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Geopolitical Risk

How did the octopus go to the war? Well armed.

Geopolitics is a study of the influence of such factors as geography, economics, and demography on policy, particularly on the foreign policy of a state. Geopolitical risk is commonly defined as the risk of one country’s foreign policy or military actions influencing or upsetting domestic political and social policy in another country or region, but its scope is much wider. Geopolitical concerns include military conflicts, civil wars, terrorist’s attacks, riots, sanctions etc. Some analysts include also epidemics and pandemics into geopolitical threats. Rightly or not, the spread of coronavirus in 2020 showed that investors should not neglect such risks.

Geopolitics and Gold

Generally, gold is considered to be a safe-haven asset against geopolitical tensions. Is that a correct view? In some sense, yes – gold prices are often positively correlated with rising tensions. The best example from the 21th century may be the 9/11 terrorist attacks. After them, the gold prices in the London market rose from $271.50 to $287 (or almost 6 percent) in one day, as the chart below shows. It times of high uncertainty, investors often flee to gold, as it does not entail counterparty risk and it is the ultimate means of payment in hand when all other means of payment fail.

Geopolitics and Gold Chart

However, gold does not always gain due to geopolitical crises. The best example may be the terrorist attacks in Paris in November 2015 and in Brussels in March 2016. Their impact on gold prices was only temporary and quickly vanished. Actually, gold prices declined in both November 2015 and March 2016 when attacks in Paris and Brussels occurred respectively.

Geopolitics and Gold Chart

There are three main reasons why geopolitical concerns do not affect gold as strongly as it is commonly perceived, and why the relationship between geopolitics and gold is not as simple as it seems to be. First, the yellow metal “smells war” – its price rises in anticipation of a conflict, but when rumors turn into action, the price of gold is often unaffected or even decreases, as this is when the profit-taking begins. In other words, gold traders buy the rumor, but sell the news.

Second, gold is mainly a bet against the U.S. economy. This is why terrorist attacks (or other geopolitical events) which occur overseas and not in America often do not have any durable effects on the gold market, or they even exert downward pressure on gold, as there is a flight to safety to the U.S. Treasuries and the greenback appreciates.

Third, some military actions reduce risks rather than increase them. This was the case with Operation Desert Storm during the Gulf War in 1991 – the presence of the U.S. army in Kuwait meant a significant reduction of political risks in the Middle East. Therefore, after an initial spike, the gold price dropped as the campaign turned out to be successful.

Summing up, gold is considered to be positively correlated with geopolitical issues. Although gold serves as a safe haven, the importance of the geopolitical concerns for the gold market is often overstated (thus, we do not advise automatically buying gold because of the rise of geopolitical risks). Gold does not necessarily gains during crises, because its behavior depends on the type of crisis. In other words, investors should be aware that not all conflicts affect the price of gold, and even when they do, crises often do not escalate further, so investors risk purchasing gold at unfortunate times, after the momentum has passed. In many historical cases, after the initial spike, the price of gold quickly returned to the pre-crisis level. Therefore, long-term investors should not make a decision based only on geopolitical events, which often strengthen gold only in the short-term, but always look at the fundamentals.

We encourage you to learn more about the precious metals market – not only what is the link between the geopolitical risks and gold, but also how to successfully use gold as an investment and how to profitably trade it. Great way to start is to sign up for our Gold & Silver Trading Alerts. If you’re not ready to subscribe yet and are not on our gold mailing list yet, we urge you to sign up. It’s free and if you don’t like it, you can easily unsubscribe. Sign up today!

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