Gold Prices Drop Over 20%, Can Central Bank Buying Slowdown Support Gold Again?

TL;DR · The core driver of gold's decline is the reversal of interest rate expectations. The market has shifted from betting on Federal Reserve rate cuts to anticipating continued rate hikes over the next 12 to 24 months, diminishing the appeal of non-yielding gold. · Gold prices have retraced over 20%, but the long-term gains have not completely vanished. Compared to early 2025, precious metal prices are still generally up 24% to 100%, indicating that this round of adjustment has not erased all previous gains. · Central bank buying may temporarily slow due to high gold prices, but the long-term allocation logic remains unchanged. Gold previously broke through $5,000 per ounce, which may have suppressed some central bank purchases; interest in buying may resume as prices fall back to around $4,200. · Fiscal deficits and inflation create contradictory effects. Increased inflation risks boost gold's safe-haven demand but also force central banks to maintain high interest rates, which in turn suppresses gold prices. · Gold has more support compared to other precious metals, primarily due to central bank demand. During the same period, silver, platinum, and palladium have all seen declines exceeding 40%, while central banks primarily allocate to gold, which may explain its relatively resilient performance.

After a strong rally from 2025 to early 2026, the global precious metals market is undergoing significant adjustments.

From the end of January to mid-October this year, gold prices have fallen by over 20%, while silver, platinum, and palladium have all seen declines exceeding 40%. The most important change behind this adjustment is the shift in global monetary policy expectations from rate cuts to rate hikes, prompting investors to reassess the opportunity cost of holding precious metals.

However, even with significant retracement, precious metal prices remain approximately 24% to 100% higher than early 2025 levels. Gold has not only retained a considerable portion of its previous gains but has also experienced a decline that is notably smaller than that of other precious metals during this round of adjustment.

As a result, two opposing forces are at play in the gold market: on one hand, global central banks are tightening monetary policy, continuously suppressing the prices of non-yielding assets; on the other hand, fiscal deficits, inflation risks, geopolitical instability, and ongoing central bank allocations to gold continue to provide support for the market.

As gold prices fall from above $5,000 per ounce to around $4,200, whether the central bank's previously slowed demand for gold due to high prices can be reignited becomes an important observation indicator for the gold market moving forward.

Federal Reserve Shifts to Rate Hikes, Gold's Upward Logic Faces Reversal

The turning point for gold prices coincided almost simultaneously with the news of Kevin Warsh's nomination as Federal Reserve Chair.

Warsh has long been viewed as a hawk on monetary policy, skeptical of quantitative easing and zero interest rate policies. This is in stark contrast to previous market expectations that the White House might push for further rate cuts by the Federal Reserve.

With Warsh at the helm of the Federal Reserve, the direction of monetary policy is gradually changing. The Fed ended its easing bias in June this year and implemented a rate hike in September, while signaling the possibility of continued tightening of monetary policy in the future.

This shift quickly reflected in the interest rate futures market.

Pricing in the federal funds rate futures and SOFR markets shows that investors are beginning to anticipate multiple rate hikes by the Federal Reserve over the next 12 to 24 months. This is the first time since 2022 that the market has re-incorporated expectations for multiple rate hikes.

The change in interest rate expectations directly diminishes the appeal of gold. Gold itself does not generate interest, and when short-term rates rise, the returns on cash, government bonds, and other yielding assets increase, further raising the opportunity cost of holding gold for investors.

More importantly, this round of monetary tightening is not unique to the United States.

Central banks in the European Central Bank, Bank of Japan, Reserve Bank of Australia, Norges Bank, and Bank of Korea had already entered a rate hike cycle before the Federal Reserve took action. The synchronized rate increases among major global economies mean that the pressure on gold is no longer limited to dollar assets but comes from a broader global repricing of funds.

However, while the reversal of interest rate expectations can explain the recent significant adjustments in gold, it does not fully account for why gold prices have not fallen further. While global monetary policy is tightening, government debt and fiscal deficits are forming another force that contrasts with high interest rates.

Fiscal Deficits Continue to Widen, Long-Term Demand for Gold Remains

The expanding fiscal deficits of major global economies are becoming an important support factor for gold prices.

According to projections from the U.S. Congressional Budget Office, the federal budget deficit for the U.S. government could reach 6.6% of GDP by the fiscal year ending September 2027. This forecast does not yet account for additional military spending that may arise from ongoing conflicts in the Middle East, including funding needed to replenish the U.S. Department of Defense's ammunition stockpile.

