Does buying the gold dip make sense?

“Gold has suffered a rough few months, tarnishing the bull case for the metal. But it still has a role to play in investor portfolios, and now is a good time to buy the dip.

A yearslong rally in the precious metal came to an end, oddly enough, with the Iran war. Since hostilities began on Feb. 28, gold is down 22%. This seems paradoxical. Shouldn’t a geopolitical crisis that unleashes global price pressures be positive for an asset often billed as a hedge against inflation and instability?

Investors seem to be betting that the Federal Reserve will raise interest rates in response to inflation pressures, which would hurt gold’s value relative to cash as it pays no yield. Historically, gold has tended to perform best when “real,” inflation-adjusted interest rates are falling, says Giovanni Staunovo, commodities strategist for the UBS Chief Investment Office.

In addition, there have been persistent market rumors that central banks in the Middle East sold gold during the conflict to raise needed cash, though the only confirmed sale was by Turkey, Staunovo said. Turkey’s central bank sold 81 metric tons of gold in the first half of this year according to the World Gold Council, worth $10.6 billion at current prices.  

While gold’s decline has been jarring, some additional perspective is still in order. Gold’s 12-month price increase, at 21%, is still slightly better than the S&P 500. And neither reason for gold’s decline during the crisis deals a deathblow to its reputation as a useful risk hedge.

Start with global central-bank holdings. If indeed they found their gold reserves to be a useful source of liquidity during a crisis, that would actually reinforce the case for it as a reserve asset, notwithstanding the short-term price reaction.

Gold buying by central banks has been elevated roughly since Russia’s invasion of Ukraine in 2022, data from the World Gold Council shows. That partly reflects a desire by countries outside the Western orbit to diversify away from U.S. dollars and reduce their exposure to sanctions.

But demand hasn’t been limited to the likes of Russia and China, indicating rising global wariness of geopolitical risks. The biggest net purchaser in the first half of the year was Poland, according to the Council. 

As for the Fed, it is still unclear how it will actually respond to oil prices. Markets got a reprieve during the Iran ceasefire, but oil is again on an upward march after the recent resumption of hostilities.

The Fed might raise rates, but that is far from certain. The market-implied odds of a rate hike by September currently stand at around 50%, according to the CME FedWatch tool. 

New Fed Chairman Kevin Warsh’s distaste for forward guidance only clouds the horizon further. So far, he has offered rhetoric promising price stability, but little else to go on.

He has convened several task forces to examine everything from what drives inflation to the impact of artificial intelligence on productivity. These might not report back until the end of the year.

One possibility is that this new Fed moves too slowly to respond to the oil-price shock while it finds its intellectual bearings. That could allow broader inflation pressures to gather.

Another is that the AI-investment boom fizzles, pushing the Fed to loosen even as oil stays high because of geopolitical factors. Both these scenarios could mean falling real rates, and so would be positive for gold.

Perhaps the best argument for gold is the behavior of stocks, which have kept advancing throughout most of the war. Equity investors overall remain highly optimistic on AI. Meanwhile, they are remarkably complacent about risks from Iran or anywhere else.

In this environment, keeping some allocation in gold to hedge against the unforeseen is rational. When stocks are priced for a goldilocks world, there is often value in gold.”