How has war impacted the Gold price in the modern era?

With the United States now in a shooting war with Iran, how might a protracted conflict impact gold prices?

The historical pattern since the 1980s suggests that, beyond an initial safe haven bump, a war alone doesn’t seem to significantly impact the trajectory of gold prices. As wars drag on, other factors tend to drive the market – particularly monetary policy.

We saw that safe haven bump on Monday, as markets digested the onset of hostilities, with gold briefly trading above $5,300. However, by Tuesday morning, the yellow metal was already giving up those gains due to dollar strength and a growing sense that the Federal Reserve will hold interest rates higher for longer.

Safe haven spikes

Since the 1980s, gold has typically gotten the biggest boost in the run-up to hostilities.

For instance, during the long buildup of forces in the Middle East during Operation Desert Shield beginning in 1989, gold gained 15 to 20 percent. There was another price spike of around 10 percent when the U.S. launched Desert Storm.

Similarly, gold got a brief haven boost in 2003 when the U.S. invaded Iraq for a second time to topple Saddam Hussein.

We saw a similar pattern when Russia invaded Ukraine. The yellow metal surged above $2,000 an ounce at the onset of the war.

But underscoring the fact that gold’s wartime performance is heavily influenced by other factors in the economy, the launch of the War on Terror drove a very different scenario. After 9/11, the gold price briefly collapsed as a liquidity crisis gripped the markets.

War tends to quickly lose its grip on markets

While wars and rumors of wars tend to cause the gold price to spike, war momentum has faded quickly in the modern era once hostilities commence and markets get a feel for the likely trajectory of the war. At that point, other factors such as inflation expectations, interest rate policy, dollar strength/weakness, and the general state of the economy tend to have more impact on the gold market.

This suggests it's not so much war driving the markets, but the uncertainty that surrounds the possibility of war that sparks those initial gold rallies.

Once war is in play, other factors step to the forefront of the markets. Depending on those factors, the price of gold can move in either direction.

A year after Desert Storm, gold had given up all its pre-war and early safe-haven gains. However, during the wars in Afghanistan and Iraq War II, gold was in a 10-year bull market driven by Federal Reserve monetary easing leading up to the 2008 financial crisis and the zero percent rate era of the Great Recession. Between 2001 and 2011, gold surged from $250 to over $1,900 an ounce.

Russia’s invasion of Ukraine in February 2022 roughly corresponded with the Federal Reserve's war on inflation. The Fed bumped interest rates up for the first time on March 16. With subsequent hikes, the gold price quickly unwound, erasing those early war gains. By October, the gold price was below $1,650 an ounce.

In conclusion

In the modern era, the price of gold during wartime seems to be driven more by economic and monetary policy than battlefield headlines.

That’s not to say the gold price doesn’t react to war news at all. We will almost certainly see increased price volatility as markets digest the latest developments. However, these price swings, while sometimes deep, tend to be short-lived.

It's clear that war alone didn’t solely drive gold’s largest wartime moves in the modern era. The biggest gains were due to a combination of war + monetary response.

Since the 1980s, gold has performed best during protracted conflicts coupled with aggressive monetary easing, negative real interest rates, and growing government debt.

Of course, these factors are all inherent in times of conflict.

War is expensive. It typically drives debt higher. Central banks are often forced to drop interest rates and run quantitative easing programs to support government borrowing and spending during drawn-out wars. This is, by definition, inflation.

The war with Iran doesn’t look like it will wind down any time soon (although war is hard to predict). Keep in mind, this conflict was launched as the economy is already being dominated by a Debt Black Hole. Despite recent bearishness on the possibility of rate cuts, this debt-riddled bubble economy can’t function in a normal interest rate environment. More cuts are almost certainly on the horizon, although we are already in an inflationary environment.

If the Iran conflict resolves quickly, it won’t likely impact the trajectory of gold. However, a long, drawn-out conflict could create a Vietnam scenario with impacts reverberating throughout the economy. War spending (coupled with the War on Poverty) in the 1960s drove borrowing and spending that set the stage for the stagflationary decade of the 1970s. The underlying economy is arguably shakier now than it was then. To borrow a phrase from Pink Floyd, Iran could be just another brick in the wall.