The market tends to often work in counterintuitive ways. For example, gold prices topped in August 2020 and remain more than 10% below its all-time highs just under $2,100. This was despite several bullish catalysts like a pandemic, weakening dollar, a historically dovish Federal Reserve, very generous fiscal policy, rising inflation, and incredible political uncertainty.

In recent months, many of these bullish tailwinds have turned into headwinds. For example, the Fed has become hawkish with the 2-year going from 0.17% in August to 1.5% currently. Fiscal policy has also normalized with the expiration of enhanced unemployment benefits, stimulus payments, and child tax credits. The pandemic has also improved, and the economy is gradually returning to normal.

Just like gold (GLD  ) failed to rally despite several bullish catalysts in the latter parts of 2020 and 2021, it has rallied 7% YTD despite a hawkish Fed and rising rates. There are two reasons for this - concerns of a Fed policy error and escalating tensions between Ukraine and Russia.

There are some who fear that the Fed is embarking on a tighter course for monetary policy just as the economy is about to slow. This is a double-negative for stocks because it implies slowing or negative earnings growth, while higher rates imply outflows from the asset class. This would be a Fed policy error similar to what happened in 2018 when the Fed had to terminate its rate hike cycle prematurely.

Gold is one way to hedge against this as investors position themselves for this outcome. While, growth is likely too strong to actually go negative, some ingredients are in place for the "perception" of a policy error to increase. This can be due to factors like consumer spending and economic activity weakening on a year over year basis or inflation having a negative effect on discretionary spending or consumer confidence.

Gold prices are primarily determined by interest rates and inflation. However, a third factor - political uncertainty - can also drive inflows. This is also the case as fears grow of a conflict between Russia and Ukraine and the spillover effects it could have. NATO countries would be obligated to defend Ukraine especially because it would set a bad precedent, and many European countries are dependent on Russia for their energy needs. Thus, a Ukraine-Russia conflict has the potential to send energy prices spiraling in an an environment where energy prices are already high.