Gold has been a store of wealth for millennia and more recently the price of gold has tended to move in the opposite direction to stocks and dollars, providing investors with some diversification in their portfolios.

However, this year gold has so far failed to function as a safety cushion for investors against financial market volatility. GC00 gold price,
+1.49%
hit their lowest level in two and a half years on Friday morning with the most active gold futures GCZ22,
+1.49%
falling $15.30, or 0.8%, to $1,621.10 an ounce. This was the lowest intraday level since April 2020, when gold traded as low as $1,595.20 on Comex, according to Dow Jones Market Data.

“The main driver was the rise of around 20 basis points in 10-year Treasury yields TMUBMUSD10Y,
4.228%,
as recent signs that high inflation may be more rigid than expected suggest the Fed will remain in a hawkish mood,” Caroline Bain, chief commodities economist at Capital Economics, said in a Friday note. “Admittedly, the price of gold has not fallen as much as the sharp rise in real yields might have suggested. But we suspect that the reduced liquidity of inflation-linked bonds could be a reason for this divergence.

See: ‘Flimsy’ Treasury market risks ‘large-scale forced selling’ or surprise that leads to breakdown, says BofA

Rising bond yields and the strength of the US dollar dampen the attractiveness of gold as they increase the opportunity cost of holding a non-performing asset. The benchmark 10-year Treasury bond yield tried to set another multi-year summit on Friday, rising to 4.226% from 4.225% on Thursday afternoon. Thursday’s level was the highest since June 2008.

John Higgins, Chief Markets Economist at Capital Economics, explained the inverse relationship between the price of gold, which pays no interest, and the yield of long-term government bonds (see chart below).

In a hypothetical example he wrote in a note dated Oct. 14, an investor hoping to have $1,000 of “safe haven” in today’s money after 30 years has two options for investing. Either they can invest $1,000 in gold or they can invest in a 30-year zero-coupon Treasury bond that offers a 2% real yield. A day later, the real yield on the bond has fallen to 1.5%, which means they have to invest more in the bond for its real value at the end of the period to be the same. In order to maintain the same initial costs of alternative investments, the price of gold will also have to increase.

SOURCE: REFINITIV, CAPITAL ECONOMY

See: The U.S. dollar is taking its toll: what it means for the stock market and investors

Meanwhile, the ICE US dollar index DXY,
-0.88%,
an indicator of the greenback’s strength against a basket of currencies, fell 0.9% to 111.84 on Friday but is up 16.5% year-to-date, hurting to the attractiveness of the yellow metal for those who hold other currencies.

Gold is still seen as a hedge against inflation as market volatility and geopolitical instability are expected to increase its appeal as a ‘safe haven’. However, this year hot inflation was countered by the Federal Reserve and other central banks which raised interest rates sharply, stoking fears of a recession.

“It is possible that the price of gold will decline further in the near term as it adjusts to the higher level, adjusted for liquidity distortion, of long-term TIPS yields,” Higgins wrote. “We expect it to end this year roughly where it is now, and to pick up a bit next year as the Fed changes course and real yields fall. Our end-2022 forecast and end of 2023 are $1,650/oz and $1,700/oz, respectively.

Fed officials are heading for another interest rate hike of 0.75 percentage points from their benchmark interest rate at their Nov. 1-2 meeting, but some have started signaling if and how slow the rate of increases soon, The Wall Street Journal reported Friday.

Meanwhile, San Francisco Fed President Mary Daly said on Friday that the Fed needs to start talking about slowing down the rapid pace of its recent increases in its benchmark interest rate.

Market participants have already priced a 94.5% chance of another 75 basis point hike at the November meeting, according to CME Group’s FedWatch tool. The Fed has raised its federal funds futures by 300 basis points since its March meeting, one of the fastest moves in history, including three consecutive rate hikes of 75 basis points.

Lily: Stock market live: Dow up near 600 points as traders ponder potential slowdown in Fed rate hike

The indication that the central bank could switch to lower interest rate hikes after its November meeting applauded the stock market on Fridaywith the Dow Jones Industrial Average DJIA,
+2.47%
jumping nearly 750 points, or 2.5%, while the S&P 500 SPX,
+2.37%
gained 2.4% and the Nasdaq Composite COMP,
-0.81%
climbed 2.3%. However, three major indices are all still bearish since the end of September. For the year, the S&P 500 was down 21.3%, while the Dow was down 14.5% and the Nasdaq fell 30.6%.

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