Gold's Traditional Crisis Response Returns

Gold staged a dramatic rally on Tuesday, pushing prices in the futures market to fresh two-week highs above $4,170. The advance of $75.50, or 1.85%, was notable, but the bigger story wasn't the size of the move — it was what drove it, marking an apparent reversal from the pattern that has governed gold trading in recent months.

Since the U.S.-Iran conflict escalated on February 28 of this year, I, along with every other commodity analyst, have repeatedly pointed to anticipated Federal Reserve policy, rather than safe-haven demand, as the dominant force behind gold's direction. That relationship has held for nearly five months, and it runs counter to how gold has traditionally behaved. For decades, if not centuries, uncertainty, particularly uncertainty stemming from military conflict has been the primary driver of gold's trend. Since late February, however, that dynamic has been turned on its head, with escalating tensions between U.S. and Iranian forces failing to produce the safe-haven buying that history would suggest.

Gold's traditional role goes beyond simple uncertainty. It has long served as a tool for protecting purchasing power against the erosion caused by persistent inflation in fiat currencies. In that capacity, though, it competes directly with real interest rates and the “guaranteed” fixed income they offer. Strip it down further and gold is really battling the dollar and Treasuries — gold, after all, trades against the U.S. dollar. Real rates matter because they determine the actual yield available from holding Treasuries.

This is where things get more complicated. It isn't just the current fed funds rate that determines where capital is best parked; the market's perception of where rates are headed also shapes Treasury pricing, since markets price in what investors expect six months out. In short, the escalation of the Middle East conflict has pushed crude oil prices high enough that traders believe the resulting inflationary pressure will force the Fed to raise rates, which in turn strengthens gold's chief adversary, the U.S. dollar.

The reason for laying out this cause-and-effect chain is that, for the first time since February, it did not dictate gold's direction on Tuesday. Instead, as the conflict spread into new territory, oil prices spiked in their usual fashion — WTI crude has climbed more than 4% since Tuesday morning at the time of writing. This time, though, the dollar didn't follow higher even as rate-hike expectations rose alongside oil. On Tuesday, at least, gold behaved as it has for most of history: as a safety net in times of crisis.

Wishing you, as always, good trading.