Using Gold To Hedge Korea Nuclear War Risk? This Is How To Do It, According To Goldman

Tyler Durden's picture

In a note on the role of gold as a "geopolitical hedge of last resort", Goldman chief commodities strategist, Jeff Currie, writes that while it is tempting to blame the rally in gold prices on recent events in North Korea - which have certainly helped create a bid in gold - they only explain a fraction, or ~$15/oz of the more than $100/oz rally since mid-July. Instead, Goldman finds that the events in Washington over the past two months play a far larger role in the recent gold rally coupled by a sharply weaker dollar.

Currie writes that Goldman's market strategists have found that Trump’s approval rating is a good proxy for this "Washington risk" with a high correlation to both interest rates and gold prices (see Exhibit 1).

The Washington risk premium is highly correlated to Trump's approval rating

Goldman also notes that the Trump risk premium is reflected in both real interest rates and a weaker US dollar account for 85% of the price movement in gold prices this past year.

The Trump risk premium as reflected in real rates and the US dollar (as reflected in a basket of EM FX) explain 85% of the price movement

So what about the risk, or threat, from a North Korean escalation, potentially culminating with a nuclear exchange? Here Goldman is more skeptical about the causal linkage between the growing risk level and the price of gold.

The view that North Korea is a stable equilibrium is consistent with a lack of a large North Korean risk premium in gold prices and consistent with the history of gold prices. While gold has acted as a call option on extreme geopolitical events such as the Gulf Wars and other tail risks in the past, on average it doesn’t respond to geopolitical risk after controlling for other macro variables, such as real interest rates and the US dollar. We find that gold is a good hedge against geopolitical risks when the event leads to a debasement of the dollar. More broadly, we find that oil is a better geopolitical hedge historically given that oil producers such as Iraq, Iran, and Russia have been at the center of most geopolitical risks since the early 1970s. Clearly, this is not the case with North Korea, which leaves gold as the best option to hedge the current geopolitical risk.


Although events in North Korea are very serious, the lack of a large North Korean risk premium suggests that the market views military escalation and disarmament as still very much tail risks. This is a classic Nash equilibrium where no one can gain by a unilateral change of strategy if the strategies of the others remain unchanged. North Korea may not really have an incentive to launch an attack as this would likely lead to retaliation. But it is also unlikely to give up nuclear capabilities as it likely sees them as a guarantee of its safety. As a result from game theory perspective it is a stable equilibrium.

So if gold isn't rising on North Korea, what is it rising on, and just what risk does gold hedge? Goldman's "short answer" - currency debasement typically resulting from a central bank printing money.

This dynamic is captured by a negative correlation between gold prices and real interest rates. As the central bank prints more currency, the price of the currency as measured by the real interest rate declines. The lower real interest rate, in turn, reduces the opportunity cost of holding a real asset like gold, leading the market to bid up gold prices. So at the core, gold is a hedge against debasement, which is why we have termed it the “currency of last resort.” This also explains why gold can be a good inflation hedge but is not always one. If debasement leads to inflation, then gold will serve as an inflation hedge. But as we saw over the past decade, debasement doesn’t always lead to inflation, and is not the only source of it, either.

Gold: the currency of last resort

That said, Goldman is not so naive to uniformly claim that gold does not serve as a hedge to geopolitical risk: it does, as several historical precedents demonstrate:

We find that gold can effectively hedge against geopolitical risk if the geopolitical event is extreme enough that it leads to some sort of currency debasement, and especially if the gold price move is much sharper than the move in real rates or the dollar. For these events, gold essentially serves as a call option and can therefore be thought of as a “geopolitical hedge of last resort.” For example, gold served as an effective hedge after the events of September 11, 2001 when the US Federal Reserve substantially increased dollar liquidity, debasing the US dollar. Gold also proved an effective hedge during the Gulf Wars as governments printed money. That said, it is interesting to note that the oil supply disruptions created by Gulf War I led oil to act as a better hedge than gold, which has been the case during several geopolitical events centered around oil-producing nations. However, during Gulf War II, when supply disruptions were minimized, gold acted as the better hedge.