What is even more concerning is that such a massive fiscal deficit is occurring against the backdrop of a relatively robust U.S. labor market.

Currently, the U.S. unemployment rate is about 4.2%, which is historically low. Typically, a lower unemployment rate indicates stronger tax revenues and less spending on unemployment benefits, making government deficits relatively manageable.

However, over the past decade, mandatory fiscal expenditures such as social welfare have continued to expand, and the cost of financing federal debt has risen, causing the U.S. budget deficit at the same unemployment rate level to widen by about 4 percentage points compared to a decade ago.

Ten years ago, when the unemployment rate was around 4%, the U.S. fiscal deficit was only about 2.5% of GDP, while today this ratio has exceeded 6%.

At the same time, the interest expenditure on U.S. federal debt as a percentage of GDP has risen from about 1.2% to 3.4%.

Fiscal pressure is not unique to the United States. Brazil and China have budget deficits that account for about 8.5% of GDP, while France, Japan, and the UK are in the range of 4% to 6%. Except for China, which still faces a low inflation and interest rate environment, most economies are under pressure from rising debt financing costs.

Population aging further increases pension and healthcare expenditures, making some fiscal pressures more long-term.

For gold, this change has dual significance.

On one hand, the continuously expanding fiscal deficit may exacerbate inflation and weaken investors' confidence in the sustainability of government long-term debt, thereby increasing gold's appeal as a store of value. On the other hand, inflation driven by fiscal expansion may also force central banks to continue raising interest rates, leading to short-term pressure on gold.

This contradiction is playing out in global markets.

Except for China, the core inflation rates of most major economies remain above central bank targets. Loose fiscal policies, geopolitical conflicts, and supply chain restructuring collectively create persistent upward price pressures.

Moreover, the act of raising interest rates itself may also increase fiscal burdens. As government debt expands, higher interest rates mean higher interest expenditures. At the same time, slowing economic growth may reduce tax revenues and increase fiscal expenditures such as unemployment benefits.

If governments continue to expand borrowing to cope with these pressures, a mutually reinforcing relationship may form between fiscal deficits and inflation.

Additionally, supply chain disruptions caused by conflicts in the Middle East and Ukraine, as well as policies promoting localization and nearshoring of supply chains by major economies, may also increase production costs for businesses. In the face of these supply-side shocks, raising interest rates may not directly address issues related to energy, logistics, and commodity supply, but it could suppress investment and growth in capital-intensive industries such as AI and real estate.

Therefore, the future trajectory of gold does not solely depend on interest rate levels. If central banks continue to tighten monetary policy but still fail to control inflation at target levels, gold may regain upward momentum.

Rising Geopolitical Risks, Gold's Relative Advantage Over Stocks Remains

Historically, gold and U.S. stocks often occupy advantages in different macro environments.

Over the past century, gold's long-term price performance has almost kept pace with the S&P 500 index, but the strong cycles of the two asset classes show significant differences.

During periods of economic stability and strong U.S. global influence, U.S. stocks typically outperform gold significantly. Conversely, during times of economic turmoil, heightened international conflicts, or market concerns about the stability of the financial system, gold tends to perform better relative to stocks.

This difference can sometimes last for ten to twenty years.

Historical data shows that in certain long-term cycles, the cumulative excess performance of U.S. stocks relative to gold reached 1800% to 240%; while in other cycles, stocks may lag behind gold by 80% to 95%.

For example, from the 1930s to early 1940s, late 1960s to 1970s, and from 2001 to 2011, gold had a clear relative performance advantage. In contrast, during most of the 1980s and 1990s, as well as much of the time from 2011 to 2021, U.S. stocks performed stronger.

Since 2021, despite the U.S. stock market continuously hitting new highs, the cumulative performance of gold and silver has still led, even considering the recent price retracement.

In recent years, the U.S. withdrawal from Afghanistan, the Ukraine conflict, escalating tensions in the Middle East, and conflicts between the U.S., Israel, and Iran have all reinforced market demand for precious metals to varying degrees.

However, rising geopolitical risks do not necessarily mean that gold will rise.

