27-Oct-23 Commodities

Gold at a time of tragedy

Amidst rising tensions in the Middle East, gold seems to be living up to its reputation as a safe haven. Ironically, softer inflation data might also prove supportive

Predicting a logically possible event is generally a safe bet, if only the time horizon is long enough.[1] Take the idea that gold can still act as a hedge against geopolitical risks or rising inflation, as it did during its spectacular price gains of the 1970s. Over the past decade or so, by contrast, the precious metal has often failed to gain in response to geopolitical risk events.[2]

In recent weeks, since the horrendous attack by Hamas on October 7th on Israel things have been different. At a time of countless human tragedies unfolding in Gaza and rising tensions in the Middle East, gold seems to be living up to its reputation as a safe haven for scared investors.[3] The gold price has risen significantly since the end of the first week of October. Compared to the closing price on Friday, October 6th, it gained over 8% when it peaked on October 20th and since holding on to most of these gains.

For reference, compare this to previous times of geopolitical tensions. After the terrorist attacks of September 11, 2001 the price of gold rose by 6.5% within five trading days, while equities, as measured by the MSCI World Index lost around 5%. However, in the two months following the attack, gold lost 5%, whereas the MSCI World Index rose by 4.5%.

Roughly where it should be: gold prices compared to U.S. Treasury yields over the long term

Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 10/25/23

"And to take a more recent example: after the end of the first full trading week after the Russia's full scale invasion of Ukraine in February 2022, the gold price rose by only 1.3% (but after another 5 days by almost 8%), while the MSCI World Index only reacted mildly negatively, and only did so after a little delay: 5 days after the Russian assault, the MSCI World Index was actually up 2%; after 10 days it was slightly in the red. After two full months, gold was still up almost 2%, while the MSCI World Index was still slightly in the red."

These two comparative examples show that context matters, when it comes to the gold price. With the growing popularity of exchange traded vehicles for gold investments, market technicals probably matter more nowadays than in decades gone by. The metals appeal may also have been boosted by a lack of short-term alternatives, with the MSCI World Index down roughly 2% since October 6th, and bonds offering the opposite of protection in recent weeks.  

Our Chart of the Week makes this point about how the context matters in a slightly different way, by showing the gold price compared to the inverse of nominal yields on 10-year U.S. Treasuries since 1980. By that measure at least, the precious metal is now roughly trading where it should be. Of course, the problem with any such claim is that there is no obvious way to value gold. The metal generates no real “earnings”. However, the opportunity cost of holding it might be captured by returns generated by other safe assets, such as U.S. Treasuries. Purists will argue that a better proxy for the opportunity cost of owning gold would be real, rather than nominal interest rates. These are tricky to estimate or measure, though, especially when going back decades.

History also shows that gold cannot be relied on to fulfil its function as a hedge against inflation during periods of secular declines in inflation and nominal interest rates. For example, gold lost more than 80% in real terms between 1980 and 2001.[4] That should be kept in mind when assessing the medium-term prospects for the gold price, if interest rates remain at a high level for longer than expected. Moreover, we believe that we have reached the end of the current hiking cycle and that increased prospects for a recession will help keep a floor under the gold price. The continued purchases of bullion by central banks, such as China and India, should also be supportive. Perhaps ironically, though, so would be softer inflation data, at least in the short to medium term.   

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1. Deutsch, D. (1997) The Fabric of Reality: Towards a Theory of Everything, Penguin, esp. pp. 98-122.

2. See, for example: The mystery of gold prices (economist.com)

3. Gold rallies as geopolitical turmoil overshadows rising bond yields (ft.com)

4. See, for example: The mysterious quiescence of the gold market (economist.com)

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