The last few weeks have been “different” to say the least. Just to list a few obvious ones:
- The US and Israel made an unprovoked attack on Iran. By the admissions of Trump’s own staff, Iran did not pose any material threat to the US at this point. More importantly, this escalation occurred while negotiations between the US and Iran were ongoing.
- The Straits of Hormuz have been closed, choking off nearly 20% of the world’s oil supply. In addition, there has been extensive damage inflicted by Israel to the South Pars gas field – the largest gas field in the world, which is jointly operated by Iran and Qatar.
- Extensive damage to countries that had US military bases, such as Bahrain, Qatar, Kuwait, the UAE, and Saudi Arabia. The invincibility of the US Army’s defence systems has pretty much been laid threadbare by Iran, so much so that even the mainstream media is speculating about the end of the Petrodollar.
All these events should have caused gold prices to skyrocket and perhaps even cross $6,000/oz, and yet, what we witnessed was the exact opposite. Gold plummeted to just above $4,000/oz. Higher oil prices and the much higher-than-anticipated PPI (for Feb 2026, which came in at a monthly 0.7%) were the supposed triggers behind gold’s plunge. That, of course, is an extremely bizarre and almost child-like economic explanation for what happened. The antidotes follow.
I. Wars and Higher Gold Prices
The prevailing notion that wars cause gold prices to spike is indeed correct. For the wrong reasons, though. It is not for reasons that people buy gold during times of uncertainty, as is almost always parroted. Wars are almost always financed through monetary inflation, and this leads to higher gold prices to account for the increased currency in circulation.
The best example of this is the two world wars; here are the facts.
- The accumulated US National debt between 1789 and 1945, over the 156 years, was about $259 billion.
- Out of this $259 billion, $243 was incurred during the 10 years of the two world wars. Or nearly 94% of the National debt was accumulated during 10 years, and the remaining $16 billion took 146 years.
Wars and monetary inflation are indeed conjoined twins. This was true even under the Fed-managed “Gold Exchange Standard”. What hope is there under a completely fiat system!
The current war with Iran is indeed going to be a very expensive one for the US economy. The Pentagon has requested $200 billion in emergency funding for the Iran war, which has lasted just over six weeks (including the June 2025 conflict), while the ongoing Ukraine war, which has lasted for more than 4 years, has incurred less than $180 billion.
The Iran conflict is going to lead to an explosion in the National debt, even by the loose standards that Trump has set for himself. This is not going to be without consequences, and we should not be surprised by double-digit price inflation by mid to late 2026. And hence we will witness substantially higher gold prices later this year. Perhaps even well above $6,000/oz.
II. Oil Prices and Gold
The rationale peddled is that rising oil prices divert money from gold, and hence gold and oil prices are inversely correlated. I suppose many of the algo trades happen using the above logic, and hence we have indeed seen this negative correlation over the last couple of weeks.
The above hypothesis, notwithstanding its seeming accuracy for the fleeting moment, would indeed be a correct one if and only if the supply of money and debt were held constant. But we do know that both are expanding, and hence the above rationale is faulty.
The closest comparison to what is happening today would be the stagflationary 1970’s. The difference is that the decade ahead will be worse, both in terms of the depth of the recession and the extent of price inflation, than the 1970s. During that period, while gold moved from $35 to $850/oz, oil prices (WTI spot) also increased from $3 to nearly $40/barrel. As shown, both moved in unison due to monetary inflation manifesting as price inflation.
III. Interest Rates and Gold Prices
Of all the misperceptions floating around in the world of finance and economics, this one takes the cake. Here is the rationale peddled almost on a daily basis – high price inflation would imply a higher or, at the very least, static fed funds rate. This higher interest rate is good for the US dollar and hence bad for gold.
Forget Economics. Anybody with access to a phone and basic literacy skills would know that the above is patently incorrect. The above rationale has been valid for only 4 out of the last 55 years.
The reason is that what matters is the real interest rate (the yield after adjusting for price inflation), and not nominal interest rate movements. Given current price inflation trends, a PPI of 0.7% in Feb 2026 (before the Iran war, which has nearly doubled crude oil prices) indicates that the US will need a double-digit interest rate just to break even with price inflation. Given the quantum of National debt, the US cannot even afford a 5% interest rate, let alone a double-digit one. Therefore, the US Fed will keep the real fed funds rate negative for the foreseeable future, implying substantially higher gold prices in the years ahead.
Looking Ahead
Given below is a summary of what’s likely to happen to interest rates, gold, and oil prices over the next 2 to 3 years. This assumes a continuation of the current trend of annual deficits of $2 to $2.5 trillion and no major new wars. Of course, the bubbles have started to burst, and all indications are that the credit bubble and Housing Bubble 2.0 will begin unwinding this year. This is likely to be followed by the bursting of the AI bubble and finally a long unwinding of the US bond bubble.
So, we should expect much higher deficits and debt than what the current trend indicates. That could well imply that the projections below indeed prove conservative.
About the Author
Shanmuganathan N (aka Shan) is an Economist based in India and can be contacted at [email protected]