Gold failed to act as a safe haven for investors amid escalating geopolitical tensions, experiencing a significant sell-off on Thursday, March 19th. The price of gold plummeted 14% from its level prior to the start of the U.S.-Israeli conflict with Iran, a surprising move given its traditional role in times of uncertainty.
Cotația aurului a scăzut. FOTO: Profimedia
The unexpected decline, reported by The Wall Street Journal, has left investors disappointed in the traditional safe-haven asset. This downturn challenges the conventional wisdom that gold thrives during periods of inflation and geopolitical risk.
While technical explanations for gold’s underperformance exist, analysts suggest they don’t fully account for the magnitude of the drop. A key factor appears to be the asset’s recent popularity, which led investors to quickly sell off holdings as the conflict began, either to secure profits or reduce exposure to risk.
The value of gold is typically assessed in U.S. Dollars and the dollar’s strength following the commencement of hostilities with Iran, driven by the U.S.’s position as a net energy exporter, initially suggested a negative impact on gold. However, the precious metal as well experienced significant declines when measured in British pounds (11%), Euros (10%), and Japanese Yen (11%).
Dollar Weakness Failed to Provide Support
Thursday’s trading session offered a potential reversal, as the dollar weakened, which typically supports gold prices. Despite this, gold experienced its worst day since the start of the conflict, falling nearly 6%. The dollar’s impact, appears to explain only a little portion of the overall decline.
Gold prices are also typically sensitive to real interest rates, adjusted for inflation. As a hedge against inflation, the opportunity cost of holding gold is the yield offered by inflation-protected U.S. Treasury securities (TIPS). Gold prices tend to fall when yields rise, becoming relatively less attractive.
And yields have been increasing. Investors are now anticipating higher inflation in the short term and expect the Federal Reserve to maintain or even increase interest rates this year—a significant shift from expectations just a month ago, which predicted two or three rate cuts. This has driven up yields on 10-year TIPS.
This partially justifies a lower gold price, but doesn’t fully explain the recent declines. Historically, gold prices moved consistently in the opposite direction of TIPS yields, but this relationship broke down as gold became more expensive. Over the past year, gold increased alongside rising yields. However, during the conflict, the inverse correlation appears to have returned, moving in opposite directions in 11 of the last 15 days. Again, this only accounts for a small portion of the drop.
Gold Became a “Crowded Trade”
The most compelling explanation is that gold had become a “crowded trade.” Similar to stock market dynamics, assets that experienced the largest gains before the conflict began saw the steepest declines when investors moved to reduce risk.
This phenomenon was fueled, in part, by traders using leverage to amplify their positions. As they reduced risk, they sold their long positions and repurchased short positions, leading to unusual volatility in popular speculative stocks.
It’s impossible to determine exactly how much investors borrowed to purchase gold. However, it’s clear that the asset attracted significant speculative capital over the past year, reflected in massive purchases of the SPDR Gold Shares, the largest gold ETF. The situation became so extreme last fall that the price of gold and stocks popular among retail investors moved in tandem.
As speculators reduce their exposure, gold naturally suffers.
Central Bank Purchases Also Drove Investor Interest
The recent surge in gold began when central banks started diversifying their reserves, favoring gold over dollars following the freezing of Russian foreign assets after the invasion of Ukraine. This trend then attracted other investors looking to capitalize on the momentum.
However, the conflict in Iran raises questions about how far this process can continue. The role of foreign exchange reserves is to protect a country’s ability to import during times of shock. Iran’s response to the attack has created what the International Energy Agency calls “the largest supply disruption in the history of the global oil market.”
What we have is a moment when oil importers should draw down reserves, not accumulate them—and if they don’t increase their reserves, they will find it harder to buy gold. Oil-rich countries in the Persian Gulf region, facing financial difficulties due to an inability to export through the Strait of Hormuz, could also shift from buyers to sellers.
A similar dynamic applies to individual investors, particularly in India and China, where gold investment is more common than in the West. As oil prices impact their economies, they may decide to sell some of their gold holdings.
These issues are likely temporary. As with all assets, once the “crowd” exits, the price can revert to fundamentals. In the case of gold, these fundamentals include inflation, interest rates, and geopolitics. However, it remains uncertain how many of the buyers from the past year will demand to sell for this to happen. If central banks are among those sellers, gold could have further to fall before regaining its luster, the American journalists conclude.
