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

This Monday, spot gold fell by 8% during the day, reported at $4122.26 per ounce, while New York gold dropped by 9.74% to $4165 per ounce. Spot silver saw a nearly 8% decline, now at $62.49 per ounce. New York silver fell by 10.0%, reported at $62.64 per ounce. Spot platinum dropped over 8%, reported at $1773.47 per ounce. Spot palladium fell nearly 5%, reported at $1346 per ounce.

Since Israel and the United States went to war with Iran, gold has accumulated a drop of about 24% from its pre-war high. The returns for investors holding gold during this period are even less than those from the smallest micro-cap stocks.

According to analysis by the Wall Street Journal, the fundamental reason for gold's current "malfunction" is that over the past year, gold has evolved into a highly crowded trade. After the outbreak of the conflict, investors viewed it as the most apparent chip to sell off first—whether to avoid risk or to repay leveraged debts. While factors like dollar appreciation and rising real interest rates provide some explanation, they are insufficient to support such a significant drop.

Deeper pressure comes from a structural level: the Middle Eastern conflict has shaken the logic of continuous gold purchases by central banks and may drive physical gold holders in markets like India to seek liquidation instead. The length of time for the process of clearing crowded trades remains uncertain in the market.

The Dollar and Real Interest Rates Are Not the Main Reasons

Several technical explanations circulate in the market, but the Wall Street Journal analyzes that these reasons are difficult to rationalize.

The dollar factor was first brought to the table.

Following the outbreak of war, benefiting from the U.S. status as a net oil exporter, the dollar appreciated significantly, which theoretically would suppress gold priced in dollars. However, gold priced in pounds also dropped about 11%, in euros it fell about 10%, and in yen it declined about 11%, indicating that dollar appreciation is not the primary cause. Last Thursday, when the dollar weakened during the day, gold recorded its largest single-day drop since the conflict began, further debunking this explanation.

The explanation regarding real interest rates is also limited. As the market expects the Federal Reserve to maintain interest rates or even raise them—significantly shifting from previous expectations of two to three rate cuts—yields on 10-year Treasury Inflation-Protected Securities (TIPS) have climbed, which has somewhat reduced gold's relative attractiveness.

However, over the past year, the traditional inverse relationship between gold and TIPS yields has broken down, as both had been rising in tandem for a long time. According to the Wall Street Journal, only 11 out of the last 15 trading days have shown a reverse trend; thus, the explanatory power of real interest rates for gold's drop remains limited.

Core Reason: Collective Exit from Crowded Trades

According to the Wall Street Journal, there is only one strong explanation for the sharp drop in gold: it is a severely crowded trade that is accelerating its collapse. Just as with stock market performance during this conflict, assets that had risen the most tend to fall the hardest as investors retreat.

Over the past year, gold has attracted a significant influx of speculative funds. This trend is clearly seen in the changes in holdings of the major gold ETF—SPDR Gold Trust. Last autumn, gold prices even began to fluctuate in the same direction as popular stocks favored by retail investors, indicating a significant speculative flavor.

Some investors borrowed funds to increase their gold positions, and when market risk appetite reversed, they were forced to simultaneously liquidate their gold holdings and cover their short positions in stocks, creating a stampede effect. While the leverage in the gold market is difficult to quantify precisely, the massive influx of speculative funds is an undeniable fact. As these funds gradually withdraw, downward pressure on gold is inevitable.

The Logic of Central Bank Gold Purchases is Shaken

In addition to speculative funds fleeing, the Middle Eastern conflict has also directly impacted the most important structural buyers of gold—central banks worldwide.

Analysis suggests that gold's strong rise over the past few years has largely stemmed from central banks reallocating their foreign reserves from dollars to gold after Western sanctions frozen Russian assets, which in turn attracted more funds to follow suit.

However, the war with Iran has disrupted this logic. The core function of foreign exchange reserves is to ensure the ability to pay for imports when the economy faces shocks.

The International Energy Agency (IEA) has characterized the oil supply disruptions caused by this war as the largest supply shock in the history of the global oil market. For oil-importing countries, now is the critical time to use reserves in emergencies, rather than to increase gold holdings. For oil-producing countries in the Persian Gulf, if the Strait of Hormuz is blocked, leading to a halt in oil and gas exports, these countries may even switch from gold buyers to sellers.

Physical demand is also under pressure. In India, residents are accustomed to storing significant savings in gold. As oil prices soar and impact the local economy, these physical holders may also choose to cash out.

Analysis suggests that these pressures are largely temporary. Once the crowded trades clear, gold should theoretically return to being driven by fundamentals such as inflation, interest rates, and geopolitical issues.

But the core question is how many buyers need to exit, which remains unknown. If structural buyers like central banks also join the selling ranks, gold may face a longer adjustment period before regaining its luster.