Shining in times of crisis: How gold prices reacted during major wars

Highlights

• Gold is, once again, in the limelight as the world is gripped by high inflation and ongoing tensions between Russia and Ukraine.
• Gold has been seen as a ‘safe haven’ during dire economic situations.
• Prior to World War II, gold was used as a means of trade, and countries linked their currency with gold, in turn linking with each other for international trade.
• The US introduced the Bretton Wood System after the devastating World War II and fixed the price of gold to US$35/oz.
• It was in 1971 when demand outpaced supply, freeing gold from the Gold Standard and Bretton Wood systems.

Gold, as an investment option, has managed to maintain its sheen over the past several centuries. It has become a well-accepted dictum in the investing world that gold acts as a ‘safe haven’ during economic turmoil.

The ongoing tensions between Russia and Ukraine have wiped out billions of dollars of investors’ money in a few days around the world. But the yellow metal seems to stand tall amid the crisis, with gold prices on the move since the Russia-Ukraine crisis began.

Gold is currently trading around US$1,900/oz, the highest since June 2021. During the peak of the COVID-19 pandemic, we witnessed the gold rally in 2020, when prices shot up to US$2,067/oz, its lifetime high.

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Gold has been used since ancient times for trade and commerce. It was only after World War II that gold relinquished the role of being used as money. The Bretton Woods system was introduced in 1944, which established the dominance of dollar for international trade. The then US policymakers fixed the price of gold at US$35 per ounce.

The Bretton Woods system was launched in order to provide more stability after the chaos of the war, which fixed the exchange rate but provided more flexibility than the traditional Gold Standard. In the Classical Gold Standard regime, all countries linked their currencies to gold. As each currency was fixed to gold, the exchange rates between the currencies were also fixed.

The Bretton Woods system provided capital controls, which in turn enabled governments to stimulate their economies without incurring any financial market penalties. The United States ended the system in 1971, which was replaced by fiat money.

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Gold’s love for war

During a war or a war-like event, the prices of several commodities are affected. War means excessive money printing and increased government spending. After the Bretton Woods and Gold Standard system ceased to exist in the 1970s, gold was set free from the limits of governments and banks, and prices were adjusted on demand and supply dynamics.

Image source: Refinitiv; Analysis: Kalkine Media

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The 1970s was a period of upheavals as the world was at the peak of the Cold War. The Iranian Revolution (1978), Iran-Iraq war (1979), Iranian hostage crisis (1979) and the invasion of Afghanistan by then Soviet Union at the end of 1979 were the prominent events that shook the world.

At the beginning of 1978, gold was trading around US$200/oz. By the end of 1979, the turmoil in the Middle East and Afghanistan had cranked up the prices above US$800/oz.

If we look at the gold price chart, we can see that prices gradually started to retrace once the dust of war settled. The prices came down to ~US$400/oz in 1982.

Gold prices skyrocketed once more during the first Gulf War, when Iraq invaded Kuwait in 1990. However, as war discussions continued, gold prices quickly rebounded to pre-war levels. Gold prices continued to fall quickly after the conflict ended, and by the end of 1991, they had returned to nearly pre-invasion levels. Following that, gold continued to fall as disinflation took hold.

Another watershed moment that saw gold prices soar was in the wake of 11 September 2001 terrorist attacks in the United States. Following this, the United States invaded Iraq in 2003, again prompting gold prices to rise. The yellow metal reverted to its pre-war value only after a sense of assurance that the war would be brief and successful.

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What’s fuelling the current bull-run of gold?

The current heat in the prices of gold is a mixture of ‘cold war’ and inflation. Along with the geopolitical difficulties, there are strong fundamentals that are propelling gold higher since late January of 2022. Inflation is exploding in most parts of the world as a result of the COVID-19 pandemic's aftershocks.

The gold price has risen this month, as US-Russia tensions over Ukraine and fears of a prolonged higher inflation period have stoked safe haven-investment demand.

Bottom Line

Gold seems to gain from the financial crisis and war events. The war seems to affect the prices for the short-term and as the clouds of war are over the price tends to soften. The current price rise is the result of inflation and troubles in Eastern Europe. It is anticipated the prices will correct once the inflation figure cools down and some sort of arrangement is reached in Eastern Europe.

The financial crisis seems to have a more deepening effect on the gold prices rather than war when investors tend to migrate towards a safer and stable destination of investment.