Portfolio Adviser • Portfolio Adviser May 2025 • Risk

Abhimanyu Chatterjee, chief investment strategist at Dynamic Planner, examines why gold is viewed by investors as a bright spot amid the gloom as Trump’s tariffs stir up global economic turmoil

The initial shots in a potential global trade war have been exchanged. Like opposing fleets manoeuvring in Victorian naval engagements, governments are positioning themselves strategically to strike the most effective blows – a tense quiet before the anticipated conflict.

Following the announcement of US president Donald Trump’s tariffs, affected nations have reacted distinctly: China implemented retaliatory tariffs, delayed aircraft engine orders and limited rare earth metal exports; the EU levied fines on major tech companies such as Apple and Meta. These actions are unsettling financial markets, with both the Vix and Merrill Lynch Option Volatility Estimate index, indicators of heightened risk in equity and fixed-income volatility, showing increases.

While fixed-income volatility was already elevated due to uncertainty surrounding global inflation and interest rate paths, the US administration’s recent policies and statements have generated further uncertainty, pushing equity market volatility to levels not seen since the Covid-19 lockdowns.

The chart below illustrates the performance of major asset classes. Notably, amid the turbulence, gold stands out as the only bright spot. It has demonstrated significant resilience, surging around 9% in April 2025, while the MSCI World Equity index is down by around 5% in US dollar terms. This has sparked the question of whether the precious yellow metal can serve as a portfolio hedge.

Gold, as a metal, has very interesting properties. It does not interact with air, heat or moisture, which contributes to its durability. Most of the gold ever mined still exists today in some way shape or form. It has been maintained that gold has intrinsic value and therefore retains its value in periods of inflation. Post-Covid, as the spectre of inflation loomed, gold investments across allocations increased, resulting in an upward march of price. The recency bias has engendered the view that gold can be used as a hedge for market downturns.

However, it is essential to qualify the term ‘hedge’. A true hedging instrument shows a negative correlation in price to the instrument being hedged. In considering gold as a hedge against inflation, one struggles to find a statistically valid negative correlation showing increase in gold prices as inflation increases.

Alternatively, since rising inflation causes bond prices to drop due to the erosion of the value of money, one would expect a negative correlation when observing returns on government fixed income and those of gold.

However, the relationship has been completely the opposite: the returns from gold increase with the returns of government fixed income and vice versa. Again, it’s hard to justify the use of gold as a systematic hedge for rising inflation or falling bond prices.

This brings us again to the question: what does gold hedge? To answer that, a slight detour is required. In March 2016, Scott Baker, Nicholas Bloom and Steven Davis wrote a paper outlining a new index of economic policy uncertainty (EPU) based on newspaper coverage. The authors aimed to quantify the level of uncertainty surrounding economic policy across a range of 20 countries.

Each national EPU index relies on the frequency of newspaper articles that contain terms related to the economy, uncertainty and policy. Specifically, the measure searches for articles containing ‘economic’ or ‘economy’, ‘uncertain’ or ‘uncertainty’, and one or more policy-related terms relevant to that country.

What the paper finds is the index proxies movements in policy-related economic uncertainty and is a harbinger of negative economic effects of uncertainty shocks, like greater volatility in equity markets, rates and economic growth. When we overlay the price of gold on the level of Global Policy Uncertainty index, we find a strong relationship.

As the level of policy uncertainty increases, the price of gold goes up, as investors (still) consider it as a safe haven of the last resort. So, what does gold hedge? The answer appears to be, without confounding correlation with causality, policy uncertainty. When policymakers reassess the global order and implement changes, investors tend to steer away from traditional asset classes and flock to gold.

In an era defined by shifting political landscapes and unpredictable policy decisions, gold seems to attain some added lustre and enduring appeal. Its intrinsic value, decoupled from governmental fiat, offers a tangible sanctuary against the turbulence of policy uncertainty.