Recent global events have been nothing short of remarkable: the economy is tanking, the coronavirus pandemic appears to be getting worse, and the US is experiencing its largest protests in nearly 30 years. Yet, American stocks on the S&P500 have just had their best 50-day rally in history, soaring 40% from their March 23rd lows. And gold prices, historically such a safe haven asset in times of uncertainty and unrest, dropped almost 2.5% last week, their largest weekly drop in two months. So why is the market reacting this way, and what does that mean for the precious metal going forward?
Why were gold prices falling?
Lockdowns around the globe and continuing uncertainty have helped to prop up the price of gold, with prices reaching as high as $1,763 an ounce in mid-May. However, last week bullion dropped below the $1,700 level to around $1,678, a 5% drop from its recent high. Overall, the price of gold is still up by more than 11% this year and has increased gradually, with a few bumps along the way.
So while gold is touted as one of the safest assets to preserve value amid the pandemic, it hasn’t proved completely immune to market volatility. The most recent drop can be attributed to the fact that latest data on US employment numbers came out much better than expected, giving credence to the hope of economic recovery as lockdown measures across the world begin to ease. The release showed that that 2.5 million Americans found jobs in May instead of an expectation that job losses would continue to pile up. This shrank the unemployment rate to 13.3% percent compared to April’s 14.7%, pushing the prices of stocks back up and putting gold under some pressure.
The stock market has no morals
Even though there is precious little data to suggest that the spread of coronavirus is slowing, the stock market doesn’t measure a country’s health politically, socially or economically. Rather, its sole function is to accurately and unemotionally track investors’ consensus views about the health and prospects of publicly traded companies. The market is always focused on one thing, and one thing only: profit. That may seem insensitive in the face of extraordinary tensions and health pandemics, but it is at least consistent.
So how can investors profit when unemployment is so high? There are a few reasons that explain the remarkable recovery on Wall Street.
When the coronavirus plunged the economy into freefall back in March, the Federal Reserve declared it would do ‘whatever it took’ to stabilise financial markets. The central bank was as good as its word, releasing an unprecedented stimulus package of $4.5 trillion in emergency corporate lending. So, if the market seems to be recovering faster than the rest of the world, it’s at least in part because governmental policies are giving out such huge sums of money to help prop up the economy.
Even without the Fed’s help, many companies are doing exceedingly well, particularly the technology sector. Increased reliance on tech in lockdown has seen Microsoft, Apple, Google and Facebook – who together, make up about 20% of the S&P500 – all posting significant gains.
So even though the market is divorced from any economic reality right now, people are making bets that the worst of the crisis is over. It’s important to remember that rallying stock prices reflect investor confidence for the future, and not necessarily the present. The overall market mood seems to be one of hope that there’ll be no second wave of coronavirus, a vaccine will soon arrive and employment will bounce back to pre-pandemic levels.
So what next?
There are plenty of analysts that are warning investors are fooling themselves. Linette Lopez of the Business Insider writes that “almost every human being has an innate bias toward finding a coronavirus vaccine or treatment”, adding that “the market is reflecting the depth of emotion behind that bias in its wild fluctuations whenever there is even the slightest news about a vaccine breakthrough.”
It’s worth bearing in mind that there is no model that can predict what’s about to happen to the economy or the market. While confidence is high now, it may be entirely misplaced – only time will tell. In fact, policymakers at the US Federal Reserve are set to publish their first set of economic projections of 2020 tonight (7pm GMT) when the Open Market Committee (FOMC) makes its June decision.
The Federal Reserve is widely expected to leave interest rates near zero, but all eyes are on the meeting for indications of how the central bank will approach the next phase of its response to the crisis. Project an upbeat confidence, and one can reasonably expect the rally in stocks to continue. Issuing a downbeat update will test that current level of confidence and we could see another sell-off, which could in turn provide more momentum to gold. But gold’s long-term outlook has not changed, despite the knee-jerk reaction in recent days.
Wherever the market ends up heading, keep in mind that the stock market is not the economy. Paul Krugman from the New York Times summed it up perfectly in April: pay no attention to the Dow; keep your eyes on those disappearing jobs.
Important disclaimer: this document is not an official research report and the views expressed in it are those of the authors. The authors are not registered research analysts and there is no assurance the trends mentioned will continue or that the forecasts discussed will be realised. Gold as a commodity is not a specified investment for the purpose of giving advice under the Financial Services and Markets Act 2000, therefore, this does not give rise to rights to claim compensation under the Financial Services Compensation Scheme.