How do geopolitical tensions impact gold prices?
In the month of June 2017, we saw renewed tensions on the Korean Peninsula, even as select Middle Eastern countries have cut diplomatic ties with another. Border skirmishes and internal strife is not very uncommon. It is at these times that many investors look to gold, to provide a hedge against price reduction in other asset classes.
Why do gold prices stay elevated during political tensions?
This happens as gold is considered a ‘safe haven’ asset and the price rises when investors dump risky assets like equities and move money to gold. A safe haven asset is an investment like gold that is expected to retain its value or even increase its value in times of chaos. A classic example was the sub-prime mortgage crisis in the US, after which gold prices saw a dramatic rally. In fact, rates in India have quadrupled since the global economic crisis of 2008.
Understanding correlation with other assets
One needs to understand how different assets move during times of geopolitical tensions. It is well-known that when two assets have a positive correlation (closer to a value of 1), their prices tend to move in the same direction. Equities and real estate may move in the same direction over a short period of time, when market conditions are not volatile. When assets have a negative correlation (negative 1), they tend to move in opposite directions. A correlation close to zero means two assets move independently.
Several studies have proven that gold does not have a positive correlation to risky asset classes. This is why many individuals across the globe keep gold in their portfolio as it provides a hedge against declining equities or dropping bond yields. There are days when they may move in tandem as well, but that is when everything is very quiet and there is an absence of any major developments on the global front.
Geopolitical tensions apart, investors have often been urged to buy gold, also because it has held its value and beaten inflation in the medium to long-term.