When Momentum Cuts Both Ways
Tuesday’s gold selloff highlights a feature of markets that too many people forget: momentum works both ways.
Gold has had one of its best years since it was demonetized in 1971. On the spot market—where gold is purchased for immediate delivery—prices have risen from roughly $2,600 at the beginning of the year to a little under $4,100 on October 22.
Gold closed on Monday, October 20 at $4,361 per ounce. The next day, it fell to $4,116 per ounce, marking the largest one-day price decline for gold in over a decade.
What’s driving this volatility?
Investment vs. Speculative Assets
I find it helpful to think of assets as being of two main types: investment assets and speculative assets.
- Investment assets produce, or are expected to produce, cash flows.
Investors can estimate the intrinsic value by discounting those cash flows to the present and comparing that to the asset’s market price. - Speculative assets, on the other hand, produce no cash flow and therefore have no intrinsic value.
Gold falls into the latter category, making it difficult to determine whether it is undervalued or overvalued. Yet, in recent months, it has clearly morphed into a momentum trade.
I’m not making a moral or professional judgment on speculation. I simply think more like an investor than a trader. That said, among speculative assets, gold holds a special status because of its long history as a store of value—a refuge when confidence in paper money declines.
The Year’s Gold Rally: From Fundamentals to Fervor
Earlier in the year, central banks drove much of the gold buying as they diversified away from dollar holdings.
At the time:
- Inflation remained well above the Federal Reserve’s 2% target.
- The U.S. dollar index—which measures the dollar against a basket of currencies—had declined significantly.
- Concerns over trade policy and fiscal sustainability in industrialized nations added uncertainty.
In that climate, higher gold prices made sense.
As the year progressed, however, the dollar stabilized and bond yields showed little sign of rising inflation expectations. Other risk factors, while still elevated, were no worse than before. Yet, gold prices continued their meteoric rise.
By mid-summer, the composition of gold buyers shifted. Exchange-traded funds (ETFs) began seeing large inflows, suggesting retail investors were jumping in—hoping to profit before the rally ended.
But as always, the same herd mentality that drives prices up can drive them down, as the past week has demonstrated. For more insights on gold and its role in today’s markets, check out my latest podcast, Episode 12: Are We Building Another Bubble?.
A Brief History: Gold and the Global Monetary System
In the late 1800s, most industrial nations joined Great Britain in enacting a gold standard. Under a gold standard, paper currency is convertible to gold at a legally established rate of exchange. For example, the United States passed the Gold Standard Act of 1900, establishing the dollar-gold exchange rate at $20.67 per ounce.
When the first world war broke out in 1914, European countries were forced to suspend gold convertibility. After several attempts to reconstruct the gold standard in the 1920s, countries across the world abandoned the gold standard during the great depression.
In 1944, world leaders met in Bretton Woods, New Hampshire, to design a new monetary system. The resulting Bretton Woods Agreement fixed global exchange rates to the U.S. dollar, which was tied to gold at $35 per ounce—a rate established by President Franklin Roosevelt in 1934. Although this was not a gold standard in the pre-war sense – only foreign governments and central banks could convert dollar holdings to gold – it did keep gold as an anchor of the U.S. money supply.
Eventually, foreign dollar holdings began to greatly exceed U.S. gold supplies, and foreign governments lost faith in United States’ willingness to support the dollar. In August 1971, President Richard Nixon ended gold convertibility, effectively dissolving the Bretton Woods system and removing gold from its role in global monetary policy.
For a deeper look read my earlier blog post, Money and Banking Part 8: The Global Financial System old . where I explain how international institutions and exchange rate systems evolved in the decades that followed.
Gold’s Modern Role: Hedge or Hazard?
Since the 1970s, gold has traded freely on global markets, often viewed as a hedge against inflation and a store of value in uncertain times.
However, whether it will continue to perform that role remains uncertain.
One thing is clear: gold can be as volatile as any other asset—and as Tuesday’s selloff showed, momentum works both ways.
Summary
Gold’s sharp selloff underscores a truth often forgotten in markets: momentum-driven trades can reverse quickly. While early-year fundamentals justified gold’s rally, speculative behavior—especially from retail investors—has recently taken over. Understanding gold’s history and its shift from a monetary anchor to a speculative asset helps investors see that even traditional “safe havens” carry risk.
Key Takeaways
- Gold surged from $2,600 to over $4,300 per ounce before dropping sharply.
- It has transitioned from fundamental buying to a momentum-driven trade.
- Speculative demand, especially through ETFs, has increased volatility.
- Gold’s historical role as a store of value continues to influence investor behavior.
- Despite its legacy, gold can be as risky and volatile as other assets.
