Gold plunges 5% erasing all gains for the year! Why have safe-haven assets "failed" amid Middle East conflict?

War and inflation should have been the most loyal allies of gold, but this time, gold completely disappointed investors.

On Monday, spot gold fell by 5.75% intraday to $4,236.17 per ounce. New York gold dropped 7.0% intraday to $4,285.9 per ounce. Spot silver declined nearly 8% intraday, currently at $62.49 per ounce. New York silver fell 10.0% intraday to $62.64 per ounce. Spot platinum dropped over 8% to $1,773.47 per ounce. Spot palladium fell nearly 5% to $1,346 per ounce.

Since the Israel-U.S. conflict with Iran began, gold has fallen approximately 15% from its pre-war highs. Investors holding gold during this period have returns that are even worse than those from the smallest micro-cap stocks.

According to the Wall Street Journal, the fundamental reason for gold’s “failure” this time is that over the past year, gold has become a highly crowded trade. After the outbreak of the conflict, investors sold it as the most prominent asset—whether to hedge risks or to repay leveraged debts. While technical factors like the dollar appreciation and rising real interest rates offer some explanation, they are insufficient to justify such a magnitude of decline.

Deeper pressure comes from structural factors: the Middle East conflict has shaken the logic of continuous central bank gold purchases and may prompt physical gold holders in markets like India and China to sell. How long the process of clearing crowded trades will last remains uncertain.

Dollar and real interest rates are not the main reasons

Several technical explanations circulate in the market, but according to the Wall Street Journal, these reasons are hard to justify.

The dollar factor is first brought into question.

After the war broke out, benefiting from the U.S. being a net oil exporter, the dollar appreciated sharply. Theoretically, this should suppress gold priced in dollars. However, gold priced in pounds also fell about 11%, in euros about 10%, and in yen about 11%, indicating that dollar appreciation is not the main cause. Last Thursday, the dollar weakened on the day, yet gold experienced its largest single-day drop during wartime, further disproving this explanation.

The real interest rate explanation is also limited. Market expectations now are that the Federal Reserve will keep interest rates unchanged or even raise them this year— a significant shift from previous expectations of two to three rate cuts. As a result, the yield on 10-year TIPS (Treasury Inflation-Protected Securities) has risen, somewhat reducing gold’s relative attractiveness.

However, over the past year, the traditional negative correlation between gold and TIPS yields has broken down, with both rising in tandem for a long period. According to the Wall Street Journal, in the past 15 trading days, only 11 days showed a reversion to inverse movement, and the explanatory power of real interest rates for gold’s decline remains limited.

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