XAU/USD is holding steady above $2,500, potential downside looks limited

Gold has played a key role in human history as it has been widely used as a store of value and medium of exchange. Today, apart from its luster and use for jewellery, the precious metal is widely seen as a safe haven, meaning it is considered a good investment during troubled times. Gold is also widely seen as a hedge against inflation and against depreciating currencies because it is not based on any particular issuer or government.

Central banks are the biggest holders of gold. In order to support their currencies in troubled times, central banks tend to diversify their reserves and buy gold to improve the perceived strength of the economy and currency. Large gold reserves can be a reliable source of a country’s solvency. Central banks added 1,136 tonnes of gold worth about $70 billion to their reserves in 2022, according to data from the World Gold Council. This is the largest annual purchase since records began. Central banks in emerging economies such as China, India and Turkey are rapidly increasing their gold reserves.

Gold has an inverse correlation with the US dollar and US Treasuries, which are both major reserve and safe-haven assets. When the dollar depreciates, gold tends to rise, allowing investors and central banks to diversify their assets in troubled times. Gold is also inversely correlated with risk assets. A rally in the stock market tends to weaken the price of gold, while a sell-off in riskier markets tends to favor the precious metal.

The price can move due to a wide range of factors. Geopolitical instability or fears of a deep recession can quickly cause the price of gold to rise due to its safe haven status. As a lower-yielding asset, gold tends to rise with lower interest rates, while the higher cost of money usually affects the yellow metal. However, most of the moves depend on how the US dollar (USD) behaves, as the asset is valued in dollars (XAU/USD). A strong dollar tends to keep gold prices in check, while a weaker dollar is likely to push gold prices higher.