Gold, long considered a reliable hedge against market volatility, has lost its luster as a safe-haven asset and now acts as a “high-beta asset” that actually amplifies market selloffs, according to economist Robin Brooks of the Brookings Institution.
Brooks, who was a former chief economist at IIF and chief FX strategist at Goldman Sachs, said gold has not been acting as a safe-haven asset over the past six weeks since the Iran war broke out.
“Gold is down ten percent, which is far more than the S&P 500, which is down less than one percent. You’re not much of a risk hedge if you sell off harder than the S&P 500 in a bad shock. You’re the opposite,” he was quoted as saying in a Kitco.com report.
Gold is behaving like a high-beta asset that amplifies sell-offs.
Gold’s shift to a high-beta asset
Brooks outlined the various theories that had attempted to explain what had happened with gold and said that the first was that emerging market (EM) central banks had sold gold holdings during the recent shock.
But, that that was really only true for Turkey, where holdings had fallen by 128 tons to mobilise foreign exchange reserves to defend the Lira.
“Turkey is an outlier in this regard. Its insistence on pegging to the Dollar forces its central bank to sell reserves in bad shocks, a practice most other EMs ditched long ago and for good reason.”
He suggested that the second factor was that the massive rally in gold over the past year, which he called the ‘debasement trade,’ had attracted many new buyers who turned out to be more nervous and likely to abandon their positions during negative events.
Brooks offered that this would certainly explain why gold had been trading like a high-beta asset in recent weeks.
He concluded that if that was what was happening—and he thought it was—then it was just a matter of time until the ‘debasement’ crowd was eliminated and gold returned to its usual role as a safe-haven asset.
So safe-haven status isn’t gone forever, it’s just contaminated at the moment.
Market factors drive recent price rise
Meanwhile, a weaker dollar and reduced concerns about inflation, stemming from a drop in oil prices amid hopes for continued US-Iran peace discussions, contributed to a rise in gold prices on Tuesday.
Oil prices dropped below $100 a barrel amid hints of possible negotiations to resolve the conflict between the US and Iran, which in turn alleviated worries about supply disruptions caused by the US embargo on Iranian ports.
Rising crude prices contribute to inflation by increasing both transportation and production costs.
Although gold is typically seen as a hedge against inflation, higher interest rates tend to reduce demand for the non-yielding metal.
Hopes for a diplomatic breakthrough between the US and Iran led to the dollar falling to its lowest level in over a month.
This decline made gold, which is priced in the greenback, more accessible to buyers holding other currencies.
The market optimism follows a Reuters report on Tuesday that suggested US and Iranian negotiating teams might return to Islamabad this week, despite recent talks in the Pakistani capital concluding without a breakthrough.
At the time of writing, gold prices on COMEX were back above $4,800 per ounce.
Prices hit a session’s high of $4,819.75 an ounce on Tuesday. Silver, on the other hand, rose 2.8% to $77.768 an ounce.
“The downside potential for prices is limited by the fact that virtually no further Fed rate cut is priced in until the end of the year,” Carsten Fritsch, commodity analyst at Commerzbank AG, said.
As long as the market does not begin to seriously consider a rate hike by the US Federal Reserve – there are no signs of this so far – the gold price is unlikely to fall much further.