The invasion and annexation of the Crimea peninsula and region by Russia (with the possibility of outright invasion of eastern Ukraine by Russian forces), along with violence in Venezuela, Argentina, Thailand, Turkey, South Sudan, the Central African Republic, Nigeria, Iraq, and the ongoing civil war in Syria show that there is no shortage of geopolitical, social, and investment risk around the world.

Gold

Some of the effects of this are elevated oil prices, despite slow demand growth, and increased output in North America squeezing out imports of crude, compelling the major exporters in the world to compete against each other.

The geopolitical risk has not increased bond yields markedly aside from those in directly affected nations mentioned above.  However, it could be affecting the price of gold.

The Gold Price Drop:  Reasons

The price of gold has sunk over the past two years or so as Chinese economic growth and consumer income growth there has slowed; as the Indian rupee has dropped due to adverse balance of payments changes; the U.S. dollar has strengthened, partly due to the policy commitment to increased ‘tapering’ of Treasury bond purchases by the Federal Reserve Board; a general decline in all commodity prices, particularly minerals; and, finally, diminishment of inflationary expectations of investors and speculators.

It is interesting, though, that the slide in the gold price that so dispirited gold bugs last year has not continued this new year.  As inflation remains quiescent nearly everywhere in the developed economies and major emerging ones, something else is at work; or, more than one thing.

The principal one is likely political risk.  The turmoil in Crimea and the rest of Ukraine, unrest in Russia, the erratic states of Libya, Syria, Iran and its fragile economic sanctions settlement, Pakistan and Afghanistan, and all the other nations mentioned earlier in this piece are continuing, and, except for possibly Thailand, intensifying.

India Remains Solidly Bullish

Another factor is what is going on in India.  The nation goes to the election polls starting next month, and continuing into May.  It is widely expected that a pro-business opposition party will gain a plurality of seats in the lower house of parliament; perhaps even a majority, especially if the votes against it are split among several parties, including the ruling Congress Party.

Also, while India’s growth rate has declined dramatically to under 5%, recently, from nearly 10% a few years ago, it still is growing faster than most other nations.  There is also a consensus that roadblocks to investment, such as poor infrastructure and insufficient capital spending to improve it, are impediments that must be removed to unleash business spending and growth, particularly in the rural areas, and in congested cities.

The very good monsoon last year has also improved villagers’ incomes, thus providing greater purchasing power, and potential economic growth.  Whenever lower-income Indians find they have more money than expected, aside from some needed things, they also tend to purchase gold, as a store of value, or for festivals, gifts, and weddings.

Another factor is influencing Indian demand for gold.  Part of the reason the price fell last year was the central government’s levying of a large import fee on gold, which, as intended, sharply reduced demand.  However, that tax or duty is now fully absorbed and discounted by consumers and investors.  The gold price, in the meantime, has fallen, even in Indian rupee-depreciated terms, so it is roughly in the same purchasing-power range as before, with a much more positive outlook for the Indian economy than was prevalent just a few months ago.

China a Major Player, Source of Unrest

Looking further afield, it now seems that China has overtaken India as the world’s largest consumer and importer of gold.  While some of that increased demand is undoubtedly because of rising disposable income, some of it could also be because of rising fears of risk in China.

The main documented economic risk is overbuilding and misallocation of resources to real estate development and speculation.  Several developments and even entire new towns and cities are sparsely inhabited, leaving their owners and lenders vulnerable to foreclosure and even bankruptcy.  Savvy investors in China are conscious of this, and may be hedging or diversifying their investments by buying gold.

Another reason is political unrest.  There are terrorist attacks, such as a mass murder in Kunming some weeks ago, demonstrations against terribly polluted air, water, and soil, and signs of political repression even in the autonomous city-state of Hong Kong, where journalists are being stabbed and efforts to enhance democratic reforms are being stymied.

China’s new administration is also at odds with its neighbors, taking an aggressive, almost hostile stance with respect to many long-standing territorial disputes.  Tensions with South Korea, Japan, and the Philippines are escalating, amid naval buildups and confrontations both in the East China Sea, and the South China Sea, and in the borderlands with India.  A miscalculation by any military personnel could cause violent conflict, with potentially catastrophic effects, not least on business and financial markets.

Conclusions

So, the gold price increase thus far this year, while halting, relatively modest, and not awe-inspiring, could be a clue that, unlike most other commodities, the large number and alarming nature of some of the political risks that are evident and growing, may be propelling gold higher, even much higher.  It could also be showing that these political risks are not fully appreciated or discounted by investors in other assets, likely at their peril.

It is a little difficult to see the best investment angle, since gold has already rebounded quite a bit, but beaten-down stocks that have written off their own bad merger and capital investment decisions in the past decade, such as Goldcorp Inc. (USA) (NYSE:GG), Barrick Gold Corporation (NYSE:ABX), IAMGOLD Corp (USA) (NYSE:IAG) and Kinross Gold Corporation (NYSE:KGC) are not far above multi-year lows.  As the actual gold price fared far better than the miners did in recent years, ETFs like SPDR Gold Trust (ETF) (NYSEARCA:GLD) which directly own gold bullion or gold futures are a good hedge.

Aside from Ukraine, there are several other sites of possible major political and economic disruption.  It is not surprising gold is coming to be seen as an intelligent place to put some money.  The geopolitical turmoil could be another reason U.S. Treasury bond demand remains strong, domestically and internationally, and interest rates have moderated.  Stock markets may not be so invincible; their reaction to the Crimea crisis was telling.  This is already a very interesting year.

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