Investors have been betting massively on an AI-driven future over the past two years, as tech stocks have led the S&P 500 to a 60% gain. But they also bought the “barbarous relic” of a monetary era that preceded the dollar’s hegemony, pushing the price of gold up by almost as much. Notably, gold outperformed alternative hedges against the dollar by a huge margin.
Why hedge against extreme distress amid ebullient tech-driven optimism? The answer is a lot could go wrong—catastrophically wrong, in fact. Tech stocks are now the core asset of the dollar-based world monetary system. The United States has sold US$24 trillion more of its assets to foreigners than foreigners have sold to Americans.
That “net international investment position” of $24 trillion, up from $18 trillion at the end of Donald Trump’s first term in office, paid for America’s cumulative trade deficit over the past 30 years. For the past 10 years, foreigners have been buying stocks rather than US Treasury bonds, as in the past.
Foreign central banks hold less US government debt now than five years ago. If the tech boom turns out to be a bubble, so will the US dollar. The race for AI market share could dictate the fate of the dollar. If, for example, China’s open-source DeepSeek beats ChatGPT and the other American large language models, tech stocks could tank and, with them, the dollar.
There are lots of ways to hedge against the dollar. Few of them are attractive. An American budget deficit of 6% to 7% without a war or recession, as incoming Treasury Secretary Scott Bessent told Congress last week, is without precedent. But the dollar’s status as a reserve currency means that America has first dibs on the world’s capital.
The runup in inflation-indexed US Treasury yields—in part driven by expectations of a higher US deficit under Trump – pushed up the dollar against all major currencies. If US inflation rises, so will US interest rates, and the dollar’s exchange rate will rise against other currencies, even while the dollar loses value.
But even while all currencies sank against the dollar in response to rising “real” (inflation-indexed) Treasury yields, gold rose, breaking a pattern that prevailed from 2007 through 2022.
The break in the long-term relationship between TIPS and gold coincided with the seizure of Russian reserves in March 2022 by the US and its allies. China, Saudi Arabia, India, and other central banks gradually shifted reserves away from Treasuries into gold. On paper, TIPS and gold offer similar payouts: If the dollar tanks and US inflation rise, both assets will gain value.
The difference is that the Treasury can’t seize gold in a central bank’s vault the way it can seize central bank holdings of its own obligations. Up to 80 basis points (0.8%) of the rise in TIPS yields during the past six months, I showed in a January 10 analysis, can be attributed to foreign central banks’ sales of US Treasury securities.
The hedge fund pack has followed central banks into gold. A giveaway is the shift in the relationship between the price of physical gold and options on the gold price. Implied volatility is a normalized gauge of the cost of gold options, and under normal circumstances, it falls as the gold price rises.
That’s because gold mining companies have been the biggest buyers of gold options; when the gold price falls, they buy options to lock in their earnings, and vice versa. But in 2024, something new happened: The cost of gold options rose along with the gold price.
The scatter chart below of gold implied volatility against price forms a “V.” That reflects hedge fund bets on a rising gold price.
Gold is a standout in the complex of options on macro variables (stocks, currencies, bonds, and commodities). The cost of gold options (implied volatility) is trading at a two-year high while the cost of risk is muted in other markets.
Gold’s virtue is that its value is independent of government decree: It is the monetary asset of last resort, the medium of exchange that will be accepted if all else fails. With few exceptions, the debt of nearly all the major economies has risen alarmingly relative to economic output during the past decade.
President Trump is walking a tightrope, trying to stimulate economic growth through tax cuts while juggling a record non-war, non-recession budget deficit. Gold’s outperformance warns us how risky this is.
Follow David P Goldman on X at @davidpgoldman
