The armed conflict in the Middle East has been another reminder that the recent XAU/USD rally was driven largely by speculative demand. Instead of rising on US and Israeli military action against Iran, gold rode a roller coaster. One trigger for selling the metal may have been a reduced likelihood of a Fed funds rate cut. But a crowd exit has also played its part.

Capital flow dynamics into funds

Rising geopolitical risk usually increases demand for gold as a safe-haven asset. Instead, capital flowed into money-market funds. It means that investors seeking refuge rushed into the US dollar. They are following a four?year?old playbook. In 2022, at the start of the war in Ukraine, oil spiked, US inflation surged into double digits, and the Federal Reserve launched the most aggressive monetary tightening in four decades. The main beneficiary was the greenback.

Similar dynamics are unfolding this spring. On the fifth day of the Middle East confrontation, the probability of a Fed funds rate cut in June fell to below 40%. Expectations shifted toward July. The futures market now prices in chances of two easing moves this year at under 60%, down from over 70% before the conflict began.

A strong dollar and rising US Treasury yields are working against XAU/USD bulls. That backdrop is clearly negative for the precious metal. The price action implies a tug?of?war between safe?haven demand and a prolonged pause in Fed easing.

Major gold exporting countries

However, the longer the conflagration in the Middle East continues, the greater the chance that gold will rally. Like oil, a key artery of its supply chain has been disrupted. While Brent moves east by tanker, the precious metal is flown by air. Non-operational airports in Dubai are already changing the market structure. Before the conflict, prices in Delhi were lower than in London; now they have equalized. A regional premium could emerge, which would be positive for XAU/USD.

Thus, even against the unfavourable backdrop of a stronger dollar and rising US yields, gold is finding ways to resist. Its main strengths are a physical shortage and safe-haven demand.

Technically, a 1-2-3 reversal pattern is forming on the daily chart. Failure for gold to hold a fair-value level around $5,182/oz would signal bull weakness and invite selling. Conversely, a reclaim of XAU/USD above 5,375 would increase the odds of a resumption of the uptrend.