Words by Ray Jia, World Gold Council senior research analyst
Geopolitical risks have spiked again (see chart 1). Ukraine’s cross-border attack in early August, followed by Russia’s largest air assault since the war began, has escalated the conflict, while the assassination of Hamas and Hezbollah’s political leaders and subsequent retaliatory actions have sharply increased geopolitical tensions in the Middle East.
Waves of explosions in Lebanon and Israel’s declaration of “a new phase of war” have also raised fresh geopolitical concerns in the region.
The GPR Index highlights increasingly frequent periods when geopolitical risk is elevated – periods that have been particularly challenging for investors over the past three years.
So far in 2024 the GPR Index has recorded 15 spikes – days when the Index surged by more than 100 per cent – on the back of tensions in the Russia–Ukraine war and developments in the Middle East. This follows 31 spikes in 2023, 20 spikes in 2022 and 41 spikes in 2021.
Historical data tells us that when geopolitical risks stay elevated (typically above 100), global equities suffer – evidenced by the negative correlation between the GPR Index and global equity returns (see chart 2).
Currently, the correlation between GPR and the Cboe Volatility Index (VIX) is marching towards a record high.
In fact, geopolitical risks have been front of mind for institutional investors for some time. Based on results from a survey we commissioned last year, geopolitical shifts and regional conflicts are identified by global investors – including Australian financial advisors – as the third and fourth biggest trends affecting their investment decisions (see chart 3). And geopolitical instability is one of the top concerns of global central banks when it comes to reserve management.
Asset allocation implications
How have major assets fared so far this year?
Gold has outperformed to date, surging by 28 per cent (see chart 4). Global equities have delivered robust results too – while US stocks rocketed by 20 per cent, the ASX 300 witnessed an eight per cent increase, mainly driven by factors such as the prospect of lower global interest rates ahead.
But taking a closer look, when geopolitical risks spiked during April and August, equities fell back – impacted by multiple factors including surging geopolitical tensions – and gold rose higher.
In almost every week during which the GPR index soared by over 100 per cent, gold saw positive returns. Gold averaged a weekly return of 1.6 per cent during these spikes while global equities declined, on average, by 0.8 per cent.
As our previous analysis demonstrates, geopolitical risks are a statistically significant variable that drives gold’s performance (see chart 5).
Our monthly Gold Return Attribution Model (GRAM) shows that geopolitical risks have contributed 4.3 per cent of gold’s return to date this year. Furthermore, our research shows that every 100-unit increase in the GPR Index corresponds to a 2.5 per cent rise in the gold price.
Gold as an effective geopolitical risk hedge
Creating a resilient portfolio is a topic constantly explored by investors. We believe one of the keys to building this resilience is to prepare for “unknown unknowns”.
While scenarios such as global economic growth can be deduced from economic data clues, geopolitical risks tend to be sudden and unpredictable. And these geopolitical tensions often lead to financial market turmoil, damaging investor portfolios.
When we examine how various assets respond to sudden geopolitical risk spikes, gold’s robust performance during such events becomes clear. We conclude that gold is an ideal hedge against unpredictable geopolitical shocks.
This is further evidenced in our 2024 Central Bank GoldSurvey, which revealed that geopolitical risk was a key driver that spurred on central banks in their recent record-breaking gold purchases (see chart 6).
We believe that gold‘s key attributes – its safe-haven nature, its ability to generate long-term returns (especially now that a global easing cycle has begun), and its low correlation with risk assets – will continue to represent immense value to investors who seek to build a resilient portfolio in today’s world.
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