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

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."


Mr. Ed remain calm Tue, 09/05/2017 - 10:07 Permalink

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?

In reply to by remain calm

CHX13 mayhem_korner Tue, 09/05/2017 - 11:43 Permalink

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...

In reply to by mayhem_korner

coast1 Tue, 09/05/2017 - 10:08 Permalink

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

Michigander saldulilem Tue, 09/05/2017 - 11:06 Permalink

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%.

In reply to by saldulilem

anarchitect Tue, 09/05/2017 - 11:13 Permalink

"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.

CHX13 Tue, 09/05/2017 - 11:36 Permalink

"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 Tue, 09/05/2017 - 11:43 Permalink

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! 

0valueleft Tue, 09/05/2017 - 17:40 Permalink

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.

loveyajimbo Tue, 09/05/2017 - 12:39 Permalink

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.

Steve1179 Wed, 09/06/2017 - 05:42 Permalink

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 - 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.