- Gold has risen in recent weeks because of its safe-haven qualities.
- The metal does not necessarily benefit from higher inflation or oil prices; its future depends instead upon the course of the Russia-Ukraine war.
Russia’s invasion of the Ukraine has reminded us of one virtue of gold – that it is a safe haven and a useful portfolio diversifier.
The price of the metal has risen above $1,900 an ounce (oz) for the first time in 18 months. From one perspective, this is a weird development, because it has come at the same time as a sell-off in bonds. My chart shows just how unusual this is. It shows that there has been a massive negative correlation between gold and five-year US Treasury yields. Falling yields from 2007 to 2012 saw gold rise; rising yields from 2012 to 2018 were accompanied by a falling gold price; and falling yields from 2018 to 2020 saw gold recover. This relationship predicts that gold should have suffered as bond yields have risen since the autumn. But it hasn’t.
This is especially unusual because there’s a powerful reason for this link between gold and bond yields. Gold pays no interest. Which means that when bond yields are high we must sacrifice a lot of income if we are to hold the metal – and that’s a good reason not to hold it. We should therefore see the gold price fall when bond yields rise. Which until a few weeks ago was just what we did see.
So why has gold defied the rise in bond yields?
It’s not because it has risen in sympathy with the rising oil price. The correlation between the two commodities is actually very weak: only 0.14 since 2006. The two often move in opposite directions, most obviously as recently as 2020-21 when oil rose while gold fell.
Nor is it because gold has benefited from rising inflation expectations. The correlation here is also weak: that between five-year US break-even inflation and gold has been only 0.06 since 2006.
Nor is it because of exchange rate moves. Yes, there has been a strong tendency for the gold price in dollar terms to rise when the dollar falls: this is simply because a weaker dollar cuts the price of gold in non-dollar currencies which allows euro- or yen-based investors to buy more of it. But this can’t explain gold’s rise, simply because US dollar exchange rates haven’t moved much since the turn of the year.
One other thing, though, can explain gold’s rise since the autumn: the tensions on the Russian-Ukraine border which have now culminated in an invasion.
The idea that geopolitical uncertainty raises the gold price isn’t mere folklore. It has an empirical base. We can quantify political uncertainty: Nick Bloom, Scott Baker and Steven Davis have compiled indices of it. Their measure of global political uncertainty is strongly correlated with gold: since 2006 a one standard deviation rise in uncertainty has been associated on average with a $230/oz rise in gold.
Gold really is a safe haven; investors flock to it in uncertain times. Which makes it utterly different from cryptocurrencies. Bitcoin is now 40 per cent down in sterling terms from November’s peak and 19 per cent down so far this year. Which tells us it is a risky asset, and not one that offers protection from either falls in world stock markets or rises in geopolitical uncertainty.
Gold’s rise has therefore been very welcome for diversified investors. So far this year we’ve seen something unusual at least by the standards of recent years – losses on both global equities and bonds: MSCI’s world index has lost more than 10 per cent since the turn of the year and gilts 5 per cent. Balanced portfolios have therefore lost money. Only one fund in Trustnet’s database of 201 mixed investment funds (with 40-85 per cent in equities) has avoided a loss so far this year. In this context the rise in gold has helped mitigate such losses – although only mitigate because investors should not have had a very high weighting in the metal.
Which reminds us that gold is sometimes a nice way of diversifying risks.
Of course, in a sense its rise is dumb luck; few could have predicted a full-scale Russian invasion of the Ukraine a few months ago, and certainly not with sufficient confidence to base an investment strategy upon it. But the point of investing is not to predict world events – that cannot be done – but to protect ourselves from them. Well-diversified investors who have held gold have had some protection.
But, of course, if gold can rise during wartime it can fall in peace. Gold is insurance, and insurance costs you money in good times. Nobody can predict the course of events in Ukraine, but if they turn less unpleasant then gold would fall back. As such an event would probably see equities recover, balanced portfolios would do well despite being held back by gold. In times like these, what matters for investors is resilience, and gold is a part of this.
