Gold is a hedge against inflation. Gold is sensitive to expected long-term real interest rates. Gold is regarded as protective against "bad economic times".

Each of these statements represents a factor that has been cited as a driver of the price of gold. In November 2021, four economists at the Federal Reserve Bank of Chicago tested each of these propositions, publishing their analytical results in a Chicago Fed Letter.

Their analysis found evidence to support all three statements. Here's the conclusion to their essay summarizing their results:

We have investigated several hypotheses about the determinants of gold prices—in annual levels data, quarterly data in innovations form, and daily data in differences. The negative effect of real interest rates on gold prices predicted by theory holds in all three contexts. Two of the three specifications (the quarterly innovations specification being the exception) support the notion that gold is an inflation hedge and that this effect is quantitatively larger than the real interest rate effect. The two specifications that can be used to evaluate the proposition that gold prices also reflect protection against bad economic times are highly supportive of it. In the early part of the sample, variation in inflation or inflationary expectations was the single most important consideration for the real price of gold. From 2001 on, however, long-term real interest rates and pessimism about future economic activity appear as the dominant factors. While disinflation since 2001 might have been expected to result in low gold prices, any effect of low inflation was more than compensated for by unprecedentedly low long-term real interest rates and by pessimism about future economic activity.

That was in 2021. In the years since then, it would seem at least one of the propositions isn't holding the way it used to hold. And it's the big one they found held regardless of how they parsed their data: the negative effect of real interest rates on gold prices.

What's meant by that is they found the price of gold has an inverse relationship with real interest rates. After adjusting for inflation, when interest rates rise, the price of gold falls. And vice versa: the price of gold rises when real interest rates fall.

Since 16 March 2022 however, as the Federal Reserve started increasing interest rates and succeeded in causing real long-term interest rates to rise, the price of gold hasn't behaved they way. Real interest rates are now much higher than they were at that time, but instead of falling, the price of gold has risen and is now at or near record highs. The following chart shows both the pre-March 2022 inverse relationship between gold prices and real long-term interest rates and the new relationship, or rather, the new lack of relationship, between the two in the period since.

We've previously described the behavior of gold prices since 16 March 2022 as representing a paradigm shift. We think that new paradigm is like the old one, but is resetting the relative level of the price of gold at a much higher level than it was previously. It has happened as other factors driving the price of gold have become dominant over the level of real interest rates.

The behavior of gold prices since 1 March 2024 suggests that process has not yet settled. The price of gold is now ratcheting up without any significant change in real interest rates. Which factor do you suppose is more dominant right now? Are people buying gold because they're more worried about inflation and are hedging against it or are they buying gold because they're seeking to protect themselves against bad economic times?

References

Robert B. Barsky, Craig Epstein, Adrian Lafont-Mueller, and Younggeun Yoo. What drives gold prices? Chicago Fed Letter: Essays on Issues. November 2021, No. 464. [Online article]. DOI: 10.21033/cfl-2021-464.

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