Gold’s three masters – real US interest rates, the greenback and fear itself such as (geo-) political risks – strongly drive the metal’s price direction. As gold is a non-yield-bearing asset, investors are most interested in the yellow metal’s negative correlation to real rates and the dollar and its positive correlation to fear – i.e. it tends to have a low correlation to equity markets (Figure 1). This last relationship appeared to break down in early February, with the S&P 500 declining 6%, the Chicago Board Options Exchange Volatility Index (VIX) spiking above 40 and the gold price falling by 3% (Figure 2).

Investors have begun to question gold’s claim as a hedge against stock market moves and volatility, particularly its longer-term “fear benefit” – but not us. We believe the catalysts to this surge in equity market volatility explain gold’s recent counter-intuitive behaviour, and see gold’s response to new Federal Reserve Chair Jerome Powell’s hawkish testimony as evidence that its three masters are alive and well. Also, the fact that gold fell less than equities highlights its lower volatility compared to equities.

So, with the 2017 Goldilocks environment for risk assets likely over, gold’s historical correlation to financial markets should provide diversification value in a portfolio context. Likewise, as the greenback is expected to weaken again and inflation to strengthen this year, gold’s role as an inflation and currency hedge should prove to be efficacious (Figure 3). We acknowledge higher real rates toward the year-end and beyond are an inevitable headwind of varying strength, though gold’s link to real rates has weakened since December.