Eliza Wong
With the Federal Reserve’s upcoming policy meeting widely expected to deliver the first interest rate cut of the year, a compelling narrative is emerging—one that challenges conventional wisdom about how gold and equities interact in a dovish monetary regime. According to a recent report from Citi, led by analyst Derome Robinson and his team, gold and risk assets like equities have historically exhibited stronger positive correlation during ‘reflationary’ phases marked by accommodative Fed policy. Yet, current market pricing significantly underestimates the likelihood of both asset classes rallying in tandem. This article delves into Citi’s groundbreaking analysis, the macro forces at play, and what it means for investors looking to capitalize on this mispricing.
Market Pricing Signals a Clearly Dovish Fed
Citi has developed a proprietary Fed policy stance indicator that evaluates whether the market’s terminal rate expectations are aligned with underlying inflation and growth metrics. The indicator currently sits at low levels, suggesting that the Fed’s implied policy path is ‘excessively accommodative’ relative to economic fundamentals.
How the Indicator Works
The model analyzes the residual between market-implied terminal interest rates and signals from market-based inflation and growth indicators. A negative residual implies that the Fed is priced to be more dovish than what macroeconomic conditions would typically warrant. This dovish tilt is largely driven by growing concerns over labor market softness and potential shifts within the FOMC. Recent data shows a steady climb in U.S. unemployment rates and an increase in the duration of joblessness, reinforcing the case for sustained monetary easing.
Gold Is Not Just a Safe Haven—Its Role Is Evolving
In a regime of fiscal dominance and aggressive monetary easing, cross-asset correlations undergo structural shifts. Citi notes that gold’s relationship with risk assets—such as the S&P 500 and the Nikkei—and risk-sensitive currencies like the AUD and GBP tends to become more positively correlated than what options markets imply.
Historical Patterns and Current Gaps
By comparing six-month implied correlation (derived from options pricing) with realized correlation during past dovish cycles, Citi identified a substantial gap. The market is not fully accounting for gold’s shifting behavior in the current macro environment. Importantly, gold is often misclassified as a pure safe-haven asset. Its relationship with real yields is structurally unstable, undermining the case for treating it merely as a hedge against equity selloffs. Instead, Citi reframes gold as a hedge against ‘higher term premiums or policy mistakes.’
Why Gold and Equities Can Rise Together
When the Fed adopts an overtly dovish stance to counter economic vulnerabilities, gold performs well even as risk appetite rebounds. This explains why, during such phases, gold has frequently moved in lockstep with equities rather than inversely.
The Reflation Trade
A dovish Fed typically fuels reflation expectations—boosting nominal growth prospects, weakening the dollar, and elevating inflation expectations. All of these are supportive for both gold and equities. Lower real rates reduce the opportunity cost of holding non-yielding assets like gold, while also supporting equity valuations through lower discount rates.
Citi’s Strategy: Pairing Equity Upside with Gold Exposure
Given the mispricing in cross-asset correlation, Citi advocates strategies that pair long exposure to equity upside with long positions in gold. This approach is designed to capture the convergence between implied and realized correlation as the market reprices Fed dovishness.
Implementation Ideas
– Evaluate gold miners ETFs or futures alongside S&P 500 call options. – Consider structured products that blend gold and equity risk premia. – Monitor Fed communication and labor market data for confirmation of the dovish narrative.
Risks and Considerations
While the thesis is compelling, investors should remain aware of potential pitfalls. If inflation proves stickier than expected, the Fed may delay or slow its easing cycle, which could weaken the gold-equity correlation. Geopolitical flare-ups or sudden risk-off episodes could also temporarily decouple the two assets.
Key Takeaways for Investors
The market is currently underestimating the probability of gold and stocks rising together amid a dovish Fed. Historical patterns and Citi’s proprietary analysis both suggest that this correlation is likely to strengthen. Investors may benefit from strategies that embrace, rather than avoid, this convergence. Review your portfolio’s sensitivity to real yields and Fed policy shifts, and consider whether your gold exposure is structured to capture its role as a hedge against policy error—not just equity downturns. For those looking to act, now may be the time to explore paired opportunities in gold and equities before the market reprices this relationship.
