Gold’s Importance Throughout Economic Ups and Downs
Gold. The word itself evokes images of treasure chests, royal crowns and impenetrable vaults. For millennia, this lustrous yellow metal has captivated humanity, serving not merely as decoration but as a fundamental component of economic systems, as we touched on in an old post on the history of gold. The metal’s physical properties—scarcity, durability, divisibility, portability and universal recognition—made it an ideal medium of exchange and store of value long before the advent of complex financial instruments. From the Lydian electrum coins of the 7th century BC to its role anchoring the Bretton Woods system until 1971, gold has been interwoven with the fabric of global commerce and monetary policy for millennia.
Even in today’s world of fiat currencies, digital transactions and sophisticated derivatives, gold retains a unique and often counter-cyclical significance. Its importance transcends mere industrial application (though its use in electronics, dentistry and aerospace is not negligible). Primarily, gold functions as a critical component of diversified investment portfolios and a strategic asset held by central banks worldwide.
Why does this ancient metal continue to hold sway in the digital age? Its perceived role as a “safe haven” asset is paramount. During periods of economic turmoil, geopolitical instability or financial market panic, investors often flock to gold. Unlike currencies, which are subject to the monetary policies and economic health of their issuing nations, or stocks and bonds, which are tied to corporate performance and creditworthiness, gold is often seen as an asset apart. It carries no counterparty risk – its value doesn’t depend on someone else’s promise to pay. This intrinsic quality becomes particularly attractive when trust in traditional financial systems or governments wavers.
Consider recent history. During the global financial crisis of 2008–2009, as major financial institutions teetered and markets plunged, gold prices surged. Investors sought refuge from the systemic risks engulfing banks and credit markets. Similarly, during the peak economic uncertainty of the Covid-19 pandemic in 2020, gold prices jumped as fears of economic collapse and unprecedented monetary stimulus drove gold demand. Or simply look at what’s happened so far this year: Gold prices have reached their highest levels on record in 2025, rising notably above the symbolic USD 3,000 per troy ounce barrier as investors fret about global tariffs.
While demand for gold tends to pull back in times of economic and political calm—which have been notably absent in recent years—it does not dry up altogether. In part, this is because institutional demand underpins the gold market. Despite the collapse of the gold standard in the 70s, monetary authorities globally still hold substantial gold reserves—collectively, over 35,000 metric tons. These central bank reserves serve multiple purposes: Diversifying national assets away from reliance on specific currencies (like the U.S. dollar), acting as collateral in international transactions, providing a backstop in extreme crises and signaling financial strength and stability. Notably, recent years have seen a trend of net purchasing by central banks, particularly those in emerging economies like China, India, Turkey and Russia, which are seeking to reduce reliance on dollar-denominated assets and bolster their financial sovereignty.
Furthermore, the rise of accessible investment vehicles like gold-backed Exchange Traded Funds (ETFs) has democratized gold investment. Individuals can now gain exposure to gold prices without the complexities of storing and insuring physical bullion. This increased accessibility means that shifts in retail and institutional investor sentiment can translate more readily into price movements.
In essence, gold’s importance persists through economic ups and downs because it occupies a unique psychological and economic space. It is a tangible asset in an increasingly intangible world, a historical store of value perceived to hold its worth when paper assets falter, and a strategic reserve for nations navigating a complex global landscape. Its price is a barometer of global economic anxiety and confidence, reflecting investor reactions to the prevailing winds of inflation, interest rate policies and geopolitical risk.
How Inflation Affects Gold Prices
One of the most widely cited relationships in finance is that between gold and the inflation rate. The conventional wisdom holds that gold acts as a hedge against inflation—as the general level of prices for goods and services rises, eroding the purchasing power of fiat currencies, the price of gold tends to increase, preserving wealth. The logic is intuitive: If a dollar buys less bread tomorrow than it does today, investors may prefer holding an asset like gold, whose supply is relatively fixed and whose value isn’t directly tied to the policies driving currency debasement.
Historically, this relationship has shown periods of strong correlation. The most prominent example is the stagflationary environment of the 1970s in the United States. As inflation surged, hitting double digits, and economic growth stagnated, the price of gold experienced a spectacular bull run, soaring from around USD 35 per troy ounce (after the U.S. government quit the gold standard in 1971) to over USD 800 per troy ounce by early 1980. During this decade, holding gold provided significant protection against the dramatic loss of purchasing power experienced by holders of cash or fixed-income assets.
