Gold Price Development: The Influence of Interest Rates, Inflation, and Geopolitics

The influence of interest rates and central banks on the gold price

Of all economic factors affecting the price of precious metals, the interest rate is perhaps the most dominant. The interest rate policy of central banks, and specifically that of the US Federal Reserve (the Fed), acts as the thermostat of the global economy.

To understand why the gold price falls or rises after an interest rate decision, we must look at the concept of 'opportunity cost' and the interaction with the dollar.

Gold pays no dividend or interest

The fundamental difference between gold and other asset classes is that gold generates no cash flow.

• Those who own stocks often receive dividends.
• Those who own government bonds receive coupon interest.
• Those who have savings in the bank receive interest.
• Those who own physical gold possess an asset with no counterparty risk, but receive no periodic payout.

This difference forms the core of price formation. We call this the opportunity cost: the cost of missing out on income elsewhere.

The effect of a rising interest rate

When central banks raise the policy rate, the return on 'safe' government bonds and savings accounts increases. For large institutional investors, it becomes more attractive at that moment to park capital in bonds rather than in gold. After all, you receive a guaranteed return of, for example, 4% or 5%.

Holding gold becomes relatively 'more expensive' because you miss out on that interest. Historically, we therefore often see the gold price under pressure during periods of aggressive interest rate hikes.

The effect of a low or falling interest rate

When the interest rate is close to zero (or even negative), the advantage of bonds and savings disappears. The opportunity cost of gold is then negligible. In such a climate, investors are quicker to choose gold because of the potential for price appreciation and wealth protection, since the alternative (money in the bank) yields nothing.

The role of the real interest rate

Although the nominal interest rate (the percentage you see on your screen) is important, professional gold traders look primarily at the real interest rate.

The formula: Real interest rate = Nominal interest rate – Inflation

This figure tells you what your money is actually gaining (or losing) in purchasing power.

• Positive real interest rate: If the interest rate is 5% and inflation is 2%, you actually make a 3% profit. This is often unfavorable for the gold price.
• Negative real interest rate: If the interest rate is 4%, but inflation is 6%, you are effectively losing 2% purchasing power per year, even though you receive interest. In this situation, gold historically performs best. Gold compensates for the loss of purchasing power of the currency.

The power of the Federal Reserve (Fed)

The American central bank has a disproportionately large influence on the gold market. This is because gold is traded internationally in dollars. An interest rate hike by the Fed often makes the dollar stronger (foreign investors buy dollars to benefit from the high US interest rate).

A stronger dollar makes gold directly more expensive for anyone paying with other currencies (like us with the euro), which can dampen demand. Therefore, gold investors watch the speeches of the Fed Chair closely.

Often, the gold price reacts to the expectation of policy:

• Does the Fed hint at interest rate cuts? Then the gold price often runs ahead of the facts and rises.
• Is there unexpected news that rates must remain high for longer ("hawkish" policy)? Then the gold price can correct suddenly.

Gold primarily protects against long-term inflation and loss of purchasing power

The dollar correlation: the other side of the coin

If you follow the gold market, you cannot ignore the US dollar. Gold and the dollar are like communicating vessels; there is a strong, often opposing relationship between these two superpowers.

For investors, it is important to understand that the gold price you hear on the news is almost always the price in dollars. This mechanism works as follows and has direct consequences for your purchase in euros.

The standard: XAU/USD

On international futures markets (such as the COMEX in New York and the LBMA in London), gold is traded and settled in US dollars. The symbol for gold is XAU and the currency is USD. This means that the value of gold is inextricably linked to the strength (or weakness) of the American currency.

The inverse relationship (negative correlation)

As a rule, we see a negative correlation: if the dollar moves up, gold moves down, and vice versa. This phenomenon is driven by two main factors:

1. Purchasing power for international investors: Because gold is quoted in dollars, the precious metal becomes more expensive for investors paying with other currencies (such as the euro, yen, or yuan) as soon as the dollar rises in value. You simply need more euros to buy those same expensive dollars with which you settle the gold. This curbs global demand, which suppresses the price.
2. Competition as a safe haven: Both gold and the dollar are seen as 'safe havens' in times of stress. If the US economy is flourishing and the dollar strengthens, investors have less need for the protection of gold.

What does this mean for the European investor?

As a client of The Silver Mountain, you buy your gold in euros. This adds an extra dimension to your investment: the exchange rate between the euro and the dollar (EUR/USD).

This currency effect often works in your favor and dampens volatility, an effect we also call the 'natural currency hedge':

• Scenario: The gold price falls in dollars.
  Often this happens because the dollar becomes very strong. But if the dollar is strong, it usually means the euro weakens. You get fewer dollars for your euro.
  Result: Although the gold price on the boards in New York falls, you notice less of this in the Netherlands. The gold price in euros falls less hard (or even rises) because the weak euro compensates for the drop in dollars.
• Scenario: The gold price rises in dollars.
  This often happens when the dollar weakens. A weak dollar usually means a stronger euro.
  Result: The gold price in euros rises, but possibly slightly less hard than in dollars, because your euros have become worth more relative to the dollar.

Exceptions: when the correlation breaks

There are rare moments when gold and the dollar rise simultaneously. We often see this during acute crisis situations or extreme geopolitical tensions.

At such a moment, there is so much fear globally that investors sell everything (stocks, bonds, commodities) to be as liquid as possible. They then flee to the two most liquid and safe markets in the world: the US dollar (cash) and gold.

In this scenario, the dollar acts as the safest means of payment and gold as the ultimate store of value.

Gold as protection against inflation

Inflation is often called the 'silent killer of wealth'. It is the process by which your money slowly loses its value; for the same euro, you can buy less in a few years than today.

