When the Federal Reserve is "extremely dovish," the possibility of both gold and U.S. stocks rising together is underestimated.
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The Federal Reserve will hold a monetary policy meeting next week, and the market generally expects the first rate cut of the year to take place then.
According to Chasewind Trading Desk, Citigroup analyst Derome Robinson and his team recently published a research report stating that during the "reflation" period when the Fed’s policy stance turns more dovish, the positive correlation between gold and risk assets such as stocks significantly increases, and their prices often rise in tandem. However, the current market is clearly underpricing this correlation.
According to Citigroup’s Fed policy stance indicator, the current market pricing of the terminal rate is below the level implied by inflation and growth indicators, showing that the Fed’s policy stance is already “clearly dovish.”
Against this macro backdrop, the historically observed linkage between gold and risk assets is returning. Citigroup's analysis shows that the six-month implied correlation between gold and risk assets such as the S&P 500 reflected in the options market is much lower than the levels that actually occur during similar dovish environments; the report states it “looks very cheap.”
Citigroup believes this pricing discrepancy means the market is underestimating the possibility of both rising together, and thus the bank favors strategies that pair the upside risk of stocks with the upside risk of gold.
Market pricing shows the Fed is distinctly dovish
In the report, Citigroup constructed a Fed policy stance indicator that assesses the central bank’s policy leaning by analyzing the residuals between market terminal rate pricing and market-based inflation and growth indicators.
The report points out that this indicator is currently at a low level, indicating the Fed’s pricing is “overly accommodative” relative to fundamentals.
The report further explains this dovish stance is based on consideration of future risks to the U.S. economy, especially signs of weakness in the labor market and potential personnel changes within the FOMC. Data show the U.S. unemployment rate continues to rise, and the duration of unemployment is increasing, all of which provide reasons for the Fed to maintain a loose policy.
No Longer Just a Traditional Safe-Haven Asset: Gold's Potential Remains Underestimated
In this policy-driven “fiscal dominance” environment, correlations among assets undergo systemic changes. Citigroup points out that the correlation between gold and risk assets (such as the S&P 500, Nikkei) as well as risk currencies (like the Australian dollar, British pound) often becomes more positive than what’s implied by market pricing.
Notably, the market has not fully digested this shift in correlation. By comparing the six-month implied correlation between gold prices and risk assets (from options market pricing) and the actual realized historical correlation over the same period, Citigroup finds a significant discrepancy between the two.
Citigroup emphasizes that gold is often mistakenly viewed as a safe-haven asset, when in fact the relationship between gold and bond yields is structurally unstable, weakening the case for its role as a pure hedge asset.
Therefore, Citigroup tends to view gold as a tool to hedge against "higher term premiums or policy errors".
In the current environment of the Federal Reserve’s dovish stance in response to potential economic risks, this attribute of gold allows it to perform strongly. This explains why gold can still rise in tandem with stocks in times of reviving risk appetite.
Based on this logic, the report believes that a “gold up + stocks up” combination is reasonable.
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