Sharp contrast! US stocks mark "the best quarter in six years," while gold experiences "the worst quarter in more than a decade."

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In the recently ended second quarter, the US stock market and the gold market showed a rare and extreme divergence.

In Q2 this year, the S&P 500 index and the Nasdaq Composite index surged 15% and 21% respectively, marking their best quarterly performance since 2020; the Dow Jones Industrial Average rose 13%, its strongest quarter since 2022. Meanwhile, gold fell about 14%, breaking below the $4,000 per ounce threshold and recording its worst quarterly performance in over ten years.

(Spot gold weekly chart)

The core logic driving this divergence points to one variable—the Federal Reserve. The new Fed Chair Walsh, in his first appearance, sent out a more hawkish signal than the market expected, causing interest rate expectations to shift sharply. This shift directly suppressed gold but failed to stop the surge in tech stocks driven by the artificial intelligence wave. Chip stocks led the gains, with Micron Technology up 242% in a single quarter, and the Philadelphia Semiconductor Index setting a record for the best quarter in history.

However, whether US stocks can sustain this momentum is doubted by the market. High valuations, risks from rising interest rates, uncertainties of returns from AI investments, and lingering effects from the Middle East situation pose heavy challenges for the second half of the year. Analysts generally expect the market to continue moving forward in high volatility.

US stocks: Dual driving force from the AI wave and corporate earnings

The strong performance of US stocks in the second quarter was largely driven by chip stocks under the artificial intelligence theme. Micron Technology surged as much as 242% in a quarter, AMD up 186%, Broadcom up 22%, Nvidia up 15%. The Philadelphia Semiconductor Index as a whole climbed 88%, setting its best quarterly record ever.

The S&P 500 and Nasdaq indexes have recorded 24 and 20 historical closing highs respectively so far this year. The Dow Jones Industrial Average closed at its 19th historic high for the year on Tuesday, and outperformed the Nasdaq and S&P 500 by the largest margin in June, seen for the first time since October 2022.

The resilience of corporate earnings has also supported the market. FactSet data shows about 85% of S&P 500 constituent companies exceeded first quarter earnings expectations, the highest proportion since 2021. Analysts expect S&P 500 constituent companies' Q2 profits to grow by 22% year-on-year, with full-year increase likely to reach 23%.

Notably, market breadth is expanding. The Russell 2000 index tracking small-cap stocks and the Dow Jones Transportation Average both set their best year-to-date performance since 1991, seen as important signals of economic health. In June, the Dow’s finance, healthcare, and industrial sectors rose 4.2%, 6.5%, and 7.2% respectively, all significantly outperforming the communication services and information technology sectors, which dropped more than 3%.

Stifel stock strategist Thomas Carroll recently raised his S&P 500 target to 7,800, about 4% above Tuesday’s closing price. "The resilience of the stock market should not be underestimated," said Nathan Thooft, Chief Investment Officer, Equities & Multi-Asset Solutions at Manulife Investment Management.

Gold: Hawkish Fed and multiple negatives combine for a heavy blow

Gold's defeat was startling. Gold prices slid all the way down from the near-$5,595 per ounce record high set in January, at one point dropping to $3,942.99 on Tuesday intraday, the lowest since last November, with a quarterly decline close to 14%, marking the largest single-quarter drop since 2013. Silver performed even worse, falling 20% in the quarter to $59.48, its worst quarter since 2020.

Panmure Liberum analyst Tom Price attributes the main cause of this decline to shifts in Fed policy expectations. "The biggest drag facing gold is the market’s realization that the new Fed Chair is highly vigilant on inflation and will respond with interest rate hikes," he said. "Gold is thus under pressure and falling."

As a non-interest-bearing asset, gold is naturally at a disadvantage in a high interest rate environment; the relative appeal of interest-bearing assets like government bonds rises. In January, investors were still betting on Fed rate cuts, but the war in Iran caused energy prices to soar and completely upended this expectation. The Fed’s preferred inflation indicator recently rose to 4.1%, far above the 2% policy target, and bond yields climbed alongside.

MKS Pamp analyst Nicky Shiels pointed out that gold's drop isn't due to a single factor. "The narrative has shifted to AI and SpaceX, inflation data is weakening as support for gold," she said, listing the strengthening dollar, ETF outflows, Fed policy uncertainty, and the fading 'currency depreciation trade' as combined drivers. The so-called 'currency depreciation trade' refers to investors moving funds from fiat currencies into gold or bitcoin and other assets.

Some traders also cashed out their gold positions, betting instead on soaring AI stocks, chip stocks or SpaceX’s record IPO, analysts say.

Fund flows pressure further intensified gold's downtrend. Data from the World Gold Council shows June is likely to be the second consecutive month of net outflows from gold ETFs.

Meanwhile, Industrial and Commercial Bank of China and GF Bank announced they will restrict retail clients’ precious metals futures trading from next month, reflecting regulators’ concern over excessive speculation in gold and silver markets.

WisdomTree’s Head of Commodities Nitesh Shah said, "Any measure designed to suppress buying will not be positive." However, he also pointed out central bank demand may provide some support for gold prices.

High volatility may become the new normal for US stocks

Despite the strong performance of US stocks, market participants remain cautious about the outlook for the second half of the year. According to Dow Jones market data, so far this year, the S&P 500’s daily gains or losses have exceeded 1% on more than a quarter of trading days.

"The market will be extremely volatile," said Thomas Carroll. "It makes our work more interesting."

The direction of interest rates remains the greatest source of uncertainty. "There is widespread uncertainty about the direction of global central bank policy at present, with the Fed likely at the core," said Thooft.

Whether AI investments can translate into substantive profits remains a central unresolved issue. Saira Malik, Chief Investment Officer at Nuveen, said, "The future won't just be a story about technology stocks." As market momentum spreads to broader sectors, investors are looking for the next baton.

Risk warning and disclaimerThe market has risks, investment requires caution. This article does not constitute personal investment advice, nor does it consider the special investment objectives, financial situation or needs of individual users. Users should consider whether any opinions, viewpoints or conclusions in this article are suitable to their specific situation. Investment accordingly is at your own risk. ```