Risk and response

Finally, there is the issue of liquidity, which in a full-blown conflict will likely collapse for all assets, including gold... with one exception.

This analysis, however, doesn’t take into consideration gold-market liquidity itself, which can be crucial when deciding to hedge via physical gold in a vault versus COMEX gold futures. Using a gold futures contract as the basis of the hedge makes the implicit assumption that market liquidity will not be a problem in the realization of a geopolitical event. The importance of liquidity was tested during the collapse of Lehman Brothers in September 2008. Gold prices declined sharply as both traded volumes and open interest on the exchange plunged. After this liquidity event, investors became more conscious of the physical vs. futures market distinction and began to demand more physical gold or physically-backed ETFs as a hedge against black-swan events.

Currie's conclusion: if buying gold, don't buy futures or ETFs - buy the real thing: "The lesson learned was that if gold liquidity dries up along with the broader market’s, so does your hedge—unless it is physical gold in a vault, the true “hedge of last resort."

The distinction of "electronic" or paper gold versus physical may be one the cryptocurrency community will soon be forced to learn, especially if North Korea does carry out, as it threatened over the weekend, an attack using an Electro Magnetic Pulse which could promptly empty all those bitcoin "vaults."

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BaBaBouy's picture

BEWARE X X X X X X X X ... Advice from the Vampire Squid on GOLD...

Pool Shark's picture

Cash, Bonds, Gold.

Sleep well at night...

Dame Ednas Possum's picture

Trump is being made the pasty of last resort. 


Pool Shark's picture

I would prefer waxy chocolate Hanukkah coins to a Trump Pastie.

remain calm's picture

Listen to Goldman, they would never fuck the little people.

Mr. Ed's picture

Well look at what they did for "the little people" Greece 15 years ago!

But, I've always wondered who fat-boy Kim's broker is... could be Goldman. He obviously needs an outside broker to play the "trade-my-crazy-news" game, and Goldman would probably be happy to handle his trades given the opportunity to front-run them!

I just wonder who's making more money off the "I put on a position and the talk crazy stuff" trade: Goldman or fat-boy?

The_Juggernaut's picture

Scared the hell out of me.  At first I thought the headline read "according to Gartman".

Mr. Ed's picture

What's with the downvote there? Goldman troll?

CHX13's picture

...bcs they own the vault with (supposedly your) gold. If you don't hold it...

Mustafa Kemal's picture

Do those pasties come with tassles?

quadraspleen's picture

clue: what he's talking about isn't gold. If the SHTF in the way it could, gold will be priceless for a short time, then worthless. Pick your moment.

sharkalert's picture

Gold and Silver are soooo cheap!

ET's picture

Becoming less so.

Physical Gold and Silver demand is rising and inventories are declining.

As people move out of crypto, they are moving into Hard Assets like Physical Gold and Silver.

FreeShitter's picture

Stop spamming your shit dude....we get it, you are broken record already. We all pretty much own some gold and silver here and dont need spam.

BandGap's picture

What what what?

I guess up is up again, and down is down. For the time being anyway.

DC Beastie Boy's picture

Ironically it's Au and AG have been relatively stable

mayhem_korner's picture

Au an Ag are constantly manipulated, esp. by through buying and dumping of paper GLD shares.  The real worth of the physical is completely obscured.

CHX13's picture

NONONO, the paper price of them, or rather, the fiat value in terms of gold and silver are being manipulated, not fizzical gold and silver. As such DCBB is kinda correct. Gold and Silver (not valued in $-terms) are quite constant, which is why our central planners hate it and got rid of the (pseudo-) gold standard "temporarily" in August '71. Time's almost up though. Tick tock...

