'Gold caught in speculative frenzy': Economist Ruchir Sharma warns of liquidity overdrive

Breakout Capital founder and Rockefeller International Chairman Ruchir Sharma said the simultaneous surge in gold, stocks, and the dollar reflects "massive amounts of liquidity sloshing around the system," warning that the current "everything rally" could unwind sharply if central banks withdraw excess money next year.

In an interview with CNBC, Sharma said, "Stocks are partying like it's 1999 and gold is partying like it's 1979, and those two eras were so very different, with 1979 being associated with rampant inflation, geopolitical turmoil. And 1999 with the tech boom, which is what the AI boom is today."

"The only explanation that I get here is the fact that there's still massive amounts of liquidity sloshing around the system and that's fueling momentum trades across different corners of the market," he said.

Sharma, who has long been bullish on gold, cautioned that the recent surge in gold prices is no longer led by traditional safe-haven demand. "I've been a bull on gold for the last few years, but my concern is that there's no good story that too much money cannot spoil. The main demand for gold over the last few months has shifted to ETF demand. When the gold bull market started in earnest around 3 years ago following the sanctions that the US imposed on Russia, that was led by central bank buying. But the last few months it's really been a lot of ETF buying-in fact the ETF flows into gold in the last quarter were the highest ever," he said.

He noted that more than $1.5 trillion in excess liquidity remains in money market mutual funds even five years after the pandemic stimulus, driving speculative trades. "Gold has now got caught up in this liquidity-driven speculative frenzy," Sharma said. "What will happen is that next year, let's say that if inflation resurfaces and by any chance the Fed is forced to withdraw some of this liquidity, then the problem is going to be that gold will no longer act as the hedge."

Explaining why gold's rise may turn risky, he added, "A lot of people who say they're buying gold say they're doing it because it'll be a hedge...but my point is that gold's parabolic increase that's taken place in the last few months is not being driven by the traditional safe investors looking for just hedges. It's being driven by the same momentum retail crowd that's been driving up stocks as well."

According to Sharma, this means gold and stocks could fall together when liquidity tightens. "On the downside, there'll also be a positive correlation. So that's the big change that's happened and that's something we need to be cognizant of rather than thinking that gold is going to act as a hedge on the downside," he said.

When asked if gold had worked as a hedge so far, Sharma said, "Absolutely. So it's not been a hedge, it's been a parallel trade. Everything is rising in sync. We've never had a period where, in fact, gold has outperformed stocks in a bull market. That's just never happened. So, currently everything is rising. Everyone's happy...It's been like an everything bull market."

He added that the surge in gold is being driven by retail investors and excess money in the system, not traditional safe-haven buying. "I'm still bullish on gold in the very long term, but my concern is that on the upside now, we're seeing so much retail flow and so much massive liquidity find itself into gold that on the downside people will be surprised that there is also a positive correlation at least for a while," he said.

Asked how the unusual gold-stock correlation might end, Sharma replied, "A lot of people used to point to gold as an inflationary warning. So, the way I think that this ends is that traditional inflation finally does show up at some point-possibly next year-and then when the Fed is forced to increase interest rates and central banks have to withdraw some of this excess liquidity...that's when both stocks and gold go down simultaneously."

He concluded with a warning: "Until that happens, I guess it's a party everywhere. And that famous line goes that we know that this party is feeling extended, but the clock has no hands."