While the prices of commodities — from food to fertiliser to palm oil to crude oil — are soaring, yellow metal prices are weakening.

Despite the spectre of sharply decelerating GDP growth, inflation the world over is surging, leaving most central banks with no choice but to embrace harsh monetary tightening. The IMF has forecast global inflation to remain elevated at 8.8 per cent through 2022 amid higher cost of energy and food articles.

Theoretically, and this is also borne out by experience, gold is supposed to act as a hedge against high inflation typically brought about by unchecked money creation. Going by this hypothesis, gold should be seeing increased buying during the current bout of high inflation.

What, then, explains the current incongruity of the price of a reliable safe-haven asset like gold falling at a time when inflation in the US persists at four-decade highs and with the rest of the world in a similar predicament? In fact, international prices of gold have declined almost 10 per cent till date this year.

Softening prices

This curious case of softening gold prices against the backdrop of global turmoil does have an explanation. It can be attributed to the synchronised weakening of the non-dollar currencies and the rising US interest rates. To put things in perspective, the benchmark US 10-year Treasury yield has touched 4 per cent, a multi-decade high. A year ago, it ruled at 1.5 per cent.

For the sake of perspective, the price of gold is not dictated by the demand and supply of physical gold alone. There is an investment demand for gold as well as a speculative demand which, put together, means that the traded volume of gold far exceeds the physical quantity that actually changes hands.

That’s why its market price also rests on other safe-haven bets such as the yield (or returns) on US treasury bills or the exchange value of the US dollar. Unlike treasury bonds, gold is not an interest-bearing asset, and its attraction falls when safe alternatives like US treasury bonds begin to yield more. The current yields on the US treasury long-dated notes have hardened to levels not seen after the 2008 crisis. Also, the persistence of higher inflation for a longer period has forced major central banks outside Japan to pivot to more hawkish stance than ever. A direct consequence of the US Federal Reserve’s back-to-back interest rate hikes has been the value of greenback climbing to muti-decade heights. The dollar index that tracks the value of the US currency against a basket of major legal tenders including Japanese Yen and British Pound Sterling has been trending above the 113 mark for months now. A year ago, the dollar index was trading at about 93.7, a substantial gain of 20.6 per cent.

These two factors are the major reasons that cap the upside rally in the international gold prices. It should also be noted that gold is priced in dollars in the international market and, therefore, a strong dollar limits its headroom for moving up.

All this is not to suggest that gold has reached the end of the road as a safe-haven asset. Nor does it mean that gold’s function as a highly liquid store of value and a fall-back medium of exchange has eroded for good. On the contrary, its intrinsic value remains intact and, as an asset class over the long term, it has fared well compared to other asset classes like bonds, bank deposits or even real estate.

Over the five decades since the end of the gold standard in 1971, the price of gold has appreciated to $1,800 per ounce — a CAGR of 8.2 per cent. That is a decent rate of return for a 50-year period.

What remains to be seen is how the yellow metal will fare once the current interest rate hiking cycle in the US eases, either as inflation comes down (a soft landing) or as the economy proves simply unable to bear the cost of money going any higher (a hard landing where the economy tips into recession or stagflation). Should it be a hard landing, count on gold to shine once again.

The writer is MD and CEO, Manappuram Finance Ltd