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What does a stratospheric rally for gold mean for the stock market?

Gold is on a historical side, surpassing records that have been around for decades and targeting a psychological round number above $ 2,000.

The haste for precious metal comes, unsurprisingly, amid the worst public health crisis in generations, but what does the rise in age-old port value mean for longer-term equities?

Gold GOLD,
+ 2.05%
has traditionally grown as stocks have fallen due to the yellow metal’s status as a safe game in times of uncertainty.

However, gold has risen by more than 26% as US stocks recovered from a low during the worst corona virus crisis on March 23. As gold rose, the S&P 500 index SPX,
+ 0.08%
rose by nearly 45%, the Dow Jones Industrial Average DJIA,
-0.22%
has advanced 40%, and the technology-heavy Nasdaq Composite Index COMP,
+ 0.85%
increased by nearly 55% in the same period.

Those tandem moves have sparked hackers from investors who fear gold indicates stocks are too expensive because the economy is still faltering from the COVID-19 pandemic that resulted in a record 32.9% annualized GDP in the second quarter, representing the highest quarterly decline rate ever recorded with data dating back to 1947.

Ryan Detrick, chief investment strategist for LPL Financial, in a recent blog post, noted that gold and stocks can rise together, despite the perception that asset prices are inversely correlated.

Correlations measure how asset prices move relative to each other. A correlation of 1 would mean that stocks and gold move perfectly together, while a correlation of zero would indicate no relationship; and a correlation of negative 1 indicates that assets are moving in exactly the opposite or reverse direction.

For example, the moving 100-day correlation of gold to the S&P 500 is 0.25, indicating a slightly positive relationship between precious metal prices and the broad market benchmark over the past decade, according to Dow Jones Market Data.

However, over a 50-day moving average, the correlation is negative 0.23 and negative 0.046, or close to zero, over a 20-day moving average, which means that there is almost no correlation with a slight opposite correlation over the medium term.

Detrick says the tandem gains for gold and stocks are quite rare, but could usher in a further rise in both assets, rather than necessarily suggesting an ominous outcome for rising stocks.

“Think about this: 2020 is the first year since 1979 that both gold and the S&P 500 hit new highs during the calendar year,” he said.

“It is widely believed that stronger gold probably means that something is wrong in the markets and that investors are more defensive, but it may not be that simple,” Detrick wrote.

The LPL strategist said that when this bullish gold and equities condition occurred more than four decades ago, both assets achieved double-digit returns.

“Gold added another 17% and the S&P 500 rose 26% in 1980,” he said.

That said, data shows that gold tends to continue to rise when it starts to trade on record, while stock prices eventually die out. A map by Detrick emphasizes that gold has built up a seven-year base, which could suggest a long and powerful rally for the precious metal (see attached chart):

There isn’t a huge sample size of data where the pair of gold and stocks both traded close to records, but between 2007 and 2011, a period when there were six record lengths for precious metal, the average return for gold was 14.6%, compared to a loss of 0.23% for the S&P 500, according to Dow Jones Market Data.

It’s worth noting that when gold hit a record high in 2007, it was the first time since 1980.

Gold has maintained its price range since the first financial crisis in 2007, and has accelerated as the Federal Reserve and the U.S. government have allocated trillions in funds to help mitigate the economic damage caused by the pandemic.

So-called money pressure was one of the factors gold bulls refer to when they argue for further runs for the metal. The Fed has also announced its intention to support the financial markets by keeping rates very low, with rates from federal benchmark funds between 0% and 0.25%.

In addition, the Fed has been steadily bragging assets, including debts, to maintain the ten-year treasury bond TY00,
+ 0.06%
TMUBMUSD10Y,
0.536%
at or below 0.60%.

That’s an environment that strategists can support both gold and equities, as low government debt returns can spur investors into riskier assets like stocks, but that design makes buying gold, which doesn’t offer a coupon, more attractive to potential buyers.

An attack of weakness in the dollar DXY,
+ 0.38%,
traded around a two-year low, compared to half a dozen rival currencies, as measured by the ICE US Dollar Index, also supported gold.

The weaker dollar has made gold more attractive because bullion is usually priced in dollars. And a weaker dollar can also support stocks of companies that have positions in foreign markets, making their goods and services more attractive to foreign customers.

It is unclear how long gold and equities can maintain their current trends, especially during a period in the market where the corona virus crisis has clouded the economic outlook and fueled unusual asset movements.

“The takeaway: Gold’s rally is the latest in a long list of unusual market moves that make us nervous,” Lindly Bell, chief investment strategist at Ally Invest, wrote in a Friday paper.

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