Why does the price of gold rise when the threat of conflict looms? What is the correlation between the yellow metal and war that consistently allows the price per ounce to rise to record highs?
In recent history, we have seen this trend repeatedly play out. The late 70s illustrate this point very well. The Iranian Revolution in 1978, the Iran-Iraq war in 1979, the Soviet Union’s invasion of Afghanistan in December 1979, and the Iranian hostage crisis in 1979. The gold price reacted to all of these events; gold prices rose by 23% in 1977, 37% in 1978, and an incredible 126% in 1979.
Taking a more contemporary war into account. As the situation in Syria began to take off and the United States and its allies prepared for an offensive, gold began a sharp rise, with the price increasing by over $250 an ounce between June and August of 2013. The Syrian conflict was understood to bring a new wave of political instability to a region of the Middle East that had been reasonably stable despite the turmoil just to the East. There was also speculation that as fighting raged between the Syrian government and the US-backed rebels, radical Islamist groups, such as ISIS, would use the chaos to gain a foothold in the eastern Mediterranean.
Fast-forwarding to Russia’s invasion of Ukraine a couple of weeks ago, we see a similar trend, with gold reaching a 15 month high. The price of oil also rose substantially, as did palladium. These increased based off of a threat to the global supply. The Black Sea region is said to handle over 2.5 million barrels of oil a day, and Russia accounts for 40% of the palladium mined globally.
“Gold is money, everything else is credit” — J.P Morgan.
However, neither Ukraine nor Russia are major gold producers. Whilst Russia is 5th in Global Gold Reserves rankings, with over 2 229 tonnes, this isn’t nearly enough to threaten the gold trade. This then begs the question as to why gold increases when war is on the cards.
Unfortunately, the answer is far less exciting than the latest Hollywood action movie or a treasure chest full of gold doubloons being captured by the Royal Navy from rogue pirates. Simply, it boils down to instability.
Like with any modern market, sentiment is a huge portion of what drives the gold price. In the heavily globalised world, we live in, there is an understanding of how an event on one side of the planet can affect an unrelated market on the other side. When the Ever Given ( one of the largest container ships in the world) blocked the Suez Canal for six days, it was estimated that $6.7 million a minute was being lost. The idea of geopolitical instability drives the gold price higher, and talks of war are among the biggest instigators of instability. A regional conflict or proxy war may be confined to a geographical area, but these have a ripple effect on global markets. Gold acts as a natural currency hedge against looming uncertainty.
An excellent example of this phenomenon is the ongoing trade war between China and the US. In early 2018 when tensions between the two economic superpowers began to ease slightly, the gold price fell. Fortunately for gold investors, a careless President Trump comment stating that “missiles will be coming” steadied gold’s fall and even gave the precious metal a small boon of 0.1%. Trump’s threats were directed at Syrian forces who had begun a renewed assault on the town of Douma at the time, one of the few remaining areas in rebel control. The writing was on the wall for all to see, the Syrian government had won the war, but even though the conflict was drawing to a close, new developments could influence the gold price.
“Although gold and silver are not by nature money, money by nature is gold and silver.” — Karl Marx.
Precious metals like gold and silver are more resistant to inflation because they derive their value differently than fiat currency and other commodities. Precious metals are naturally occurring resources with a finite amount. In economic terms, this means they hold their intrinsic value and have a ‘market cap’. Although the price of gold can be volatile in the short term, it has always maintained its value in the longer run.
“Gold will be around, gold will be money when the dollar and the euro and the yuan and the ringgit are mere memories.” — Richard Russell.