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Rising Asset Prices - Outside View by Asad Dossani
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Rising Asset Prices
Oct 4, 2010

Something quite interesting has been happening in the last few weeks. Stock markets have risen globally, while at the same time, gold has been rapidly rising, and at one point futures prices crossed $1300/oz. What is going on here?

Normally stocks and gold should move in opposite directions. When investors are optimistic, stocks will rise and demand for gold as a safe haven will fall. Similarly, when investors are pessimistic, they sell stocks and buy gold as insurance to their portfolio. This has historically been the case, as gold's bull run has largely come out of the financial crisis of 2007 and 2008, while at the same time stocks markets fell dramatically around the globe.

What can we learn from this information? If gold and stocks are both rising at the same time, it makes it difficult to interpret whether investors are optimistic or pessimistic about future economic prospects. The reality of the situation is that there is a high level of uncertainty about future economic prospects. Economic data coming out tends to be mixed. If we then extend this to investors themselves, we could conclude that investors themselves are uncertain - and this is reflected in the fact that both gold and stocks are rising at the same time.

How about the direction of bonds? Well, bonds have been rising too. Rising bonds are usually a sign of investor pessimism, and don't usually occur at the same time as rising stocks. How can we explain stocks, bonds, and gold all rising together?

I talked about this a bit in my article last week; the answer comes down to the central banks of the world devaluing their currencies. Low interest rates, quantitative easing, and running the printing presses all achieve the same thing: they devalue a currency by increasing the supply of money.

When the supply of money is increased, that money has to go somewhere right? This is exactly why gold, stocks, and bonds are all rising at the same time. The excess cash that is being pumped into economies around the world is getting invested in stocks, gold, bonds, and many other investments.

As long as global economics remain weak, quantitative easing will be a tool that central banks use to prop up their economies. And this will lead to asset prices rising across the board simply because there is a greater stock of money. Does this mean that your investments are more likely to be winners? Yes and no. Yes because if asset prices are more likely to rise, there's a higher chance an investment that you own will rise in value too. No because higher inflation as a result of increasing the money supply will erode the real value of your investments.

Rising asset prices, and specifically rising stock prices, is not necessarily a sign that the economy is getting better. It is, like in this case, a result of an increased money supply that has to be invested somewhere. This is an important point to remember because if and when quantitative easing ceases and money supply stops increasing, we could see large falls in stocks or gold or other assets.

Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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