HSBC: Gold is behaving like a risk asset but bullish case remains

After an initial safe-haven boost at the onset of the Iran war, gold corrected and has behaved more like a risk asset. However, HSBC analysts say the de-dollarization trend still makes the yellow metal a good long-term investment.

As I have noted, wars in the modern era haven’t had a major impact on the gold price beyond an early safe-haven bid. After a brief initial spike, other factors in the economy have tended to drive the gold price, particularly the trajectory of monetary policy.

This has proved true during the current conflict. Gold initially surged to $5,400 an ounce at the onset of hostilities but quickly corrected and then sold off.

As oil prices spiked, inflation worries threw a wet blanket on hopes for Federal Reserve interest rate cuts. Some analysts have even predicted a new hiking cycle. This has created significant headwinds for gold as a non-yielding asset. While I don’t think this case against gold stands up to scrutiny, the narrative seems to be currently controlling the market.

HSBC analysts noted that interest rate worries and a strong dollar have created significant headwinds for gold since the war kicked off.

“A stronger U.S. dollar has certainly been a headwind, deterring non-US buyers, while a hawkish repricing of interest rates has increased the opportunity cost of holding a non-yielding asset.”

But they pointed out that gold’s performance during the tightening cycle in 2022 and 2023 undercut the narrative that gold can’t chart gains in a higher-rate environment.

“Gold withstood a similar surge in the greenback and rates throughout 2022, weakening this traditional thesis.” 

In an interview on CNBC, HSBC chief precious metals analyst James Steel pointed out that the relationship between real rates and gold appears to have broken down.

“The change happened in 2022. Before that, if you looked at the real rate on the 10-year – that's the 10-year minus inflation – it had a beautiful inverse correlation with gold, going right back to the end of Bretton Woods, when the gold came off the dollar exchange. Gold is not as sensitive to real rates, particularly on the 10-year, as it used to be. And that's also when we got a lot of retail buying in the market, elevated geopolitical risks, and also central bank buying.” 

HSBC analysts said they believe that gold is effectively serving as a risk asset in the current market, with speculators and traders in control. 

“Ownership has shifted towards retail and other leveraged buyers, many of whom are forced to liquidate holdings in periods of market stress.” 

However, HSBC analysts remain bullish in the longer term.

"There remains a decent long-term investment case for gold, particularly amid ongoing global de-dollarization.” 

In fact, the war may well accelerate this trend as more countries become wary of the weaponization of the dollar. The war will also drive more borrowing and spending, further eroding Uncle Sam’s abysmal fiscal situation. Many countries are already becoming wary of loaning a bankrupt U.S. government more money.

We're already seeing evidence in this with India bypassing the dollar in some oil transactions.

Steel said he doesn’t think the U.S. dollar is in danger of losing its reserve status. However, that doesn’t preclude a diversification of reserves and a modest decline in dollar demand.

“We believe that the dollar will remain the world's reserve currency for the foreseeable future, and by that we mean for a very long time to come. But that's not to say, for example, that every central bank may need as many dollars as it has… One of the ways you can reduce your dollar exposure is to buy gold.”

Even a modest decline in dollar reserves spells trouble for an economy that depends on foreign dollar demand to support its money-printing habit. If the world needs fewer dollars, they will begin to return to the U.S., causing a dollar glut. This will increase inflationary pressure domestically as the value of the U.S. currency further depreciates. In the worst-case scenario, the dollar could collapse completely, leading to hyperinflation. 

In the meantime, Steel said we should expect continued volatility in the gold market, especially if the Iran war drags on.

“Don't forget, we've had a lot of new money come into the market, and we've had a parabolic rally in January. When a market goes up like this, it really invites volatility. I think that's going to be the benchmark word for this year – volatility – in gold. Just because it's a safe haven, and just because it's a quality asset, doesn't mean it's not volatile.”