Gold is also sometimes referred to as fundamental, but this term is used here in a slightly different sense than it is for stocks. That’s also why I rarely focus on gold, but today I’ll make an exception. So half – we look at the ratio of gold prices to stocks. The latter goes through certain long-term cycles, today a few notes about them and how stock prices and gold prices should actually develop “model-wise”.
1. Cycle: The following chart shows the ratio of gold prices to the US stock index and also the prices of these two assets separately. Gold lost to equities for a long time after the 1970s, the cycle turned up after 2000, the next turn came a few years after 2008. Real rates are considered to be a significant driver of gold prices – their decline should push prices up and vice versa. However, the same should be the case with stocks – higher real and nominal rates should increase the required return and thus drag down prices and valuations.
Source: X
I do not see any simple explanation of the described cycle based on rates. In relation to the relative prices of shares and gold, one can also mention the point of view according to which they show a shifting affection and aversion to financial and real assets – if investors prefer real assets, gold should gain and vice versa. I would add here, however, that the definition of real and financial assets is very loose here: Although stocks are classified as financial assets, they are actually ownership shares of real assets. So we would rather talk about shifts in popularity between two types of real assets.
2. Model trend: When we look at the above curves, we may wonder how the stock price should actually behave in relation to the gold price. It can certainly be grasped in more ways than one, some time ago I analyzed a little bit how share prices should behave relative to the monetary base or the product in a model. This can be countered in the following way: Let’s assume that the product in the economy would grow by 2% and prices also by 2% per year (at the target of the central bank). The nominal growth of the economy would thus be 4% on trend. In this model, the central bank would increase the base so that the final money supply grows by 4% per year – thus covering 2% real growth and increasing the price level by 2% (the speed of money circulation and multiplication does not change).
In an efficient market, stocks could grow over the long term at a rate corresponding to the required rate of return (that is, in the special case that they pay no dividends). In our case, the risk-free returns will be exactly 4% (corresponding to the nominal growth of the economy). The required return is then made up of risk premiums. And they would therefore effectively show how much faster the shares will grow compared to the nominal growth of the entire economy (or the broader money supply). So if the stock market risk premium were, say, 5.5%, the economy would grow by 4% annually, the money supply as well, and stocks by 9.5% (4% + 5.5%). That is, just 5.5% faster (dividend yields would reduce this number).
The price of gold could also rise by 4% in this model – copying the growth of the money supply. Or only by 2% – it would only copy inflation. In both cases, it would appear that stocks will rise again faster and the gold/stock ratio will trend down. And then, in case of interest, we can hang other assumptions. The graph shows what language practice speaks, but of course a lot depends on the chosen time period. The second figure shows stock and gold gains since 1988, along with volatility as a proxy for risk:
