Gold: A Beneficiary of Geopolitical Risk
Geopolitical risk, policy rate dynamics, and central bank buying provide tailwinds for gold
Chief Investment Office, Goh Jun Yong20 Oct 2023
  • Israel-Hamas conflict provides short-term boost for gold
  • Inverse relationship between real rates and gold challenged; gold displaying downside resilience
  • US debt sustainability issues limit further rate hikes, curtails downside for gold
  • Healthy gold demand in China and continued central bank buying in August bolsters tailwinds
  • Hold gold as a portfolio risk diversifier and black swan hedge
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Short-term boost from conflict in the Middle East. It is almost a foregone conclusion that gold benefits during tumultuous times given its status as a haven asset. Unsurprisingly, the recent escalation of Israel-Hamas tensions into a full-blown war boosted gold significantly, lifting spot prices almost 5% since 7 October (the inception of the latest flare-up). What remains uncertain at this point is how much more and how much longer gold prices will continue to rally from here. To a large extent, this would depend on how the conflict plays out – if it is contained and resolved within the next one to three months, then it is likely that the bulk of the rally is behind us.

However, if the conflict spreads and becomes a destabilising force regionally, gold may yet have legs to run. Given the efforts by the US and its allies to contain the conflict, which include back-channel talks with Iran to warn against escalation, as well as the maintenance of a safe corridor open between Israel and north Gaza, our base case is that of a ring-fenced conflict rather than a regional crisis. On a more quantitative front, we analysed past risk-off incidents to see their effects on gold price and found that, such episodes resulted in a gold rally that lasted an average of 15 days (trough to peak) and resulted in an average increase in price of c.8.0%.

Increasing resilience to real rate rises. Since the start of the Fed’s rate hiking cycle in March last year, interest rates and the dollar have been the primary headwind for gold. This makes sense as treasury yields represent the (risk-free) opportunity cost of holding non-interest-bearing gold. However, this relationship has been somewhat challenged in recent times; the inverse directionality between real rates and gold price remains, but the downside sensitivity of gold price (in response to a rise in rates) has diminished to some extent.

From 1 June to 16 October, the 10Y inflation-indexed US Treasury (GTII10) yield, which is seen as a proxy for real rates, increased 58.8%, while gold receded just 1.5%. Even if we disregard the supportive effect of the Israel-Hamas conflict on gold, the point on reduced downside sensitivity remains valid – between 1 June to 6 October (just before tensions escalated in the Middle East), the GTII10 yield increased 73.6%, while gold fell 7.3%. There are many reasons behind this phenomenon, but a key explanation is that markets are predicting a peak in rates in the near future and positioning themselves for it.

Figure 1: Real rates soared since June but Gold held steady

Source: Department of Treasury, Bureau of Fiscal Service, DBS


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