War and inflation should be gold's most loyal allies, but this time, gold has thoroughly disappointed investors.
On Monday, spot gold fell more than 7% intraday, currently trading at $4,164 per ounce, while New York gold fell 8.9% intraday, trading at $4,200 per ounce.
Spot silver fell more than 9% intraday, currently trading at $61.57 per ounce. Since the start of the Israeli-US war against Iran, gold has fallen by about 15% from its pre-war high. Investors holding gold have seen returns during this period that are even lower than those allocating to the smallest micro-cap stocks. According to media analysis, the fundamental reason for gold's "failure" lies in the fact that over the past year, gold has evolved into a highly crowded trade. After the outbreak of conflict, investors saw it as the most conspicuous asset and were the first to sell—whether to hedge against risk or to repay leveraged debt. While technical factors such as a stronger dollar and higher real interest rates provide some explanation, they are insufficient to support this magnitude of decline. A deeper pressure comes from a structural level: the Middle East conflict has shaken the logic behind central banks' continued gold purchases and may drive physical gold holders in markets like India to liquidate their holdings. How long the process of clearing this crowded trade will take remains uncertain.
Neither the US dollar nor real interest rates are the main reasons
Several technical explanations circulate in the market, but according to an analysis by the Wall Street Journal, these reasons are all difficult to justify.
The US dollar factor is the first thing to be mentioned.
After the outbreak of war, the US dollar appreciated significantly due to the US's status as a net oil exporter, which theoretically should have suppressed gold prices denominated in US dollars. However, gold prices also fell by about 11% when denominated in British pounds, about 10% when denominated in euros, and about 11% when denominated in Japanese yen, indicating that the appreciation of the US dollar was not the main reason. Last Thursday, the US dollar actually weakened, while gold recorded its largest single-day drop during the war, further undermining this explanation.
The explanation of real interest rates is also limited.
As the market anticipates the Federal Reserve to maintain or even raise interest rates this year—a significant shift from previous expectations of two to three rate cuts—the yield on 10-year Treasury Inflation-Protected Securities (TIPS) has risen accordingly, somewhat diminishing the relative attractiveness of gold. However, the traditional negative correlation between gold and TIPS yields has broken down over the past year, with both having risen in the same direction for a long period. According to media analysis, the inverse relationship has only reappeared on 11 out of the last 15 trading days, indicating that real interest rates still have limited explanatory power for the decline in gold prices. The core reason: a collective exodus of crowded trades. The most compelling explanation for this sharp drop in gold prices is that a severely crowded trade is rapidly disintegrating. Just as with the stock market's performance in this conflict, assets that have previously risen the most tend to fall the most when investors withdraw. Over the past year, gold has attracted a large influx of speculative capital. This trend is clearly visible in the changes in holdings of the major gold ETF—SPDR Gold Trust. Last autumn, gold prices even began to move in the same direction as popular stocks favored by retail investors, indicating a strong speculative element. Some investors borrowed funds to increase their gold holdings, and when market risk appetite reversed, they were forced to simultaneously liquidate their gold holdings and cover their short stock positions, creating a stampede effect. While the leverage scale of the gold market is difficult to quantify precisely, the large influx of speculative funds is undeniable. As these funds gradually withdraw, downward pressure on gold prices is inevitable. The logic of central bank gold purchases is shaken. In addition to the exodus of speculative funds, the Middle East conflict has also directly impacted the most important structural buyers of gold—central banks of various countries. Analysts believe that the strong rise in gold prices over the past few years largely stemmed from central banks shifting their foreign exchange reserves from dollars to gold after the Western freeze on Russian assets, a trend that attracted more funds to follow suit. However, the Iran war disrupted this logic. The core function of foreign exchange reserves is to ensure the ability to pay for imports when the economy is impacted. The International Energy Agency (IEA) characterized the oil supply disruptions caused by the war as the largest supply shock in the history of the global oil market. For oil-importing countries, now is the time to use reserves for emergencies, not to increase gold holdings. For oil-producing countries in the Persian Gulf region, if the Strait of Hormuz is blocked, disrupting oil and gas exports, these countries may even turn from gold buyers to sellers. Physical demand is also under pressure. In India, residents have historically been accustomed to storing large amounts of savings in gold. As soaring oil prices impact the local economy, these physical gold holders may also choose to cash out. Analysts believe that the aforementioned pressure factors are mostly temporary. Once the crowded trades have cleared, gold will theoretically return to being driven by fundamental factors such as inflation, interest rates, and geopolitics. However, the core issue remains: how many more buyers need to exit the market is still unknown. If even structural buyers like central banks join the selling spree, gold may face a longer period of adjustment before regaining its luster.
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