Gold continues to reach new highs, most recently passing $2,500. While many consider precious metal as a hedge against inflation, the main factors that keep gold shining are the prospect of falling interest rates, weaker USD, geopolitical unrest, and rising chances of a recession. Let’s take a look.
Inflation is coming down, but so what
First things first, inflation. Inflation is still above 3% – above the Fed’s target – but is on a downward trend. And it won’t stop the Fed from start cutting rates next month.
If people consider gold a hedge against inflation, should lower inflation put downward pressure on gold prices? As I have pointed out, inflation hasn’t been the leading cause of the rise or fall of gold prices in recent history. The following chart highlights this assessment. During the rise in inflation in 2021-2022, gold prices did not do much and only slightly increased, and as inflation started to decline in 2023-2024, gold prices kept climbing to reach new highs.
Figure 1
Source: FRED and author’s calculations
So, if it’s not about inflation, what is it about?
Interest rates are about to fall
One of the key drivers behind the recent rally in gold is the decline in long-term interest rates. Indeed, they have been strongly linked with the bullion. As the Federal Reserve is expected to cut rates in the coming months, this trend and the prospects of a weaker USD – given the expected rate cuts – will likely keep gold prices elevated.
Recession bells are starting to ring
While gold may not be a great hedge against inflation, it is more of a hedge against high-risk events such as recessions. The recent jobs report has raised alarm bells that the US could face a recession as the Sahm rule hit the 0.5 threshold – suggesting the US has entered a recession. While even Sahm herself thinks this time it’s different and her rule should be taken with a grain of salt, it’s still enough to drive up demand for precious metals, as was the case during the Covid-induced recession of 2020, see chart below.
Figure 2
Source: FRED and author’s calculations
Geopolitical unrest
Speaking of uncertainty, one factor that could contribute to the rise in gold is geopolitical unrest. The wars in Israel and between Russia and Ukraine have contributed to a rise in the geopolitical risk (GPR) index, which measures how geopolitical events could affect economic activity. As long as these wars continue, the high uncertainty will likely keep people seeking gold as a haven asset.
US elections?
While I did not find evidence that US elections correlate with the direction of gold prices, I will cautiously hypothesize that this election cycle could be different. Given the concerns over the next president looms, this could put more upward pressure on gold prices this time.
Bottom line
The combination of lower interest rates, geopolitical uncertainty, and possible recession will likely keep gold shiny and its investors continuing to buy it.