The prospect of further currency debasement in the developed world should in theory support gold prices as investors seek protection from potential inflationary risks.
However, as Japan surprised the market by announcing plans to double its monetary base, bullion lost ground.
Indeed, gold has dropped close to 9% in the past two months despite debate over the potential for further quantitative easing (QE) in the US and the UK, and speculation that the ECB might announce further policy accommodation.
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All that should, in theory, support the price of gold, with further QE equating to the printing of more cash, which in turn should stoke inflation and push up bullion prices.
Tom Kendall, head of precious metals research at Credit Suisse, believes, however, that the transmission mechanism from QE to inflation at a time of deleveraging and weak economic growth is indistinct at best.
He says advocates of the theory that the printing of money should equate to the buying of gold overlook the fact the printing of money in any single currency is being overwhelmed by the global effort to stimulate growth and avoid systemic failures in the financial system.
“While the policy actions undertaken today by the world’s largest central banks to keep the global financial system functioning might have unwelcome and unintended consequences at some point in the future, for the time being they have reduced the prospects of further banking and liquidity crises in general,” says Kendall.
“The impetus, therefore, for investors to buy gold – or buy more gold – as a tail-risk hedge has diminished.”
So the question is what accounts for the recent decline in the price of gold?
Simon Derrick, global head of FX strategy at Bank of New York Mellon, believes that rising tensions in North Korea have been the driving force behind price action in the gold market.
Indeed, gold price declines began to emerge on February 11 as North Korea promised more long-range rocket tests ahead of a nuclear test. Further falls came on February 19 as North Korea threatened South Korea with “final destruction”.
Gold prices then regained some composure as the newsflow and sabre-rattling from North Korea slowed down towards the end of February.
That calm was destroyed on Tuesday by news that North Korea was reactivating its Yongbyon nuclear complex, allowing it to create enriched uranium for its weapons programme.
Since, gold has dropped by 3.5% in dollar terms as military tensions in Korea have heightened.
“In short it looks like sharp declines seen in gold over the past two months have been a direct reaction to the current crisis on the Korean peninsula,” says Derrick.
The reaction to the current crisis is in line with the gold price’s behaviour in previous bouts of rising nuclear tensions.
The build-up to the Yom Kippur war in 1973 saw gold prices slide as tensions mounted between the US and Russia. Similarly, gold prices went on an 18-month downtrend in 1980 as the election of Ronald Reagan as US president heralded a sharp rise in military spending and an escalation of the cold war between the US and Russia.
Derrick says although it might appear counter-intuitive that investors should shun gold during times of geopolitical crisis, it does make sense.
“The only reason to hold gold is if there is a broad fear of currency debasement,” he says. “In contrast, geopolitical tensions provide the rather more profound threat of destruction of life and property.
“Put another way, gold goes up when investors are concerned about the unit of account, gold goes down when they are worried about what is being accounted for.”
The lesson for currency investors is that rising tensions in Korea should feed through to strengthen the world’s true safe haven: the dollar and its underlying debt markets.