However, the relationship is not automatic or perfectly consistent across all time periods. Several factors can complicate the gold-inflation link:
- Interest Rates: Gold tends to respond more reliably to unexpected surges in inflation or periods when inflation significantly outpaces prevailing interest rates. Gradual, predictable inflation that is matched or exceeded by interest rate returns may not trigger a significant flight to gold, as other assets might offer sufficient compensation for the erosion of purchasing power.
- Timescale: Gold’s effectiveness as an inflation hedge often appears stronger over the very long term (decades or centuries) than over shorter periods (months or years). Short-term price movements can be heavily influenced by other factors like speculative flows, interest rate expectations or geopolitical shocks.
- The Nature of Inflation: Gold may react differently depending on whether inflation is driven by demand-pull factors (strong economy, high spending) or cost-push factors (supply chain disruptions, energy shocks). Cost-push inflation accompanied by economic weakness (stagflation) has historically been more bullish for gold.
- Competing Hedges: In recent decades, other assets have sometimes been perceived by investors as inflation hedges, such as certain commodities, real estate or even equities in specific inflationary environments. The availability and perceived attractiveness of these alternatives can influence demand for gold.
- Central Bank Credibility: If markets believe that central banks will soon have any temporary spike in inflation under control and are committed to maintaining price stability, the demand for gold purely as an inflation hedge may diminish. Conversely, if central bank credibility falters, gold’s appeal can rise sharply.
Therefore, while rising inflation often creates a favorable backdrop for gold prices by diminishing the appeal of fiat currencies, it’s not a simple one-to-one relationship. The expectation of future inflation, the level of inflation relative to interest rates, the cause of the inflation, the availability of alternative hedges and the credibility of monetary authorities all play crucial roles in determining how strongly gold prices react to inflationary pressures. Investors view gold less as a perfect inflation-tracking instrument than they do as an insurance against scenarios where inflation runs significantly out of control or severely damages the real value of conventional financial assets.
The Effect of Interest Rates on Gold Prices
If inflation often provides a tailwind for gold, policy interest rates frequently act as a headwind. The relationship between gold and interest rates, particularly real interest rates (interest rates adjusted for inflation), is one of the most critical drivers of its price.
Gold, in its physical form or via most direct investment vehicles, generates no yield. It pays no dividends, coupons or interest. Holding gold means forgoing the potential returns available from interest-bearing assets like government bonds, corporate bonds or even simple savings accounts. When interest rates rise, the return available on these alternative assets increases, making them relatively more attractive compared to holding a non-yielding asset like gold. This increases what economists call the opportunity cost of holding gold. A higher opportunity cost may incentivize investors to sell gold and shift capital into assets that offer a positive yield, putting downward pressure on the gold price.
Conversely, when interest rates fall, the yield on competing assets decreases. This lowers the opportunity cost of holding gold. If interest rates become very low, or even negative in real terms (see below), the lack of yield from gold becomes far less of a disadvantage. In such environments, investors might find gold relatively more appealing, potentially leading to increased demand and upward pressure on its price.
When considering the impact of interest rates on gold prices, it is essential to distinguish between nominal interest rates (the stated rate, e.g., the yield on a 10-year U.S. Treasury bond) and real interest rates. Real interest rates adjust nominal rates for the effects of inflation and thus represent the true return an investor receives after accounting for the erosion of purchasing power due to inflation. It is real interest rates that have the most significant inverse correlation with gold prices.
Consider these scenarios:
- High Nominal Interest Rates, Low Inflation: If nominal interest rates are 5% and inflation is 1%, the real interest rate is approximately 4%. This positive real return makes interest-bearing assets attractive, increasing the opportunity cost of holding gold. This environment is typically negative for gold prices.
- Low Nominal Interest Rates, High Inflation: If nominal interest rates are 1% and inflation is 5%, the real interest rate is approximately -4%. Holding interest-bearing assets means losing purchasing power in real terms. In this scenario (negative real interest rates), the lack of yield from gold is irrelevant; its potential role as a way of preserving purchasing power becomes paramount. This environment is often highly supportive of gold prices.
Central banks, particularly the U.S. Federal Reserve (Fed), play a pivotal role here. By setting benchmark policy rates (like the Federal Funds Rate) and through tools like quantitative easing or tightening, they heavily influence nominal interest rates across the yield curve. As a result, market participants scrutinize pronouncements from central bankers for clues about the future direction of interest rates. In line with this, expectations of future interest rate hikes tend to pressure gold prices downward before the hikes even occur, as markets price in the higher future opportunity cost. Conversely, expectations of interest rate cuts often provide support to gold prices.
