Chartbook 422: The malign coincidence revisited: The great "melt up" of 2025, hyperfinancialization and liquidity.

If you think of equity investment as a sign of optimism and gold as a hedge against catastrophe, then in 2025 there was something weird going on: US equities and gold surged together.

By the end of the year, on some metrics, both had entered bubble territory. According to a recent BIS note by Giulio Cornelli, Marco Jacopo Lombardi and Andreas Schrimpf, it is the first time in half a century that this has happened.

The graph on the left shows the result of a statistical test (unit-root test) that, loosely put, shows whether data series are exhibiting non-stationary behavior i.e. whether they are “exploding” upwards or downwards away from their previous track. The high ratings for both gold and the S&P 500 in the final months of 2025 suggest that something “explosive” is going on in both markets. And, as the data going back to the early 1970s show, “(t)he past few quarters represent the only time in at least the last 50 years in which gold and equities have entered this territory simultaneously”.

A historical novelty like this calls for an explanation. So how does one account for equities and gold “partying together”?

In a widely-read FT piece in the autumn Ruchir Sharma commented as follows:

Most analysts think gold is soaring amid a new stock boom because investors want to hedge against rising policy uncertainty, particularly in the US. This theory implies, however, that global investors have an extraordinary tolerance of cognitive dissonance in fully embracing artificial intelligence-driven optimism for US stocks and the caution associated with gold. It also just seems a bizarre choice — why hedge with gold at a time when more direct forms of protection (such as buying put options on stocks) are cheap by comparison? I think there is another explanation for the gold-stock duet: massive liquidity. Governments and central banks rolled out trillions of dollars in stimulus during and after the pandemic. Much of that is still sloshing around the system and continues to drive the momentum trade across many assets, including stocks and gold. On the back of it, the sum Americans hold in money market mutual funds surged after the pandemic and now totals $7.5tn, or more than $1.5tn above the long-term trend. While the Federal Reserve says its policy is “mildly restrictive”, the fact is that nominal interest rates are still below the rate of nominal GDP growth, which keeps financial conditions loose. Governments are doing their part, led by the US with the highest deficit in the developed world. The flip side of a huge deficit is a huge private sector surplus (as the Kalecki-Levy equation shows). Liquidity is also a function of people’s risk appetite. The more confident they feel about the upside in financial assets, the more money they are willing to pour into the markets. US households have ramped up their exposure to stocks and other risk assets in recent years, emboldened by a united government-central bank front to protect markets. Investors have been conditioned to expect a state rescue at the slightest hint of trouble. By sharply lowering the risk premium, state support in effect opens the liquidity floodgates. For investors, the downside feels protected and the upside uncapped. Hyper-financialisation is also boosting liquidity. The spread of new trading apps and exotic, largely commission-free investment vehicles make it much easier for anyone to buy financial assets, funnelling liquidity into multiple corners of the market. The gush of liquidity helps explain the new tie between gold and stock prices. Historically, the correlation between them was zero. In the gold rush of the 1970s, stocks were dead in the water; in the stock boom of the 1990s, gold prices were falling. Now they’re rising together on a tide of liquidity.

Sharma concocts his liquidity hypothesis out of a bunch of quite distinct factors:

• Liquidity due to COVID stimulus and loose monetary policy.

• “Fed put” i.e. expectation of a Fed bailout in case the market slumps.

• Fiscal deficits, which, by macrofinancial accounting identity, mean private surpluses. (Kalecki-Levy)

• Endogenous money-creation driven by risk appetite

• Hyperfinancialization sucking in new, retail money.

As a cocktail, these arguments don’t necessarily go together well and some of them e.g. Kalecki-Levy don’t point directly at financial markets.

