Why the Gold Price is Falling

Reasons Why the Gold Price Fell

#1 Dollar Strength

Due to the likelihood of the war in the Middle East continuing for longer than initial expectations, financial markets were spooked.

Even more worrisome than the disruption to the crude oil market due to the closure of the Strait of Hormuz, was the possibility of a global recession...or at least a slowdown. This is because consumers in developed nations are in no position to handle high inflation due to high oil prices.

Add to that the economic impact caused by the disruption in the energy trade. So, there is a high probability of a major economic slowdown.

Whenever there is a concern in financial markets about an economic slowdown, the biggest beneficiary tends to be the US dollar.

This is because the market perceives the dollar, due to its reserve currency status, as a safe currency to hold excess funds. As all commodities, including gold, are priced in dollars, they tend to face selling pressure whenever the dollar strengthens.

This was a big reason for the pressure on the gold price.

#2 Interest Rate Outlook

Implicit in the rise of commodity prices, gold in particular, was the assumption that inflation would stay above normal in the foreseeable future.

The thinking behind this was that central banks around the world were lowering interest rates steadily which in turn would keep consumption strong.

Thus, as long as the developed economies avoided a recession, inflation would not fall to low levels.

Precious metal prices do well in time of rising inflation or inflation expectations. However, that situation has now changed due to the surge in crude oil prices.

The outlook for inflation has spiked which is something central banks cannot ignore. This means that the possibility of interest rate hikes are back on the menu as it were.

Higher interest rates attract funds away from assets that don't pay interest like gold. This has contributed to the decline in the price.

It remains to be seen if a fall in crude oil prices due to the reopening of the straight of Hormuz will change the interest rate outlook. But that development is tied to the conclusion of the war, which is still ongoing.

#3 Profit Booking

What is often ignored by retail investors is regular profit booking. Many investors buy with a fixed target price in mind but there is no assurance such targets will be met.

Sophisticated investors - the smart money - on the other hand, regularly book profits when prices rise so as to have funds ready to buy again if prices fall.

This selling often contributes to a decline in the price of assets that have previously risen a lot, in this case gold. Gold has risen so much over the last few years that some profit booking was inevitable.

When the global market outlook became uncertain some selling in gold was to be expected.

#4 Speculation

And then there is good old fashioned speculation.

It's all well and good to be bullish on gold. But we should not forget that a large part of the run up was speculative in nature.

Many people who had never traded any commodity had begun punting in the futures market. The idea was that if gold is going up, then might as well make some quick profits using leverage.

Many investors become traders just because they thought the price would continue to rise and for no other reason. This was highly risky behaviour. It was a case of FOMO (fear of missing out) at work.

However, in such cases, prices can rise only as long as the speculation goes on. The moment it stops or even reduces in magnitude, prices fall.

2026 Gold Outlook

The price outlook is a mixed bag to be honest.

There are many variables at play here that can be summed up in the following questions:

• Will the war in the Middle East end...and when?
• What is the situation in the Strait of Hormuz in terms of regular and safe passage of crude oil and natural gas?
• When will the refineries and oil & gas wells return to full production?
• Is there a likelihood of a resumption in hostilities in this region?
• What is the negative impact of the disruption in the energy trade already caused by the war?
• How quickly and by how much will inflation, caused by high fuel prices, come down?
• Will central banks put aside inflation concerns due to falling crude oil prices and consider interest rate cuts? Or will they hike rates to bring inflation under control.
• How much will economic growth slow down and how quickly will it recover?
• Will central banks continue to buy gold in large amounts as they have been doing recently?

The answers to these questions will decide the fate of gold in 2026 and beyond.

As you may have correctly summarized, the outlook for gold is not clear either in the short term.

The long term outlook remains positive but the question that every investor should answer for themselves is what is 'long term' for them personally. Is it a few years or decades?

Also, do you want to hold gold in physical form to be passed down?

Or do you to hold it in ETF form to enable trading?

In an uncertain price environment for gold, your personal risk appetite, asset allocation and financial goals matter more than ever.

Conclusion

This is what Rahul Shah, Equitymaster's Co-Head of Research, wrote in the Profit Hunter...

• Between 2012 and 2019, gold did almost nothing.
  
  It sat flat for seven years.
  
  During that time, even a humble fixed deposit would have made you more money.
  
  We don't have a crystal ball; gold could easily enter another long "flat" period just when you need your money to be working for you.
  
  I'm not saying you should never own gold.
  
  It is a great insurance policy against "bad times" or a falling currency.
  
  If it helps you sleep better, it is perfectly fine to keep 5% to 10% of your wealth in gold.
  
  If you feel the world is becoming more uncertain, you might even increase that allocation slightly to act as a hedge.
  
  Stick to the discipline.
  
  Use stocks for growth and cash for safety.
  
  Leave the gold for a separate insurance fund.

At Equitymaster, we believe in having 5-10% of one's portfolio in gold at all times.

However, investors should not see gold as a potential substitute for any other asset.

It makes sense to hold some precious metals in one's long-term portfolio, but it does not make sense to speculate on short term price movements.

While considering an investment in gold, have a time horizon well beyond 2026.

Do your due diligence.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...