A Strong Dollar and Weaker Chinese Yuan Both Drag Down Gold

But China plays a big role, too, according to

Goldman Sachs

GS 1.05%

chief commodities strategist

Jeff Currie.

That is because Chinese consumers account for almost one-third of global retail gold purchases, Mr. Currie said, and a weaker yuan reduces their purchasing power.

According to his research, the yuan has the largest impact on gold among major currencies, followed by Thailand’s baht. 

“As the Chinese yuan fell, gold followed it lower,” Mr. Currie said. 

The yuan has declined for the past five months as of the end of July—its longest losing streak since October 2018. Both the onshore and offshore Chinese currencies have lost more than 5% against the dollar year to date. Traders are worried about the Chinese economy, where growth has slowed thanks to Covid-19 lockdowns and plunging home sales. 

Gold, meanwhile, has fallen for the past four months. The most actively traded gold futures contract closed Thursday at $1,788.50 per troy ounce, down more than 12% from highs seen in March. Hedge funds and other speculative investors who sought to protect their returns against inflation have pulled back bets on rising gold prices, reflecting a growing belief that the Fed will do whatever it takes to tame inflation.

Earlier this year, gold benefited from turmoil in financial markets as consumer prices surged and signs of geopolitical turbulence emerged in Europe. Many investors favor gold during economic crises because it can act as a shield against inflation, and asset managers expect gold and other safe-haven assets to hold their value when markets turn sour.

It hasn’t worked out that way recently. Despite prolonged inflation and continuing tensions between Russia and Ukraine, the precious metal is stuck—the latest example of how the Fed’s interest-rate increases are rippling across the globe.   

Higher U.S. government bond yields, a byproduct of the Fed’s rate increases, have supercharged a dollar rally. Though the WSJ Dollar Index has slipped in recent days, it is still up nearly 10% this year. That pushes down the value of other currencies, like the yuan.

It also makes gold more expensive for overseas buyers. One knock-on effect of the strong dollar is dwindling gold purchases from emerging-market central banks, which have to combat precipitous slides in their currencies by dipping into foreign-exchange reserves. India’s central bank has had to spend its reserves to contain a plunge in the rupee—which fell as much as 6.9% this year. 

Gold also competes for investors’ interest with government bonds, which are relatively stable and, unlike gold, offer regular payouts. The 10-year Treasury yield, which tends to move in tandem with expectations for the Fed’s benchmark rate, has risen more than 1.1 percentage points this year. The 2-year Treasury yield has risen 2.3 percentage points.

The extent of the dollar’s rally this year has taken many on Wall Street by surprise, forcing strategists at investment banks to revise year-end estimates around the greenback.

“Hedge funds had initially looked to position long gold last year as inflation was rising and central banks had been slow to react with higher interest rates,” said

Andrew Simon,

chief operating officer and president at market analysis firm Macro Hive.

To be sure, the decline in the Chinese yuan hasn’t been as sharp as in some other currencies. 

“The currency weakened because of the broad dollar rally and has been driven lower by three weeks of price action—otherwise it’s been quite static,” said

Calvin Tse,

head of Americas developed markets strategy at

BNP Paribas.

Goldman previously expected gold to increase to $2,500 per troy ounce by the end of the year. In June, the Wall Street investment bank lowered its forecast to $2,300 per troy ounce. But Mr. Currie maintains the precious metal will eventually move higher as concerns around slowing growth and recession mount going into 2023. 

“We believe the bullish gold case was merely delayed rather than derailed,” Mr. Currie said in a note to clients. 

Many strategists have revised their global growth forecasts lower.

Bank of America Corp.

economists expect a recession in about half of the world’s major economies. Morgan Stanley Global economist

Cristina Arbelaez

said the outlook has “darkened significantly” and recession fears have increased since May. 

Write to Julia-Ambra Verlaine at julia.verlaine@wsj.com