As G7 nations propose placing ban on gold imports from Russia following its invasion of Ukraine, interest in the precious metal has risen significantly in recent weeks. Given Russia is the third-largest producer of gold globally, you might expect this to lead to seismic shifts in the market. But the horse may have already bolted when, back in March, the London Bullion Market Association suspended the accreditation of Russian gold refiners, leading the industry to shun Russian imports almost overnight.

Gold began 2022 trading at $1829 an ounce. After spiking to $2043 in the early days of the Ukraine war, it has now retreated to around the $1800 mark – almost where it started. Measured year-on-year, it is up by just 3.44%. Compare this with the first few years of economic and financial instability following the 2007 financial crisis, when gold more than doubled in value.

Recent events have added a layer of complexity to an asset that has, historically, been considered as a hedge against inflation. Ever since gold was used as a means of value over 4000 years ago, it has largely maintained its status as a ‘safe haven’ to protect wealth from volatile and uncertain market conditions. In recent months, however, rising interest rates implemented by central banks globally to combat inflation have only dimmed bullion’s appeal by increasing the opportunity cost of holding the asset, which yields no interest. Gold often gains when purchasing power reduces, but this year it has so far been unable to oppose such a risk-off sentiment.

So why has gold been considered a ‘safe asset’ for so long? And what’s changing?

First and foremost, gold is a finite resource: it cannot be mined indefinitely, nor can more of it be produced. This means it is more heavily impacted by value drivers in the market, with inflation being one of the most significant. Gold’s other defensive potential comes from being non-correlated to stocks or bonds. It has a history of steadily maintaining value whatever the surrounding economic conditions affecting other asset values. Many traders consider the precious metal as an inflationary hedge for these reasons, and the desire to own it in a stagflationary period is often one of the key price drivers.

The strength of the US dollar, by which gold is priced, also weighs heavily on the value of gold. The two have an inverse relationship whereby as the dollar strengthens (which it so far has done in 2022), gold weakens in value as it is more easily purchasable. Conversely, a weaker US dollar is likely to drive the price of gold higher through increasing demand – purely because more gold can be purchased when the dollar is weaker.

The relationship between the two markets is frequently cited as being responsible for intraday and short-term gold moves. This is what we’ve seen so far in 2022, and it looks set to continue: according to some analysts, gold prices will continue to struggle as the Federal Reserve leads the global push to raise interest rates. While the looming recession risk bolsters its price, the short-term outlook for gold is unstable given the tightening of global financial conditions.

What next?

Gold faces headwinds from central banks committed to fighting soaring inflation by hiking interest rates. From a physical point of view, Metals Focus suggests that demand for the precious metal will dip further towards the back end of this year amid weaker overall retail sales, particularly in the jewellery and luxury goods markets.

But for gold to shine once more, we may need to see even more market turmoil.

Published: 15 July 2022

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