Why Gold Fell in a War

5 min read

Conventional wisdom says gold rises when the world grows more dangerous. March tested that idea hard. A war began in the Middle East, oil prices surged and markets braced for the worst. Gold fell by around 11.8% over the month. That is its worst month since October 2008. To understand why, you have to look past the headlines and at the plumbing of the monetary system, which is where the real explanation lies.

What happened in March

The month opened with gold climbing after the United States and Israel launched strikes on Iran on 28 February. That was the high point. As the conflict spread and shipping through the Strait of Hormuz ground to a halt, oil prices jumped. Markets quickly concluded that higher energy costs would mean higher inflation for longer.

That changed the outlook for interest rates almost overnight. Before the war, traders expected the Federal Reserve to cut rates twice in 2026. By the end of March they had priced out cuts altogether. The Fed held its rate at 3.5% to 3.75% on 18 March. The Bank of England held Bank Rate at 3.75% the next day. At its low point gold traded nearly 19% below its January record. It bounced on 31 March, but the damage for the month was done.

Three forces that pushed gold down

The dollar. In the first weeks of a global shock, traders and companies scramble for dollars. Oil is priced in dollars. Debts are owed in dollars. That rush strengthens the dollar, which makes gold more expensive for everyone else. When a buyer in Europe or Asia has to pay more in their own currency for the same ounce, demand eases.

Interest rates. Gold pays no interest. When the expected return on cash and bonds rises, holding gold looks more costly to short-term traders. Some of them sell. They are not judging gold's long-term worth. They are simply comparing what each asset pays them this month.

The need for cash. Gold is one of the few assets that can be sold in size, at any hour, for a fair price. In a crisis, that is exactly what makes it a source of cash. Traders facing losses elsewhere sell what they can, not what they want to.

Why the most liquid asset is sold first

This last point is the one most people miss. When a fund faces sudden losses, it has to raise money quickly. It cannot sell a struggling share without accepting a terrible price. It cannot sell a building in a week. So it sells the thing that still has buyers and still holds its value. Very often, that is gold.

In other words, gold falls in the early days of a crisis partly because it is doing well, not because it is doing badly. It is the asset people can still sell. That is a strange kind of compliment, but it is a compliment all the same.

A note for British owners

Headlines quote the gold price in dollars, because that is how it is traded around the world. For a British owner, the figure that matters is the price in pounds. The two do not always move together. When the dollar strengthens against the pound, each dollar buys more pounds. A fall in the dollar price can then be partly cushioned in sterling terms.

That is why a dramatic dollar headline does not always translate one for one into the value of a coin in a British home. It is also a reminder that the pound itself moves. Gold measured in pounds reflects both the metal and the currency it is being measured against. Over long periods, it is the second of those that has tended to lose ground.

When central banks need their gold

The clearest example came from Turkey. As its currency came under pressure from the conflict next door, its central bank drew on its gold. Estimates reported in the Turkish press suggested it sold around 22 tonnes and swapped roughly 34 tonnes more in the two weeks after the war began, to steady the lira and its markets. As one Natixis analyst put it, it is likely that some central banks are selling gold "to defend their currency and/or to fund energy purchases".

Some will read that as a warning. We read it differently. This is gold doing precisely the job it is held for. A reserve that can be turned into hard currency when your own currency is under attack is the definition of a safe asset. You cannot defend a currency with more of the same currency. You can defend it with gold.

The 2008 lesson

The comparison with October 2008 is worth taking seriously. Then, as now, gold fell sharply in the middle of a crisis as traders sold whatever they could to raise cash. Many concluded gold had failed. Within three years it had set a new record high, at more than double its late 2008 low. The selling in a panic was about the need for liquidity, not a verdict on gold's value.

And again in 2020

The same pattern returned in March 2020, when Covid shut down much of the world economy. Markets fell hard and gold was dragged down with them. Analysts at the time described a rush to abandon almost every asset class and hold cash instead. One currency strategist at BMO said demand had shifted "towards physical cash", which lifted the dollar and weighed on precious metals.

That fall did not last either. By the first week of August 2020 gold had set a fresh record high, as demand for a safe store of value grew with the turmoil in markets. Twice in little more than a decade, the first wave of selling proved to be a reaction to panic rather than a judgement on gold itself.

We wrote in November about why corrections strengthen a bull market and in February about the sharp reset at the end of January. March was a larger version of the same pattern. Speculative positions were cleared out. The long-term reasons to own gold did not change.

What has not changed

War does not reduce government debt. It increases it. Higher oil prices do not make paper money worth more. They make it buy less. And the central banks that have been adding gold for years are not reversing course because of one difficult month. As Peter Grant of Zaner Metals put it at the end of March, "The underlying trend remains bullish." He pointed to central bank buying and the gradual move away from the dollar as supports that are still in place.

For a saver holding UK legal tender coins outright, a month like March is uncomfortable to watch. But nobody can force a sale and nobody can freeze the coins. The owner of a coin has no fund manager to answer to and no losses elsewhere to cover. That is a very different position from the traders who sold in March. Gains on the coins remain exempt from Capital Gains Tax for UK residents, whenever the owner chooses to sell. Gold bars do not share this advantage.

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Sources

This article is for information only. The value of gold can go down as well as up.

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Gold Insights are independent articles, researched and written by our own team at Gold Tier Advisory.