Recent movements in gold prices have created considerable confusion among market participants. Long regarded as the quintessential safe-haven asset, gold has now come to be viewed not only as an investment asset but, in some quarters, even as a speculative one. In the past, relatively clear formulas applied: gold rose when interest rates fell and weakened when the dollar strengthened. Recent markets, however, have been different. Movements that defy traditional correlations have repeated themselves, and even amid the Middle East crisis, when safe-haven demand strengthened, gold prices underwent a correction, raising questions. So what variables drive gold prices, and what lies behind the recent surge and heightened volatility?
Key Factors Determining Gold Prices
The key variables influencing gold prices can be broadly grouped into four. The first is real interest rates. Because gold, unlike deposits or bonds, pays no interest, its relative investment appeal diminishes when real rates rise. Conversely, when real rates fall, the opportunity cost of holding gold decreases, supporting prices.
The second is inflation expectations. Gold has historically served as a hedge against currency depreciation and rising prices, so demand tends to rise as inflation expectations climb.
The third is the value of the dollar. Because international gold prices are quoted in dollars, gold typically weakens when the dollar strengthens and strengthens when the dollar weakens. The last is geopolitical risk. When uncertainties such as wars or financial crises escalate, safe-haven demand strengthens, which can lead to higher demand for gold.
Anomalies in Gold’s 2022-2024 Uptrend
Gold’s full-fledged upward trend began in late 2018. Particularly noteworthy is that gold prices continued to rise over the long term from 2022 onward, even as the Federal Reserve pursued an aggressive rate-hiking policy. While high interest rates and a strong dollar are generally negative for gold, other forces exerted greater influence during this period.
The key driver was large-scale gold purchases by central banks. After the Russia-Ukraine war, when Western nations froze Russia’s foreign exchange reserves, central banks around the world began to feel the risks of dependence on dollar-denominated assets. As a result, particularly among emerging markets, a movement to expand the share of gold in foreign exchange reserves emerged. Indeed, central bank gold purchases globally have emerged as a major demand factor accounting for around 20 percent of total gold demand, weakening the existing correlations with interest rates and the dollar and supporting the rally in gold prices.
Gold: A Return to Traditional Safe-Haven Status?
The price rally continued sharply into the early part of this year. On top of sustained buying by global central banks, the second Trump administration’s tariff policies, concerns over U.S. fiscal soundness, and controversies over the erosion of Federal Reserve independence drew attention, deepening doubts about confidence in the dollar. At the same time, with the Fed cutting rates and individual investors piling in to chase the trend, international gold prices broke through $5,000 to set an all-time high.
This rally, however, briefly reversed amid heightened geopolitical risk in the Middle East. Geopolitical risk typically stimulates safe-haven demand and supports gold prices. This time, however, gold prices had already risen significantly, and investors placed greater weight on securing liquidity than on further gains. Profit-taking flows emerged as some investors sold portions of their appreciated gold holdings to prepare for uncertainties stemming from the Middle East.
Traditional correlations also reasserted themselves. As the Middle East crisis sent international oil prices surging, inflation concerns expanded once again, and U.S. Treasury yields rose. Expectations for Fed rate cuts retreated somewhat, and safe-haven demand also translated into dollar strength. Ultimately, selling by individual investors, along with traditional headwinds of rising rates and a stronger dollar, all worked simultaneously to put downward pressure on gold prices.
This dynamic sends two messages to the market. First, new variables not seen in the past are being added to the gold market. Expanded central bank purchases, doubts about dollar hegemony, and inflows of individual investor money are making gold price volatility more complex than before. Second, despite this, gold’s traditional price-determining structure has not entirely broken down. Ultimately, the current gold market needs to be interpreted as a transitional phase in which a new paradigm and existing correlations coexist.
How, then, should investors view gold going forward? In the short term, high volatility may emerge depending on the Middle East situation and shifts in U.S. monetary policy. From a long-term perspective, however, it is difficult to argue that gold’s essence as a safe-haven asset has been undermined. The continued buying stance of central banks and the trend toward diversification of foreign exchange reserves remain firmly in place as key factors supporting gold demand.
Ultimately, gold needs to be approached not as a vehicle for short-term capital gains but rather as a strategic asset to prepare for periods of expanding uncertainty. Therefore, rather than betting on short-term direction, a strategy of holding gold at around 10 percent of total assets for portfolio diversification and risk management from a long-term perspective appears to be effective.
