Investors would have been better off in microcap stocks than in the oldest source of safety.
This should be the time for gold to shine. The yellow metal has the perfect opportunity to demonstrate its role as a shield for investors against inflation and geopolitics.
Instead, it has crumbled: At one point Thursday it was down 14% from before the Israeli-U.S. war against Iran began. Investors would have been better off in the tiniest microcap stocks than in the oldest source of safety.
There are technical excuses for gold’s failure to fulfill its promise, but they don’t really stand up to scrutiny. The problem is one that bedevils investors every time they pile into fashionable trades: other investors.
Put simply, gold had become wildly popular over the past year, so when the war started it was the obvious thing to sell, either for caution or to pay down debt.
Start with the excuses. Gold is priced in dollars, and the dollar has risen a lot since the bombing began thanks to the U.S. position as a net energy exporter. That should directly hurt gold and other globally traded assets priced in dollars. Yet gold is also down a lot in British pounds (11%), euros (10%) and yen (11%).
Thursday provided another test. The dollar fell, which should help gold. But the shiny stuff had its worst day of the war so far, dropping almost 6%. At best, the dollar explains only a tiny part of the fall.
Gold is usually sensitive to real, inflation-adjusted interest rates, too. Treat it as a safe inflation-proof asset, and what you give up by holding gold is the after-inflation yield available on the benchmark safe inflation-proof assets, Treasury inflation-protected securities. Gold should fall in price, therefore, when the yield rises, since that makes gold relatively less attractive.
And the yield has risen. Investors are pricing in more near-term inflation and expecting the Federal Reserve to keep rates on hold this year or even raise them. That is a big change from the two or even three cuts expected a month ago, lifting the 10-year TIPS yield.
This does justify a lower gold price, but isn’t a good explanation for its declines at the moment. The price used to move fairly consistently in the opposite direction of TIPS yields, but the link broke down as the gold price soared. For a year gold has tended to rise as yields rose. Day-to-day moves during the war show a link has returned, moving inversely in 11 out of the past 15 days. But, as with the dollar, that can explain only a small part of gold’s fall.
Instead, the best explanation is that gold is a crowded trade. As with stocks, what went up the most in the months preceding the war fell the most as investors pulled back.
Some of this was about traders who had borrowed to juice their positions. When they cut risk they sold stocks they owned and bought back those they had sold short—leading to unusual swings in stocks popular with hedge funds.
It’s impossible to know how much investors borrowed to buy gold. But it had clearly attracted a lot of speculative money over the past year. This was reflected in heavy buying of the main gold exchange-traded fund, SPDR Gold Shares. Last autumn it got so extreme that the gold price and stocks popular with day traders moved in tandem.
As speculators pull in their horns, gold should naturally suffer.
Gold’s big gains started as central banks put reserves into gold instead of dollars after Russia’s foreign assets were frozen following its full-scale invasion of Ukraine. Big increases in central-bank buying led others to piggyback on the price gains.
The war in Iran raises questions about how far this can continue. The point of foreign-exchange reserves is to protect a country’s ability to buy imports when it suffers a shock. Iran’s response to being attacked has created what the International Energy Agency, a club of mostly rich-world countries, calls the “largest supply disruption in the history of the global oil market.”
This is the time for oil importers to be spending reserves, not accumulating more—and if they aren’t adding reserves, it’s much harder for them to buy gold. Oil-rich countries in the Persian Gulf region that face financial problems because they can’t export oil and natural gas through the Strait of Hormuz might turn from buyers to sellers, too.
Something similar applies to individuals who put big chunks of their savings in gold, something more common in India and China than the West. As the soaring oil price hits their economies, they might choose to cash in some of their gold.
These issues are temporary. As with all assets, once the crowd has left, the price can return to tracking what counts as fundamentals. In gold’s case, that means inflation, interest rates and geopolitics. But how many of the buyers of the past few years have to sell to get there remains unknown. If those sellers include central banks, there could be a lot farther to fall before gold rediscovers its luster.
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