War breaks out, but gold plummets $700? Don’t be fooled by textbooks—what matters to the market now is "liquidity"!

Source: Wall Street Intelligence Circle

The market is not experiencing ordinary volatility, but rather a complex shock of "war, inflation, interest rates, and asset runs" happening simultaneously.

Why isn't gold rising? Why are oil prices soaring? Why is the Federal Reserve so hawkish? These seemingly scattered questions all point to one thing—the market once believed everything could still be controlled, but that confidence is now loosening.

1. Why does the Federal Reserve remain so hawkish even during war?

Many people naturally think that when war increases risk, central banks should inject liquidity to save the market. But this time, the issue is that war isn't just provoking simple panic, but is pushing up energy prices. And when energy prices rise, bigger problems follow:

As oil prices rise, so do costs for transportation, manufacturing, and power generation.

Natural gas prices rise, pushing industrial costs in Europe and Asia even higher.

These costs are then passed on to consumers, making inflation even harder to control.

If the Federal Reserve starts screaming "inflation is dangerous," yet rushes to cut rates, markets will immediately assume: you’ve surrendered. So, even in wartime and even if the stock market suffers, the Fed can hardly afford to turn dovish. What it fears most now is not a stock market decline, but inflation expectations spiraling out of control.

If this war merely caused markets to drop, the Fed could endure it; but if the war fully ignites oil and gas prices, the Fed is even less likely to ease. This is the logic behind "why high rates may be maintained during wartime, and may even need to be even more hawkish in theory."

2. Why hasn't gold "skyrocketed in troubled times"?

Textbooks teach us that "when war comes, safe-haven demand rises, and gold soars," but the reality is that gold prices have plummeted—in fact, since the Iran war, they've fallen by $700.

In the short term, gold is not a "safe-haven asset," but one that’s heavily traded, leveraged, speculated upon, and subject to crowded trades. When the market enters extreme volatility, gold may not be first to rise and might instead fall. Here are a few reasons why:

· First, gold had already rallied too much. The current slump comes because the market still treats gold as a "crowded commodity position." Gold and silver had outperformed major commodities like crude oil, to the extent that they were "ahead of themselves." In other words, the market had already priced in much of the risk, panic, and concerns over U.S. dollar credit. Once a new crisis actually erupts, money doesn’t blindly chase higher, but often takes profits, closes positions, covers margin, and sells off the most profitable and most liquid assets. Gold often happens to be that "star asset that's easiest to sell."

· Second, a stronger dollar suppresses gold. Despite being a safe-haven, gold often has a "see-saw" relationship with the dollar. If war escalates and the market’s first reaction is to buy dollars and U.S. short-term bonds, then gold is suppressed. So the reality is twisted: the world is messier, but gold falls. Not because gold has lost value—but because short-term liquidity rules override long-term safe-haven logic.

· Third, the market is not in utter despair yet. Gold is not for "performance," but for "weathering the storm"—it's not the type of asset that thrills with daily limit-up moves if anything goes wrong. It's more like a "systemic insurance policy." There hasn't been overwhelming buying because most people still believe the situation will eventually be controlled, the Fed will step in, the U.S. economy won't collapse, and the financial system will keep working. As long as the market generally believes "in the end, it will be fine," gold won’t experience that kind of nationwide panic-buying pricing. So gold’s current weakness does not necessarily mean it's useless—if anything, it shows that while people talk pessimistically, deep down, they're not completely giving up yet.

3. Is it worse now than the 1970s?

That’s a real possibility.

The trouble for the U.S. in the 1970s was high inflation, sluggish growth, rising unemployment, and oil shocks—stagflation. Today might be worse, because there are several additional "big burdens":

1) The debt load is much heavier than back then. In the 1970s, the Federal Reserve could hike rates to 20% because government debt was just over 30% of GDP. Now, U.S. debt is so high that every 100 basis point hike means astronomical extra interest payments for the Treasury.

2) The asset bubble is larger. Today’s U.S. economy relies heavily on the wealth effect from the stock market, real estate prices, credit expansion, and fiscal deficits—very different from the 1970s. The problem now is, if high rates last too long, not only inflation is hit, but asset prices could be directly crushed.

3) Less policy space. The 1970s allowed for tough measures, now it's much harder. That's because today, markets, public finances, Wall Street, and electoral pressures all make it impossible for the Fed to be as bold as in the Volcker era. So, the issue today isn’t "will inflation return," but "if inflation returns, does the Fed still have the ability to truly suppress it?" That’s a painful question.

Don’t interpret “gold not rising immediately” as “risk does not exist”; on the contrary, it's precisely because risk is spreading that the market first experiences mispricings, dislocations, and stampedes. This point is especially important to note.

At the start of a crisis, the market often doesn’t follow “textbook logic,” but rather “which asset can be sold fastest, which positions are most crowded, and which gets liquidated first.”

The most dangerous thing now isn’t oil prices themselves, but that “expectations are beginning to diverge.”

· Some people still believe: the war is controllable, oil prices will fall back after spiking, and the Fed can stabilize the situation;

· Another group has begun to doubt: this is not a short-term shock, but a long-term energy disruption, inflation will rise again, and the Fed is stuck—unable to save growth nor suppress inflation.

The market has moved from "consensus" to "division." With consensus broken, price volatility gets extreme: today it’s pricing in "recession," tomorrow "inflation," and the day after switches to a "liquidity crisis." That’s why the market has seemed especially erratic and schizophrenic lately.