go up on hopes of a return to economic growth, while the negative correlation between equities and gold reasserted itself and gold has behaved like a risk-off asset once more. A misconception about gold is that equities and gold are always negatively correlated, but that’s only the case if equities are driven by fundamentals (including economic growth); if equities are driven by liquidity (or the lack of it) then they are positively correlated with gold, in both up and down markets.
Consensus on the ‘street’ seems to be that economic growth will be strong next year, bar any nasty surprises. That may not bode well for gold. Even worse, the biggest risk to equity markets is probably a premature withdrawal of liquidity, which could happen if inflation finally came through because of the pickup in growth. A similar surprise withdrawal of liquidity by the US central bank (The Federal Reserve, or Fed) happened in 2013 and the subsequent market reaction came to be known as the ‘taper tantrum’; equities and bonds sold off simultaneously, as did gold. That’s another misconception about gold: that it is always an inflation hedge. Gold will fail to hedge inflation if central banks respond to the rise in inflation by hiking interest rates. This is because the rise in (nominal) interest rates increases the ‘opportunity cost’ of holding gold.
So, for now if equities continue to go up then gold is likely to go down, because growth has become the driver and the liquidity situation remains unchanged. But if liquidity is withdrawn, equities will sell off AND gold will go down, because liquidity will then be the main driver of markets. If this is indeed the environment we’re in, then gold might have found itself in an unfavourably asymmetric situation.
That’s not to say gold is not still a good long term buy; it just might come up against some headwinds in 2021. A potentially good scenario for gold is if inflation comes through but the central banks (particularly the US Fed) don’t respond by tightening policy. That will drive real rates lower and should support gold. Another positive scenario for gold, albeit negative for equities and the economy overall, is if economic growth prospects deteriorate, perhaps because of bad news around the vaccine rollout, or a significant pickup in cases of the virus. Because this would be bad for equities, and growth (or the lack of it) would be the driver, the negative correlation between gold and equities would remain, and gold might rally as equities markets stutter.
To the pound 