Since February 28 of this year, despite the ongoing related risks, precious metal prices have significantly dropped due to rapidly rising global rate hike expectations. This indicates that when monetary tightening expectations are strong enough, interest rate factors may temporarily overshadow the safe-haven demand brought about by geopolitical risks.

Nevertheless, from a long-term historical perspective, when geopolitical uncertainty increases, gold may still outperform stocks. Especially in situations where conflicts further drive up energy prices, exacerbate supply chain disruptions, and force governments to increase fiscal expenditures, gold's safe-haven properties may once again come to the forefront.

Gold Prices Drop from $5,000 to $4,200, Can Central Bank Buying Resume?

Compared to other precious metals, central bank demand is one of the most unique supporting factors for the gold market.

The global central banks' attitude towards gold has undergone a long-term shift. From 1982 to 2007, central banks were net sellers of gold almost every year. However, since 2008, central banks have shifted to a sustained net buying of gold.

This change was initially closely related to the monetary environment following the global financial crisis. In the 2010s, major central banks implemented zero interest rate policies and quantitative easing for an extended period, prompting some countries to increase their gold reserves to reduce dependence on fiat currency assets.

However, since 2021, the factors driving central banks to allocate gold have changed.

As the world enters a rate hike cycle, zero interest rates and quantitative easing are no longer the primary reasons for central banks to increase their gold holdings. Instead, geopolitical instability, persistently high inflation above target levels, and long-standing fiscal deficits in major economies have become the driving forces.

These factors may prompt central banks to reassess the risk structure of their foreign exchange reserves.

However, rising gold prices may also suppress central banks' willingness to purchase.

When gold prices once broke through $5,000 per ounce, some central banks may have already slowed their purchasing pace. Now that gold prices have fallen back to around $4,200 per ounce, the price adjustment may reignite some central banks' interest in buying gold, especially those concerned about the fiscal situations of other countries and the escalation of international conflicts.

This change is particularly important for understanding the current gold market.

Central banks' gold allocations typically serve the goals of diversifying foreign exchange reserves, ensuring long-term asset security, and risk management, which differ significantly from the investment cycles of short-term speculative funds.

Therefore, if the structural factors driving central banks to purchase gold have not disappeared, a significant price retracement may only change the pace of central bank purchases rather than indicate a reversal of long-term demand.

However, there is currently a lack of sufficient recent data on central bank gold purchases to prove that this round of price adjustments has accelerated official buying. High prices may suppress purchases, while price declines may stimulate demand, which remains a market judgment pending actual gold purchase data verification.

Central bank demand may also explain why gold has shown greater resilience during this round of precious metal adjustments.

Unlike gold, silver, platinum, and palladium have numerous industrial applications, and their prices are influenced not only by interest rates and investment demand but also closely related to industrial production and economic cycles.

More importantly, global central bank precious metal reserves are primarily concentrated in gold, with minimal large-scale holdings of other precious metals.

Therefore, under the same pressure from rising interest rates, gold can gain additional demand support from official reserve allocations, while other precious metals are more susceptible to the dual impact of changes in industrial demand and withdrawal of investment funds.

From the end of January to mid-October this year, gold prices fell over 20%, while silver, platinum, and palladium saw declines exceeding 40%. Central bank demand may be one of the important reasons for this disparity.

The Key to Gold's Future Lies in the Tug-of-War Between Interest Rates and Long-Term Funds

The current gold market is caught in a tug-of-war between two opposing forces.

In the short term, the Federal Reserve and other major central banks re-entering a rate hike cycle means that the appeal of yielding assets such as cash and bonds is increasing. This is the primary reason for the significant retracement of gold prices from their highs at the beginning of the year.

However, in the long term, persistently high global fiscal deficits, rising debt interest costs, ongoing inflation above target levels, and increasing geopolitical risks may all limit the downside potential for gold prices.

The long-term trend of central banks continuing to allocate gold provides another layer of demand foundation for the market.

In the future, if monetary policy continues to tighten and inflation effectively recedes, gold may continue to face price pressure. Conversely, if fiscal deficits expand, geopolitical conflicts escalate, or central banks increase their gold reserve allocations again, gold prices may regain support.

Particularly noteworthy is whether official reserve funds will increase their purchasing efforts after gold prices drop from above $5,000 per ounce to around $4,200.

Whether gold can end this round of adjustment depends not only on when the Federal Reserve stops raising interest rates but also on whether central banks and other long-term funds can form sufficiently strong buying power after the price decline.