Gold or US Treasuries: Which is the Better Hedge?

Buying gold is a hedge against the credit risk of the dollar system itself, such as doubts about AI enhancing US productivity.

Written by: Song Xuetao, Wall Street Journal

Gold is both a long-term reserve asset and a financial asset that can be quickly liquidated; it meets both hedging demand and trend trading and leveraged positions. After the decline of US stocks on October 8, the safe-haven value of US Treasuries became prominent, and yields fell, but gold failed to attract safe-haven funds, which is the crux of the issue.

Firstly, deleveraging may have triggered liquidity tensions across markets.

The scenario of falling US stocks, declining US Treasury rates, and falling gold prices has occurred during extreme downturns in 2008 and 2020. However, this time is different: first, the decline in US stocks is far less than in 2008 and 2020; second, the dollar index, which reflects short-term liquidity demand in the market, has not significantly strengthened.

Regarding the former, although US stocks did not experience a panic sell-off, the resonance decline in several AI narrative-driven stocks may have triggered localized deleveraging, causing leveraged investors to sell assets to obtain cash to meet short-term margin requirements.

As for the latter, it may be related to the Bank of Japan's intervention. Observing the confirmed yen intervention actions since February this year (the chart shows the USDJPY exchange rate, with the green candlestick indicating the performance of the USDJPY exchange rate on the day of BOJ intervention), on October 22, the market trend was similar to the performance during each BOJ intervention, which may signal a new round of intervention, but confirmation can only be made retrospectively. If BOJ intervention suppressed the fact that the dollar 'should have strengthened,' it further confirms that the reason for gold's decline is the selling triggered by liquidity tensions.

Under market liquidity pressure, the risk asset attributes of gold are somewhat correlated with the performance of gold mining stocks. The significant gains accumulated by gold mining stocks in the past will also feedback into gold, increasing its risk asset attributes and price elasticity. In the past month (from September 26 to October 27), the gold mining stock ETF (GDX) fell by about 12.3%, compared to a decline of about 3.9% in the Nasdaq 100 ETF (QQQ) and a drop of about 6.1% in spot gold. Although concerns about inflation, declining real yields, and geopolitical risks still support gold in narrative terms, the impact of selling on short-term prices dominates.

Secondly, gold and US Treasuries hedge different risks.

Buying US Treasuries hedges against risks in (the US) economic growth and markets, or political risks in non-US economies; in other words, under the premise of a stable dollar system, the opposite of US Treasuries is US stocks. Buying gold, on the other hand, hedges against the credit risk of the dollar system itself, such as doubts about AI enhancing US productivity.

The market's divergence on AI allows gold to maintain its hedging value. If AI can continuously improve productivity and translate model revenue and corporate efficiency improvements into real profits, then the potential growth and tax base of the US may be supported, weakening gold's relative attractiveness.

Conversely, if AI revenue growth is insufficient to cover capital expenditures, depreciation, and financing costs, the market may reassess the economic returns previously invested. Once this concern extends from corporate profits to financial stability, fiscal burdens, and future policy responses, the value of gold as a hedge against dollar credit risk may rise.

Currently, the market is only worried that AI investment returns may fall short of expectations and that tech stock valuations need adjustment; it has not yet doubted the overall development of the AI industry and the overall financing capacity of the US. The prices of AI tech stocks have fallen after OpenAI and Anthropic disclosed slowing model revenue growth and CRWV credit risk fermentation, but the absolute scale of capital expenditure in the AI industry and the total usage of global large models are still increasing.

Skepticism about AI tech stocks and skepticism about the AI industry or even dollar credit are two different levels of trading. The former has already occurred, but it does not mean the latter will necessarily happen simultaneously. Funds can sell tech stocks and buy US Treasuries, remaining within the dollar system. Therefore, US Treasuries benefit more directly than gold.

Additionally, the simultaneous deterioration of the economic and political environment in Europe also highlights the relative resilience of the US economic and political system, suppressing 'shorting America' trades represented by buying gold.

Finally, uncertainties regarding oil prices and interest rate hikes remain a short-term constraint on gold.

In the October FOMC meeting, the Federal Reserve kept the policy rate unchanged, but two members still advocated for a 25 basis point rate hike; the statement also emphasized that inflation remains elevated and more information is needed to judge the subsequent policy direction. This pause allows time to observe the effects of previous rate hikes, but the actual interest rate pressure facing gold has not been alleviated.

Waller pointed out at the press conference: Recently, oil prices have continued to rise, while market interest rates have fallen; interest rates have already affected investments and financing in the tech sector, with credit spreads on some assets widening significantly, and capital allocation becoming more cautious; overall financial conditions have 'tightened somewhat,' and capital allocation has become more prudent. This means that the Federal Reserve has observed the transmission of interest rates to tech investments and credit conditions but has not released clearer signals of easing.

In the short term, the trend of gold needs to be observed in conjunction with oil prices, wars, and interest rate expectations. If conflicts escalate, oil prices rise, but interest rate hike expectations do not increase, and nominal interest rate increases are lower than inflation expectations, real interest rates may fall, providing support for gold. In this scenario, if gold still declines due to deleveraging or liquidity issues, it may enter a bottoming phase.

In the long term, the long-term allocation value of gold remains relatively certain, fundamentally supported by the continuous erosion of fiat currency credit due to the expansion of fiscal deficits and debt accumulation in developed countries. The allocation space for gold is related to the market's optimism about AI: optimism about AI corresponds to the peak of gold, while pessimism about AI corresponds to the bottom of gold. The higher the visibility of AI revenue, the more compressed the allocation space for gold; the lower the visibility, the larger the allocation space for gold.

Risk Warning

Inflation, war, and monetary tightening exceeding expectations; cross-market deleveraging exceeding expectations; AI investment returns and productivity boosts exceeding expectations.

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