The Russia-Ukraine Conflict & the Potential Impact on Gold

At the time of writing, many commodity prices are rallying on the news. Oil, natural gas, wheat, corn, palladium, aluminum and nickel are all trading higher, including gold. While other commodities have rallied in the past year, gold has been sitting in the shadows. Gold is often thought of as a geopolitical hedge instrument.

Geopolitical risk is an inherently difficult thing to quantify. Quantifying the relationship between an asset price and geopolitical risks is even more difficult. Looking back at periods when there has been a perception of elevated geopolitical events, it is hard to say that asset prices have behaved in a consistent manner. Any positive or negative price movement needs to be viewed in the context of broader economic activity at the time. 

Nevertheless, we can point to some geopolitical case studies that have shown a very strong positive reaction from gold. The table below gives four examples where gold has significantly outperformed equities in the aftermath of a geopolitical shock.

Notwithstanding the difficulty in quantifying geopolitical risk, we use the Geopolitical Risk Index developed by the Federal Reserve Board’s Dario Caldara and Matteo Iacoviello, which is based on automated text-search results of the electronic archives of 10 newspapers. Plotting their series against gold yields some interesting results. 

• Immediately before the buildup to the Gulf War (1990), gold prices were quite depressed. It seems the buildup ignited gold prices.

• Immediately before the 9/11 terrorist attacks in the U.S. (2001), gold was depressed. The attacks seem to have ignited gold prices. The Iraqi war soon after (2002) kept gold well supported.

Gold and Geopolitical Risks

We believe most people would agree that gold price behavior in 2021 was disappointing, with the backdrop an elevated level of inflation. Our models indicate that gold should have been trading close to $2,500/oz in January 2022 when inflation in the U.S. was running at 7.5%.¹  

Could the beginning of a war in Ukraine act as a catalyst for gold in a similar way to the noted events in 1990 and 2001? 

¹ Other relevant inputs to our model for this January gold price calculation include: dollar basket (DXY) at 96.5, U.S. 10-Year Treasury yields at 1.78%, net speculative positioning on gold futures contracts at 245,782 (source: Bloomberg, 31/01/22)