As Dario Perkins comments in a smart note for TS Lombard, the liquidity hypothesis blandly stated does not actually explain much:

The problem with the “L” word is that in the modern collateralized financial system – where liquidity is endogenous to risk appetite – it doesn’t make sense to assume a fixed quantity of available funding. Too often, pundits think of asset-price determination in terms of “loanable funds” (the fiscal deficit argument above falls into this category, AT), but this has never really been correct. There is no fixed amount of liquidity – one that is tied to monetary policy (the Fed argument above, AT) – looking for a home in the financial sector. Asset prices are set at the margin, not according to whether a new buyer (with new money) (the trading app theory, AT) is available to replace existing asset holdings. And a shift in perceived fundamentals should make buyers more determined to purchase a security and holders less inclined to sell, regardless of the amount of liquidity in the system or the level of interest rates. (Real rates were, in fact, high during dotcom, for example.) … What typically happens during a bull market is that there is a shift in risk premia/expected returns and the financial system flexes to create the new balance sheet (endogenous money creation, AT). Over time, a virtuous cycle can kick in. Returns and profits rise, particularly where there is a new technology to create new sources of wealth. This raises collateral values and leads to further increases in asset prices. If those initial expectations about returns were too optimistic or markets get ahead of fundamentals, you get a bubble; and when that bubble bursts, the process kicks into reverse – a vicious feedback loop replaces a virtuous cycle. “Money” and asset prices will be correlated, but that doesn’t tell you anything interesting.

Perkins himself clearly prefers the endogenous money argument, in which credit expansion is driven by shifting risk appetite, which isn’t incompatible with Sharma’s narrative if more precisely formulated.

That shift in risk appetite could be a general mood shift, or it might be a rotation from less to more risk-happy investors. The BIS authors add fascinating material to bolster the idea about popular hyperfinancialization.

A typical symptom of a developing bubble is the growing influence of retail investors trying to chase price trends. At times of media hype and surging prices, retail investors can be lured to riskier assets that they would normally shun, compounded by herd-like behaviour, social interactions and fear of missing out. Indeed, measures of retail investors’ interest in markets, such as internet searches, tend to surge at times of frothiness … This time around, there is also evidence that retail investor exuberance and appetite for seemingly easy capital gains have spilled over to a traditional safe haven such as gold. Since the beginning of 2025, gold exchange-traded fund (ETF) prices have been consistently trading at a premium relative to their net asset value (NAV) amid growing retail investor interest (Graph C2.B, blue line). ETF prices exceeding their NAV signal strong buying pressure coupled with impediments to arbitrage.

What the BIS authors also note is that as retail investors are buying gold and equities, professional, institutional investors are selling.

Furthermore, retail investors have increasingly taken trading positions that run counter to those of their institutional counterparts: the latter were taking money out of US equities or maintaining flat positions in gold, while retail investors recorded inflows (Graph C2.C). Although the influx of retail investors has mitigated the impact of institutional investor outflows, their growing prominence could threaten market stability down the road, given their propensity to engage in herd-like behaviour, amplifying price gyrations should fire sales occur.

So a plausible account of the current bubble is a self-feeding surge in confidence, amplified by endogenous credit creation with retail investors and the media to the fore. The risks to the financial system are somewhat moderated by the fact that institutional investors are taking more cautious positions. If there is a bust, this is good news, at least so long as retail investors are not as heavily leveraged as professional hedge funds might be.

What is missing here is sociology and specifically the diagnosis of the “K-shaped” economy. The general “melt up” in asset prices - AI stocks, commodities and gold - in the first year of the Trump Presidency is unfolding within the balance sheets of the top 20 percent of American income earners.

Source: FT

This is the most influential, vocal and politically engaged group in American society. It includes many of the readers of this newsletter, if not in the immediate present, then prospectively. We generally think of the top 20 percent of US income-earning households - by rights I should be saying “ourselves” - as being highly polarized in political terms. If we view ourselves, instead, as an “asset-owning class”, the markets tell a rather different story. Since the initial panic of the spring following Trump’s tariff announcement, the striking thing is that so many of the indicators that often move contrariwise have actually gone up together. The malign coincidence is ultimately what may define 2025.

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