Gold Hostage To Stocks

Gold has had a wild ride since Trump’s surprise election win in early November. This metal first plunged then surged, ultimately making little headway. It wasn’t until mid-April that gold regained its pre-election levels. This overall lackluster gold action was confounding given all the mounting uncertainties.  But it once again highlights that gold investment demand is often hostage to the US stock markets’ fortunes.

Before the election, gold surged every time Trump appeared to advance in the polls. Trump had a well-earned reputation as a loose cannon, implying far greater unpredictability.  Increasing prospects of a Trump victory drove gold to $1305 the Friday before the election. But that weekend the FBI cleared Clinton again on her classified-e-mail front. So gold sold off sharply on rising odds Clinton would indeed win.

On Election Day gold closed near $1276, a price that essentially wasn’t seen again until just a couple weeks ago. As the early voting results came in that evening, Trump took a surprise lead in Florida which started to grow. As the biggest battleground state with 29 electoral votes, Florida was an absolute must-win for Trump. Gold futures soared in real-time to $1337 that evening, 4.8% over that day’s close hours earlier!

For months before that vote, all indications were gold would surge on a Trump victory. Gold investment demand grows on uncertainty, and Trump is unpredictability personified. Gold’s election-evening gains didn’t seem unreasonable, merely matching the 4.8% surge seen the day after the UK’s Brexit vote in late June that also surprised. But a couple days after Trump’s victory, gold spiraled into a 5-week-long plunge.

How could gold’s price action pivot so radically across that election as uncertainties indeed soared? It was an exceedingly-vexing outcome for gold investors and speculators, leaving them confounded and disheartened. This improbable result sprung from an equally-improbable one. Contrary to virtually all expectations pre-election, the stock markets surged in extraordinary Trumphoria after his underdog win.

Though traders often forget, gold has long been hostage to stocks. Gold is a unique asset that tends to move counter to stock markets, making it something of an anti-stock trade. So gold investment demand surges when stock markets weaken, as investors seek to prudently diversify their stock-heavy portfolios. But when stock markets surge, counter-moving gold is soon forgotten so its investment demand withers.

Given gold’s global supply-and-demand fundamentals, it’s remarkable just how dominant investment demand is in driving gold’s prevailing price levels.  The definitive arbiter of gold fundamental data is the World Gold Council. It reported that global gold investment demand accounted for only 36% of overall total demand in 2016, and just 22% in 2015. Jewelry dwarfed that at 47% and 57% respectively those years.

Yet it’s not gold’s perennial largest demand category of jewelry that really moves its price, but its much-smaller investment one. Investment demand drives gold prices at the margin because it is exceedingly volatile compared to gold’s other demand categories. Between 2010 and 2016, the best jewelry-demand year was only 31% bigger than the worst one. But this same variance in investment demand was huge at 119%!

And there’s nothing that’s driven global gold investment demand in recent years like US stock-market fortunes. That sounds dubious, but the hard market data is crystal-clear. Gold investment demand surges when US stock markets weaken, and slumps when they strengthen. That’s what birthed the apparent gold anomaly after the election. Trump won, but gold demand didn’t surge because stock markets soared.

This strong inverse relationship has played out for years, but it’s often forgotten. The sole reason gold plunged between 2013 and 2015 was extreme Fed easing was artificially levitating the US stock markets. That killed gold investment demand, as there is no perceived need for prudent portfolio diversification when stocks seemingly do nothing but rally indefinitely. This same dynamic continued to play out last year.

This first chart looks at the benchmark S&P 500 stock index (SPX) and gold since early 2016.  Much of if not most of gold’s price action since then can be explained by stock-market moves. While other gold drivers arise from time to time like Fed machinations, gold is hostage to stocks. That makes gold one of the best investments to own when stock markets suffer in the major bears that inevitably always follow major bulls.