Gold glitters amidst geopolitical uncertainty

Investors think of gold as a haven, so it's no surprise that the precious metal has been an attractive asset for the past few years. Conflicts in Ukraine and the Middle East in particular have increased global geopolitical risk. Indeed, gold has experienced a significant upswing in price since the onset of the Hamas attacks.

Investors sometimes overlook gold in favour of more common asset choices like bonds when seeking protection in troubled times. But gold deserves a closer look when geopolitical risk spikes because of the complex cocktail of factors that drive the asset's pricing. 

LGT's strategists follow gold price movements closely. As with all asset classes, they incorporate valuations, economic indicators, and technical aspects into their analysis. But geopolitical risk is a critical and unconventional element. "Gold tends to rise in value as geopolitical risk worsens, and it generally serves as a diversifier in investment portfolios," explains Sebastian Petric, senior FX strategist at LGT.

Disruptive threats

Geopolitical risk is defined as the risk associated with threats between states or countries that disrupt the usual, peaceful conduct of international affairs. This can take the form of real threats (the Hamas-Israel conflict), or perceived risks (the build-up of military might in advance of an invasion). 

Gold prices have historically shown an upward trajectory in response to heightened geopolitical tensions. "This phenomenon has been substantiated by various academic researchers," states Petric, "making gold an indispensable component of any portfolio." Gold's advantage lies in its lack of credit risk. By contrast, corporate bonds are not only tied to economic factors, but also to the health of the issuing company.

"A further rise in geopolitical risk could fuel an increase in gold prices from current levels," says Petric. Indeed, any escalation in tension consistently bolsters the price of gold, or to phrase it differently, increased risk drives price movement upwards. "Gold remains a quintessential risk-off asset," Petric notes: Investors move into risk-off, or safer assets, when risk rises. 

Ending of the US dollar bull market cycle

Other economic and financial variables also play into gold price trends. Notably, gold is affected by the strength or weakness of the US dollar and the stability of US bond yields. 

In LGT's view, global interest rates have peaked. Weak economic data from Europe suggest that rates cuts could come from the European Central Bank as early as next spring. In the meantime, market volatility is likely to increase in the wake of contradictory economic news from the US. On the one hand, a cooling labour market and slowing inflation support expectations of a rate cut by the Federal Reserve Bank, but on the other, strong growth in the third quarter may make that move difficult. 

Analysts have identified a number of more technical trends in gold price movements. One is that upward and downward trends both tend to occur over long periods. Second is that gold price movements are highly autocorrelated. "What that means," explains Petric, "is that upward movements in gold prices are most often followed by even higher gold prices. It's something of a self-fulfilling prophecy." Analysts identify this as a technical momentum trend. Of course, trends can be broken, but he doesn't feel this is likely with three current gold price drivers pointing upwards: continued geopolitical risk, US bond yields trading at a plateau or lower, and a likely end to the US dollar bull market cycle.

One way to gain insight into these technical trends is by looking at the relationship between the price of gold in US dollars per ounce and the performance of the S&P 500 Index since the abandonment of the Gold Standard by the US in 1971. "Should US equities experience a downturn in the face of economic deterioration, this could serve as another impetus for a rally in gold prices," suggests Petric.

Demand for gold in China

Although the recent uptick in the gold price was triggered by the Hamas-Israel conflict, analysts continue to monitor the activities of other countries in the region, such as Iran. As Petric points out, "Iran's interests and interventions in the region add another dimension to an already multi-layered situation."

To be sure, the price of gold fluctuates just as with any other precious metal or asset class, and investors may nurse losses on its value. Nevertheless, gold continues to hold allure for investors around the globe. LGT's strategists are watching the behaviour of Chinese investors with interest as demand for gold surges. According to Petric, "Growing economic concerns in China, yuan depreciation, and the property market slump are driving investors to the safer haven of gold."

While value, pricing trends, and economic fundamentals are critical to any investment analysis, investors in gold need to add geopolitical risk into the mix in order to clearly understand the complexity of gold market dynamics.