You may have seen headlines implying that the stock market, namely, the S&P 500, is “disconnected” from the economy. What about the gold market? It’s also been on a bit of a tear as of late. Is it getting a head of itself? Or does it have something important to say?

As I pointed out recently, I think the S&P 500 is connected to the economy at the hip; that is, it accurately reflects the current, and potential future state, of the economy. From my admittedly amateurish perspective, I feel the same way about the gold market (though I’m currently not invested in it). Here’s why.

Unlike the money created by the central bank or the oil we extract from the earth, the supply of gold doesn’t vary all that much. This means it can be used to help preserve one’s wealth against a loss in the buying power of money and a corresponding increase in the prices of goods and services, also known as inflation.

John Authers from Bloomberg published a great article on gold today. He points out that gold futures are being used to take physical delivery of the metal at an unprecedented scale, particularly among family offices and high-net-worth individuals –part of the so-called “smart money.” Why would the smart money be so interested in gold, particularly the actual physical stuff?

The short answer is: fear.

Around the world, people are fearful of SARS-CoV-2, the virus that causes Covid-19. As a result, they’re doing (e.g. working) and spending less. Economists call it “demand shock.” As long as this persists, the risk that the prices of goods and services will rise (inflate) will remain suppressed.

For instance, if you’ve been to Macy’s lately, you’ll see that the prices of clothes have been slashed –some by up to 75% off, according to my wife. Raising their prices just wouldn’t make sense for Macy’s with demand so low.

On the other hand, the ongoing lack of demand keeps the pressure on central banks to continue creating (a.k.a. “printing”) money in an effort to keep their respective economies above water. Paul Tudor Jones refers to it as “the Great Monetary Inflation…an unprecedented expansion of every form of money unlike anything the developed world has ever seen.”

The Federal Reserve (the US central bank) hopes that much of the money it has created will ultimately trickle down to households, for example, in the form of relief checks or unemployment extension payments issued by the federal government. But many households are not surprisingly running out of money. Simply stated, the money supply is expanding faster than we can collectively spend it. This is why all this “money printing” is not causing inflation, yet.

Only once the fear of SARS-CoV-2/Covid-19 subsides and demand is restored can inflation really kick in. This requires effective Covid-19 vaccination efforts backstopped by broadly effective treatments. (So far, we have neither.) That could take a while, possibly a long while. The smart money knows this, it would seem. Investors also fear that, when inflation does finally start to rise, the central banks will have a tough time controlling it.

In the meantime, the smart money isn’t taking any chances with their wealth. They figure they might as well invest in gold now, before fear drives its price even higher. They’re fearful enough, in fact, that some are taking delivery of the actual physical stuff, as John Authers and other financial journalists have recently pointed out.

All of which explains why I say the gold market is connected to the economy at the hip; they see eye to eye. Will the predictions about inflation be proven right? The future is unknowable. All we can know is that the market is right, right now.