The impact of interest rate decisions by the U.S. Federal Reserve is accentuated by the fact that gold is typically priced in U.S. dollars, whose exchange rate is affected by relative interest rate differentials between the U.S. and other major economies. A stronger dollar (often driven by higher U.S. interest rates relative to elsewhere) can make gold more expensive for buyers using other currencies, potentially dampening demand. Conversely, a weaker dollar can make gold cheaper internationally, potentially boosting demand.
How Gold, Inflation, and Interest Rates Interact Together
Understanding gold’s behavior requires looking beyond isolated relationships and appreciating the complex interplay between inflation, interest rates and the broader economic environment. These factors rarely move in isolation, and their combined effect, filtered through investor expectations and risk appetite, ultimately shapes gold’s trajectory. The concept of real interest rates serves as the crucial nexus connecting these elements.
Let’s examine how different economic scenarios illustrate this interplay:
- High Inflation and Rapidly Rising Interest Rates: This is a tug-of-war scenario. As we have seen, high inflation, on its own, tends to support gold. However, if central banks respond aggressively by hiking nominal interest rates faster than inflation is rising, real interest rates can increase significantly. For instance, if inflation is 6% but the central bank pushes nominal rates to 8%, the real rate turns positive (around +2%). In this case, the negative impact of rising real rates (higher opportunity cost) might outweigh the positive impact of high inflation, potentially leading to pressure on gold prices. The market’s perception of whether the central bank will succeed in taming inflation without causing a deep recession is critical here.
- Stagflation (High Inflation, Low/Stagnant Growth, Low Real Rates): This environment, reminiscent of the 1970s, is often considered the most bullish for gold. High inflation fuels demand for gold as a store of value. Simultaneously, if economic weakness prevents central banks from raising nominal rates sufficiently to get ahead of inflation (or if they keep rates low to try and stimulate growth), real interest rates remain low or negative. This minimizes the opportunity cost of holding gold. Gold benefits from both the inflation-hedge demand and the low-rate environment.
- Deflation (Falling Prices) and Low Interest Rates: This scenario presents a mixed picture. Deflation means the purchasing power of currency is increasing, which theoretically reduces the need for an inflation hedge like gold. However, deflation is often associated with severe economic distress and economic instability. Central banks typically respond with ultra-low or even negative nominal interest rates. While deflation itself might be a headwind, the accompanying economic fear and rock-bottom interest rates (leading to low, though perhaps positive, real rates if deflation is mild) can boost gold’s safe-haven appeal and reduce its opportunity cost. The outcome depends on whether the safe-haven demand dominates the lack of inflation-hedge demand.
- Moderate Growth, Stable Inflation, Normalized Interest Rates (“Goldilocks”): In an economy perceived as stable and healthy, with inflation under control and interest rates at moderate positive real levels, gold often faces headwinds. The need for a safe haven diminishes, inflation isn’t a major concern, and positive real returns are available elsewhere. Investor appetite typically shifts towards riskier assets like equities.
In conclusion, navigating the gold market requires a nuanced understanding of how inflation and interest rates interact, primarily through the lens of real interest rates. Gold is not governed by a simple formula but acts as a complex barometer reflecting the prevailing economic climate, policy responses, risk perceptions and deep-seated investor psychology. Its price encapsulates market expectations about future purchasing power, the relative attractiveness of yielding versus non-yielding assets, and the overall level of confidence in the stability of the financial system and the geopolitical landscape.
Our Consensus Forecasts for Gold Prices
The 30+ expert analysts in our panel currently expect gold prices to dip from their current level of around USD 3,300 per troy ounce in the long term. However, our Consensus Forecast is for gold prices to remain at some of their highest-ever levels out to 2029 at close to USD 3,000, propped up by likely elevated geopolitical instability, rising Asian jewelry demand and ongoing robust central bank purchases. Gold price forecasts have been revised up in past months in light of the precious metal’s strong recent trajectory. The spread among panelists is large: For 2029, the minimum forecast is below USD 2,000 and the maximum above USD 4,000.
Due to the aforementioned factors, predicting exactly where gold prices will end up is an extremely tricky game, even for our panelists. But one thing is for certain: The yellow metal, which has been part of human civilization for millennia, isn’t going anywhere.
