Why did ‘safe-haven’ gold fall in value during market sell-off?

The gold price declined around 10% from 24 February to 16 March, the period that saw the steepest falls for global markets.

Gold is widely viewed as a safe-haven investment that protects capital during market downturns, but over much of the past month’s market sell-off it failed to perform this role.

The gold price declined around 10% from 24 February to 16 March, the period that saw the steepest falls for global markets. Although the precious metal’s decline was not as substantial as those of equity markets, it was nonetheless notable given that gold is recognised as a store of value and as a result tends to perform well during times of uncertainty.

Why golden returns did not materalise 

There is more than one reason being put forward as to why the gold price did not rise during this period, but ultimately it all leads back to liquidity.  

James Luke, a commodities fund manager at Schroders, notes that gold and gold equities were caught up in the market sell-off due to a “rush for liquidity across all asset classes”. In other words, investors have sold gold to raise cash.

He adds: “Short-term liquidation of speculative futures positions has had an impact. Hedging (selling forward) by producers, particularly in countries where gold prices are at record highs in local currency terms, such as Australia, has increased. This is when a producer agrees to sell gold at a specific price in the future.

Luke also points out that gold had also been bought as a hedging instrument for index equity positions. He adds "it is possible that the scale of equity market falls forced the liquidation of hedge positions into an environment where liquidity is reduced.”

This theory makes sense, notes Russ Mould, an investment director at AJ Bell. He points out that the same pattern played out during the global financial crisis. “As the recession deepened and stock markets tumbled, gold was dragged down as professional and private investors alike had to meet margin calls (when traders are forced to sell), settle fund redemptions or simply rustle up ready cash.”

The strength of the US dollar is another explanation. In contrast to gold’s decline, the US dollar has notably risen in value. It recently hit a 30-year high against sterling (on 18 March).

The greenback, also a safe-haven asset in its own right, typically has an inverse relationship with the gold price. When the dollar rises, gold as a dollar-denominated commodity becomes more expensive for international investors to buy, dampening demand. 

John Chatfeild-Roberts, head of strategy for independent funds at Jupiter, notes: “There are technical and human factors involved here, but basically when people are fearful they tend to go back to what they consider to be the world’s safest currency.”

Gold's time to shine?

While over a short timeframe the US dollar has been the better-performing safe-haven asset, various commentators argue that the intervention of governments and central banks to “do whatever it takes” through enormous monetary and fiscal stimulus packages will boost the value of gold. 

Unlike dollars (and indeed any other currency), governments and central banks cannot print more gold. As a result, its value is retained. In theory this attribute of the yellow metal will continue to be highly prized by investors, particularly in uncertain times.

Nitesh Shah, director of research at WisdomTree, points out: "Already the injections of liquidity and the fact that equities are not in free-fall have eased selling pressure on gold. The largess of central bank and fiscal authority action in itself is likely to drive a gold price rally.

“Gold is seen as the antithesis to fiat currencies. The fact that its supply can’t be expanded at will means that it should hold its value better than the value of the currencies issued by the central banks that are expanding monetary policy.”

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To reduce risk and also in anticipation of this scenario playing out, Chatfeild-Roberts has been increasing exposure to gold across the various multi-manager funds he oversees. At the start of the coronavirus pandemic he held 6% in gold, but he has increased the weighting to 10%.

He adds: “We still see gold as an insurance policy, but think interventions by governments to keep economies on track will have an effect in that there’s more money flying around, and that will underpin the gold price and probably increases the demand for gold and the price of it going forward.”

Over the last week there have been signs this trend has started, with the gold price rising from just over $1,500 (on 23 March) to end the week (27 March) above $1,600.

Mould concludes: “The Federal Reserve has already worked its way through a long list of policy measures – interest rate cuts, more quantitative easing, provision of liquidity to interbank lending markets and the exchange of collateral from brokers for cash. Central banks have cut interest rates 57 times between them worldwide in 2020. And UK, France, Italy, Hong Kong and others have launched fiscal stimulus packages, with the US not far behind.

“If these prove to be enough to support the global economy, gold may stay out of favour and, ironically, remain a source of ready cash as financial markets stay unsettled. But if more unorthodox policy is needed, and more ‘money’ is conjured out of thin air via negative interest rates, quantitative easing, helicopter money or increased government deficits, investors could yet return to the precious metal, just as they did from late 2008 to summer 2011, when gold peaked at almost $1,900 an ounce.”