Suicyco's picture

Only needs to double, and I'm on my investemnt. Not too shabby.

spastic_colon's picture

if by gold you mean the FANG's.........just look at them bang the FANG's today already

coast1's picture

Did you see the silver chart for today?  wtf happened a 4am, a total dump, then a quick up, then another dump, then straight up...Someone mentioned pump and dump for the insiders using paper, but today is...I used search term "silver spot price kitco"...check it out

Catullus's picture

Gold price in dollars is correlated to dollar strength? Say it ain't so

Sugarcandy Mountain's picture

Foolish to measure your gold against a failing fiat ponzi "currency." It ought properly be measured by weight.

saldulilem's picture

But but, ... bitcoin?

Michigander's picture

No...AND Bitcoin. Why can't you get that?

I am not (so you most definitely are not) smart enough to know how the future will unfold. You have no idea what will be confiscated nor do you know what the sheeple masses will accept. A clear thinking individual hedges for these unkown risks...again leaving you curbside.

Seriously though, I wish you well in your narrow minded one solution answer. I win in either case. Your odds are cut to, at most, 50%.

anarchitect's picture

"But as we saw over the past decade, debasement doesn’t always lead to inflation, and is not the only source of it, either."

Horseshit.  A general increase in the price level can only occur as the result of an increase in the money supply.  If prices of some things, like gasoline, increase, the prices of other things must necessarily fall unless the money supply has increased.  There hasn't been enough inflation in consumer staples to account for the debasement of the past decade, but you also need to look at healthcare, education, and, most of all, asset prices.

Kokulakai's picture

US households and businesses hold 15 percent of the currency stock.

That leaves enough offshore to inflate prices beyond our wildest dreams.

CHX13's picture

"Hedge of last resort" (HOLR) - I like it. He who holds the gold will have the last holr... It is where the p(b)uck will be going, eventually.

cesar's picture

Jeff Currie knows nothing about gold and his advice is worthless.

This guy is the same clown who said short gold (Feb 2016) expecting gold to drop to $1,000/ounce by feb 2017!


bardot63's picture

Right, we needed a Wall St analyst to tell us this?

0valueleft's picture

Gold is a hedge agaisn't you Goldman and you're ever reaching reckless greed, why not mention how your always there, first in line to "custodian" the gold of once soverign nations we flush down the toilet of regime change, under the guise of democrazy and lieberty.

Hey Venezuela where's your fucking gold man?????? Every minute you sit here and waste mindlessly bickering, "Gold is better than Bitcoin 5000 years blah blah....", "No it's not dummy, Bitcoin is like way better absolute amount ledger blah blah...." These evil fucks take wealth out of the system that is never to be returned. Goldman writes an article about gold, meanwhile they're buying Houston for pennys on the dollar with either your tax dollars or freshly conjured free fed food. There should be a Militia at all airports in south Texas vetting every asshole in a $5000 suit, turns out they represent any of the worlds comptrollers like Goldman, pew to the back of the bean. Tear there pagan goat asses out of the shadows and hang em on a hook.

finametrics's picture

I read this is as a warning that gold could get crushed and DXY could spike. One last major buy the gold dip opportunity.

loveyajimbo's picture

How about a hedge against the massive, unpayable DEBT and unfunded obligations, Lloyd, you "roid?  How about a hedge against the massive cleanup/repair/rebuilding bills coming with the Harvey and Irma damage, with 80% of the poor schleps uninsured?  Might add a hedge against a massively overvalued equity market in a failing economy... as well as a seditious congress that is totally gridlocked...

And some ETF's are backed by physical gold and silver, just not GLD or SLV.

bjax's picture

Or .... it's manipulated !

Steve1179's picture

Whichever way you look at  it, tensions atound the world are affecting the gold price. They always will. There's been a £64 increase in the gold price in the last month alone -

There may be more to it - but the fact that the price of gold - and demand - has increased since tensions in North Korea escalated is not a coincidence.  Different thing have caused a spike in demand and a spike in the price of gold too.  From Trump winning the US election, Britain voting to leave the UK, to the financial banking crisis ten years ago.