Gold Caught Between War, Oil, and Interest Rates: Predicting Precious Metal's Path

Gold prices are approaching recent record levels, buoyed by a confluence of factors including geopolitical instability, a softening U.S. dollar, and diminished expectations for an imminent Federal Reserve interest rate increase. The precious metal's trajectory in the near term, however, remains contingent on developments in the Middle East, energy market fluctuations, and the Federal Reserve's monetary policy decisions.

On Monday, gold climbed towards $4,400 per ounce, partly influenced by weaker U.S. economic data that lowered the probability of a September rate hike by the Federal Reserve to around 30%, down from 47% a month prior. Concurrently, a depreciating dollar makes gold more appealing to investors holding other currencies.

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The biggest risk for gold prices remains energy prices and the situation in the Middle East.

Energy prices and the situation in the Middle East present key risks. Analyst Bogdan Maioreanu from eToro notes that a potential escalation of conflict or disruptions in the Strait of Hormuz could drive up oil prices and fuel inflation. This, in turn, could prompt the Federal Reserve to maintain higher interest rates for longer, which typically dampens gold's appeal.

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A new escalation of the conflict between the US and Iran or new disruptions in the Strait of Hormuz could again cause an increase in oil prices and could increase inflationary pressure.

However, the relationship between conflict and gold is complex. While geopolitical uncertainty can increase demand for safe-haven assets like gold, rising oil prices and inflation can create a dilemma for central banks. Historically, periods of high inflation and restrictive monetary policy have sometimes pressured gold prices, as seen in May when gold dipped due to inflation fears and anticipated tighter monetary policy. Currently, U.S. inflation and labor market data have eased pressure on the Fed, benefiting gold through a weaker dollar and lower rate hike expectations.

Institutional demand, particularly from central banks, is another crucial factor supporting the gold market. Central banks collectively made record net purchases of 289 tons of gold in the second quarter, according to data cited by Reuters, underscoring their significant role in the current market dynamics.

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However, it is worth remembering that not every war is beneficial for gold. Geopolitical conflicts affect its price in two ways. On the one hand, uncertainty increases demand for safe assets. On the other hand, more expensive oil can accelerate inflation and force the Fed to keep interest rates high for a longer period. This increases the attractiveness of bonds and acts to the detriment of gold.