At the time of writing, the Middle East remains in turmoil. With no clarity on expectations, oil prices continue to be elevated. Historically, this is the kind of environment gold is suited for. Yet gold prices are on a downward trend. How is this possible?
For decades, investors have treated it as the ultimate safe haven; the asset one relies on when everything else is falling apart. War breaks out? Buy gold. Inflation spikes? Buy gold. Dollar wobbles? Buy gold. When such conditions are absent, gold is of less importance.
That distinction matters enormously right now. The conditions that drove gold’s extraordinary 2025 rally have not just softened but also reversed. To understand why gold is falling now, one must understand how absurdly well it was doing just a moment ago.
Gold’s Big Run
The metal gained 64% in 2025, its strongest annual performance since 1979. The rally was well-founded at its origin: Central banks around the world were cutting rates, bond yields fell across multiple major economies and the dollar was declining. Gold was doing precisely what it was supposed to do under such conditions.
However, soon after gold had ceased to function as a monetary hedge and had begun to function as a momentum trade, not based on its intrinsic qualities but on the assumption that the favourable macroeconomic backdrop would persist indefinitely.
Gold entered 2026 at historically elevated price levels that had, by any conventional measure, already priced in a substantial degree of global risk. When an asset is priced for catastrophe and catastrophe duly arrives, the market reaction is often more muted than expected. The war in the Middle East is serious, but it was not, in a meaningful sense, a surprise to a market that had already spent a year pricing in geopolitical fragmentation. Put simply, gold may not be rising because it had already risen. While this may explain why gold prices have not risen, it does not explain the recent dip. Several factors need to be considered.
The Federal Reserve stalls rate cuts
At the start of 2026, financial markets were operating on a broadly optimistic assumption that the Federal Reserve would cut interest rates twice during the year. Gold is priced in US dollars, the Federal Reserve’s decisions carry a disproportionate weight in determining its global cost and appeal because gold is priced in dollars. When the Fed cuts rates, US bond yields fall and the dollar weakens both of which make gold cheaper for international buyers and less costly to hold relative to interest-bearing alternatives. No other central bank has such levels of influence on gold.
Then came February’s producer price index reading. It is one of the Fed’s early-warning signals for inflation. A reading of +0.7% meant that businesses were paying significantly more than expected, suggesting that inflation was not cooling as anticipated but was, in fact, re-accelerating. If inflation is still running hot, the Fed cannot justify cutting rates. So instead of two cuts, markets are now expecting just one. Some are questioning whether even that single cut would materialise.
The ten-year U.S. Treasury yield climbed back to 4.2%. Simultaneously, bold yields across major world economies also rose. Gold competes with bonds for capital, and when bonds offer more, the opportunity cost of holding gold rises. Institutional investors who had preferred gold because of the rate-cut found no more reason to hold onto gold and adjusted their positions accordingly.
The Dollar Strengthening
It’s hard not to see the irony in this case. The very forces generating anxiety in the Middle East along with the oil supply disruption have simultaneously strengthened the case for holding dollars. In such times, investors tend to seek safety in dollar-denominated assets, which pushes the currency higher. Add to that the prospect of interest rates staying elevated; this means dollar assets are offering better returns thereby becoming more attractive.
This creates a problem for gold. Since the metal is priced in dollars, a stronger currency makes it more expensive for buyers in Asia, Europe, and emerging markets. A Japanese investor or an Indian jeweller pays more in their local currency for the same ounce thereby reducing demand which in turn causes the price to fall. Gold’s safe-haven appeal and the dollar’s safe-haven appeal are, in this respect, in direct competition with each other.
The Oil Shock
The US-Israeli strikes on Iran in late February produced the kind of supply disruption that historically might have sent investors rushing into gold.
The disruption to Gulf oil supplies following the strikes on Iranian infrastructure sent crude prices sharply higher, feeding into the cost of transportation, manufacturing, and food across every major economy. This time around the oil shock has not merely raised prices in the near term, it has also raised the expected persistence of inflation across the global economy, giving central banks in the United States, Europe, and beyond additional justification for keeping monetary policy tighter for longer. The Bank of England cited energy costs explicitly in its most recent hold decision. The ECB flagged similar concerns. These decisions make interest-bearing assets more favourable than gold.
Leveraged Positions
When Iranian tensions first escalated, gold briefly spiked. Physical demand held firm, and premiums in the spot market remained high, suggesting that long-term buyers were not panicking. But the futures market behaved differently.
Leveraged speculators, like other investors, were also caught between a strengthening dollar, and a now hawkish Central Banks had little choice but to sell. Mostly because they needed cash to cover losses elsewhere, and gold was the most liquid asset they held. When they sold, the price dropped. When the price dropped this in turn forced more selling pushing the price further down.
What does this mean for Sri Lanka?
A falling gold price, measured in dollars, might seem like welcome relief for Sri Lankan buyers. But the rupee has weakened marginally against the dollar in the same period, which means that the price of gold in local currency terms has not fallen nearly as much as the international headlines suggest.
At the same time, Sri Lanka’s central bank, which has been carefully rebuilding its foreign reserves, holds a portion of those reserves in gold; a sustained decline in the golds value may put pressure on the reserve position.
For Sri Lankans who borrowed against gold jewellery a falling gold price can reduce the collateral value of those loans.
It is worth being precise about the nature of these risks, none of them are immediate, and most do not materialize unless gold prices continue falling over a sustained period. Pawnbrokers usually have buffers to absorb routine fluctuations, and the Central Bank’s reserve position remains strong. The concerns are likely to only materialize if the current sell-off proves to be the beginning of a prolonged structural decline rather than a cyclical correction.