For centuries, gold has been known as the ultimate hedge (protection) against this phenomenon. But how exactly does this mechanism work, and is gold always perfect protection?

Scarcity versus the printing press

The primary reason gold protects against inflation lies in its natural scarcity. Central banks, like the ECB and the Fed, have the power to print unlimited money ('fiat money'). Since the financial crisis and the corona pandemic, the money supply in the system has increased explosively.

When more money comes into circulation for the same amount of goods and services, prices rise. Your savings are diluted.

Physical gold, on the other hand, cannot be printed. The annual addition of gold through mining is very stable and limited (about 1.5% to 2% per year).

Because the amount of gold remains relatively constant while the mountain of paper money grows, the price of gold rises when expressed in that paper money. You simply need more and more euros to buy that same unique amount of gold.

Preservation of purchasing power in the long term

It is important to distinguish between price and purchasing power. Investors often look at the daily price, but the real power of gold is the preservation of purchasing power.

A classic example illustrates this perfectly:

• In the time of the Roman Empire, you bought a luxury toga, a belt, and sandals (a tailored suit of that time) for 1 ounce of gold.
• In the 1920s, you bought a good tailored suit for 1 ounce of gold.
• Today, for the equivalent of 1 ounce of gold (approx. €2,500), you can still buy a luxury tailored suit.

The currency has changed or even completely disappeared over those thousands of years, but the exchange value of the gold has remained the same. Gold does not necessarily make you 'richer' in goods, but it prevents you from becoming poorer due to inflation.

The nuance: short versus long term

Yet there is a nuance that is often overlooked. Gold is a perfect inflation protector in the long term, but it does not always react 1-to-1 to inflation figures from month to month.

Sometimes inflation is high, but the gold price drops temporarily anyway. This is often due to the intervention of central banks (see point 1: interest rates). If inflation rises, central banks raise interest rates to cool down the economy. That higher interest rate can temporarily depress the gold price, despite high inflation.

Only when it becomes clear that inflation is structural ('sticky') and does not simply go away with an interest rate hike, or when the real interest rate remains negative, do we see gold catching up.

Stagflation: the ideal scenario for gold

There is one specific economic scenario in which gold often beats all other investments, such as stocks and bonds: stagflation.

Stagflation is a toxic cocktail of stagnation (low economic growth, high unemployment) and inflation (rising prices). In this situation, central banks cannot raise interest rates too hard (because then the economy collapses), but they also cannot stimulate (because then inflation explodes).

In this uncertain environment, capital flees en masse to tangible assets ('hard assets') such as gold and silver.

Geopolitics: the effect on the gold price

Besides the cold calculation models of interest rates and inflation, the gold price is strongly influenced by a human factor that should not be underestimated: emotion. Or more specifically: uncertainty. In times of geopolitical tensions, gold acts as the ultimate safe haven.

When world peace wavers or international trade relations are under pressure, we see investors turning en masse to the only currency that carries no political risk.

The mechanism: why gold during crises?

To understand why gold rises when war threatens, you must look at what gold is not.

• Gold is not someone else's debt.
• Gold cannot go bankrupt.
• Gold is not dependent on the promises of a government or financial institution.

In times of peace and prosperity, investors settle for 'paper promises' (stocks, bonds). But as soon as a conflict breaks out, fear arises that those promises cannot be kept, that borders will close, or that currencies will collapse.

Capital then flees in a so-called flight to safety to tangible assets with no counterparty risk.

The impact of conflicts: short versus long term

The effect of geopolitics on the gold price is often twofold.

• The shock reaction (short term): Immediately after the news of an invasion, a terrorist attack, or an escalation in the Middle East, we often see a vertical price increase. This is the 'fear premium'. Investors buy gold blindly as insurance. Note: These peaks are sometimes short-lived. As soon as the situation stabilizes (even if the conflict is not yet over), the extreme fear subsides, and the price can correct again.
• Structural consequences (long term): Geopolitical conflicts often have long-lasting economic consequences. Think of sanctions, trade wars, or the blowing up of energy supplies. This leads to structural inflation and disrupted supply chains. In this scenario, the gold price remains high for a long time, not only due to fear but because the economic fundamentals have deteriorated.

The new trend: central banks and de-dollarization

A very important development in the current geopolitical arena is the behavior of central banks themselves, particularly in the East (such as China, Poland, Turkey, and India).

Since the Western sanctions against Russia, where foreign exchange reserves were frozen, many countries have been shaken awake. The realization has grown that foreign exchange reserves in dollars or euros are politically vulnerable. "If you don't hold it, you don't own it."

In response, central banks are now buying physical gold at a record pace. Gold is neutral, politically unaligned, and accepted worldwide. These massive purchases by states place a solid floor under the gold price.

This is not a temporary hype, but a structural shift in the global financial system where gold is regaining a more prominent role as an independent reserve.

Elections and political instability

Not only wars, but also domestic politics in superpowers like the US influence the price. Markets hate uncertainty. When elections approach and the outcome is uncertain, or when candidates propose policies that will cause the national debt to explode, investors seek cover in gold.

Geopolitical uncertainty increases the demand for gold as a 'safe haven'.

Conclusion: what interest rates, inflation, and geopolitics do to the gold price

The gold price is determined by an interplay of interest rates, inflation, geopolitical uncertainty, and confidence in currencies like the dollar. These factors do not work in isolation but jointly influence how attractive gold is as a store of value. As a result, the gold price sometimes moves against expectations, and short-term fluctuations are difficult to predict.

For many investors, the power of gold lies not in timing, but in diversification and protection of purchasing power in the long term. Physical gold offers security in a changing economic environment, without being dependent on financial policy or counterparties.

At The Silver Mountain, we guide investors who want to consciously use gold as part of a well-considered wealth strategy.