Gold Plunges 8%, Wiping Out All Gains This Year; Why Are Safe-Haven Assets "Failing" Amid Middle East Conflict?

How much longer will the process of crowded trade liquidation last? The market currently has no consensus.

War and inflation should be the most loyal allies of gold, but this time, gold has completely disappointed investors.

This Monday, spot gold fell intraday by 8%, to $4,122.26 per ounce; New York gold declined by 9.74% intraday, to $4,165 per ounce. Spot silver dropped nearly 8% intraday, currently at $62.49 per ounce. New York silver fell 10.0% intraday, to $62.64 per ounce. Spot platinum declined over 8%, to $1,773.47 per ounce. Spot palladium fell nearly 5%, to $1,346 per ounce.

Since the Israel-U.S. conflict with Iran began, gold has fallen approximately 24% from its pre-war highs. Investors holding gold during this period have returns that are even worse than those from the smallest micro-cap stocks.

According to The Wall Street Journal, the fundamental reason for gold’s “failure” this time is that over the past year, gold has evolved into a highly crowded trade. After the outbreak of the conflict, investors sold it off as the most prominent asset—whether to avoid risk or to pay down leveraged debt. While technical factors like the dollar appreciation and rising real interest rates offer some explanation, they are insufficient to justify such a magnitude of decline.

Deeper pressure comes from structural factors: the Middle East conflict has shaken the logic of continuous central bank gold purchases and may prompt physical gold holders in markets like India to sell. How long the liquidation of crowded trades will last remains uncertain.

Dollar and Real Interest Rates Are Not the Main Causes

Several technical explanations circulate in the market, but according to The Wall Street Journal, these reasons are hard to justify.

The dollar factor is first considered.

After the war broke out, benefiting from the U.S. being a net oil exporter, the dollar appreciated significantly, which theoretically should suppress gold priced in dollars. However, gold priced in pounds, euros, and yen also declined by about 11%, 10%, and 11%, respectively, indicating that dollar appreciation is not the main cause. Last Thursday, the dollar weakened on the same day that gold experienced its largest single-day drop since the conflict began, further disproving this explanation.

The explanation involving real interest rates is also limited. Market expectations that the Federal Reserve will hold or even raise interest rates this year—marking a major shift from previous expectations of two to three rate cuts—have caused the 10-year TIPS yield to rise, which in turn somewhat reduces gold’s relative attractiveness.

However, over the past year, the traditional negative correlation between gold and TIPS yields has broken down, with both rising in tandem for a long period. According to The Wall Street Journal, in the past 15 trading days, only 11 days showed a reversal of this relationship, and the explanatory power of real interest rates for gold’s decline remains limited.

Core Reason: Collective Exit from Crowded Trades

The most compelling explanation for gold’s sharp decline, according to The Wall Street Journal, is that it is a severe crowded trade collapsing rapidly. Just like the stock market performance during this conflict, assets that previously surged the most tend to fall the hardest when investors retreat.

Over the past year, gold attracted a large influx of speculative capital. This trend is clearly visible in the holdings of major gold ETFs—specifically, the SPDR Gold Shares. Last fall, gold prices even began to move in tandem with popular stocks favored by retail investors, indicating a strong speculative component.

Some investors borrowed funds to increase their gold positions. When market risk appetite reversed, they were forced to liquidate gold holdings simultaneously to cover stock short positions, creating a cascade effect. While the leverage scale in the gold market is difficult to quantify precisely, the large inflow of speculative funds is undeniable. As this capital exits, downward pressure on gold is inevitable.

Central Bank Gold Buying Logic Shaken

In addition to the exit of speculative funds, the Middle East conflict has directly impacted the most important structural buyers of gold—central banks.

Analysts believe that the strong rally in gold over the past few years was largely driven by central banks shifting their foreign exchange reserves from dollars to gold after Western sanctions froze Russian assets. This trend attracted more capital to buy gold.

However, the Iran war has disrupted this logic. The core function of foreign exchange reserves is to ensure import payments during economic shocks.

The International Energy Agency (IEA) has characterized the current oil supply disruptions caused by the war as the largest supply shock in global oil markets ever. For oil-importing countries, this is a time to draw on reserves for emergency needs, not to increase gold holdings. For oil-producing countries in the Persian Gulf, if the Strait of Hormuz is blocked and oil and gas exports are interrupted, these countries might shift from being gold buyers to sellers.

Physical demand is also under pressure. In India, residents traditionally store a large portion of their savings in gold. With soaring oil prices impacting the local economy, these physical holders may also choose to cash out.

Analysts believe these pressures are mostly temporary. Once the crowded trade is cleared, gold should theoretically revert to fundamentals driven by inflation, interest rates, and geopolitical risks.

But the core question remains: how many buyers still need to exit? If central banks—these significant structural buyers—also start selling, gold could face a longer and more arduous adjustment before regaining its shine.