The Equity-Gold Price Conundrum

The relentless rally in equity markets has pushed valuations to extreme levels based on traditional metrics. In this report, we analyze the two common arguments made by equity bulls on why this time is different and current valuations are justified. We find that either gold or equities are currently mispriced, as, a) both arguments would imply that gold should outperform stocks and b) if neither of the scenarios plays out, equities are due for a substantial correction.

Amidst the global COVID-19 pandemic, equities had a staggering rally over the past 12 months. The S&P500 almost doubled in less than a year from a low of 2240 on March 23, 2020, to currently 3860 at the time of writing. In addition, some narrower indices have done even better. Particularly certain technology stocks have relentlessly risen amidst an environment of economic stress.

This has led to a sharp increase in the equities-to-gold price ratio (see Exhibit 1) even as economic growth has collapsed while the Fed increased its balance sheet at an unprecedented level.

This increase in the equities-to-gold-ratio is not caused by gold performing poorly as prices for the yellow metal are up12% since the end of 2019. It’s simply a consequence of equities’ doing really well. But equity valuations according to traditional metrics have now approached extreme levels. For example, the total market cap to GDP (Buffet indicator) is currently at 193% (see exhibit 2), the highest on record, 50% above the peak during the dot.com bubble.

Moreover, global equities to GDP are also extremely high, currently at >120% (see exhibit 3).

The Cyclically Adjusted Price Earnings Ratio, or CAPE, a measure developed by Robert Schiller, is also flashing red with the second-highest reading in history going back to the late 1900s (see exhibit 4).

Price to sales ratios also hit a record high (see Exhibit 5).

There are other indicators that suggest that equity prices have detached from underlying fundamentals. The put/call ratio on the CBOE has now reached the levels of the dot.com bubble (see Exhibit 6).

We also saw an unprecedented inflow of new market participants. People with very little or no market exp4erience opened online brokerage accounts at an unprecedented speed during the global lockdowns. More than 10 million Americans opened a trading account in 2020 according to the Wall Street Journal[1]According to CNBC[2], ten percent of Americans bought a stock for the first time in the past 12 months, and a staggering twenty-two percent of Gen Z (currently 6-24 years old) opened a stock market account in the last 12 months.

And stocks are not the only assets that are skyrocketing. Cryptocurrencies, which since 2017 had temporarily lost their luster, are rallying at a breakneck pace since the outbreak of the pandemic (see exhibit 7).

Judged on only those metrics, stock markets are clearly in a bubble. But is this time maybe really different as the bulls argue? In our view, there are only two ways that current stock prices could indeed be justified;

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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