Plotlines: Gold falls vs oil, a murky inflation signal

April 30, 2008


Gold’s oil-buying power is at its lowest in three years. (The chart shows the price of oil rising relative to the price of gold.) Hedge funds and other traders who play the gold/oil spread could be taking profits. Otherwise, this is hard to explain, since gold is considered a leading indicator of inflation.

In the past two weeks, crude oil prices rose to a record near $120 a barrel, while the spot price of gold fell from around $950 to $870 an ounce. Today an ounce of gold buys 7.65 barrels of oil. When gold was near $1,000 an ounce earlier this year, an ounce bought more than 10 barrels of oil. Gold’s weakest point relative to oil was in 2005 around 6 barrels.

Is the underperformance signalling that inflation expectations are overblown? Perhaps the Fed knows something … it cut a key interest rate another quarter percentage point on Wednesday and said it expected inflation to moderate in coming quarters, as energy and commodity prices level out. “I am still not getting why gold is trading down here and crude is up there. So something’s gotta give,” said Jonathan Jossen, an independent floor trader on the COMEX gold floor.


My initial thought is that, absent a few electrically-conductive engineering applications, gold is almost exclusively an inflation/currency hedge. The price of oil, though, also reflects expectations of future demand. One of the big drivers of the growth of the price of oil, at least before the collapse of the dollar, was the rise in industrial demand from both China and India. Since the price of oil has become dearer relative to gold, given the chart, it could reflect that oil is expected to be in more demand, so it could be an early sign of a recovery.


This is pure manipulation. The fed has been monitoring and controlling gold prices for a long time and it seems they are more determined than ever to bring gold prices down to reduce fears of inflation. They may be succeeding during the short term, but the long term inflation prospects are very high. The fall in oil and Gold prices does not signal an early sign of a recovery, for the fundamentals of the U.S. Economy has not changed. Default notices and number of foreclosures are on the rise, and housing prices are continuing to fall. The U.S. deficit continues to grow at an alarming rate as U.S. government continues to spend money they clearly do not have on thins such as the stimulus packages, the war in Iraq, and various other social programs and there still talk about another stimulus package and a possible bailout of banks through the purchase of these mortgage backed securities, which will only exacerbate the problem. The Feds continues to lower interest rates while the banks continue to hoard money to shore up their worthless portfolio of bad mortgages, and they are doing everything they can to delay or minimize the write offs or their growing losses on their mortgage portfolio. The lowering of interest rates if only going to increase the future rates of inflation and the future decline of the dollar. This is nowhere near the end, it is only the beginning.

Posted by J M | Report as abusive

As the article notes, gold and oil have been moving in tandem recently, with a marked divergence setting in around mid-March. When a divergence is manifest like this, barring absolute de-coupling, equilibrium must somehow be achieved. Will gold rise to catch up with oil? or will oil come down to catch up with gold? The most likely explanation for all this has been the rise in the markets recently. According to the tape at least, the US, Chinese, and other markets have put in a good bottom, and equities are on the rise. Even many small cap stocks are empirically breaking out to new highs. A bear market, the dotcom bust for example, was a totally different phenomenon than what we’re seeing now, which is rather a period of weakness, followed by recovery. As equities rise, so will money rotate out of previous hot investment classes, into newer areas perceived as being of greater value in terms of risk/reward. Since gold is of less applicable value than oil, and is more symbolic, money began coming out of gold to buy equities, and oil remained high for it’s utilitarian value. However, since oil is high and equities low, the rotation should begin to deflate oil as it continues to inflate equites. Doom and gloom has become a popular mentaility because it is hard-wired into human nature. However, the world is not in a depression, but as inflationary pressure shows, it is growing. Stocks are and will continue to recover, and commodity price will abate going forward. I would be a possible buyer of oil on a healthy dip, but that has not happened yet. People have already bought into the equity dip, and as this new bull phase developes, at least till the next cycle of tightening begins, I would hold beaten down stocks in favor of the more lofty commodities. JMHO, time will tell.

Posted by Earl Dennis | Report as abusive

The Fed is trying to control the price of gold but it’s not working. From the World Bank in Brussels Belguim to the largest commercial banks in the US this country is in trouble.
Over 250 Billion given to firms to build confidence and major bank write-offs are simply driving the dollar down lower than it’s ever been.
Gold and Oil are moving together and Gold has and always will be the best hedge during this time of UNCERTAINTY.
It will be much higher before it’s all said and done.
Jeff Clark


We live in a much different world and the dynamics are not what would be expected if you try to look back historically for answers, this is uncharted territory. For decades foregin central banks have been manipulating their currency versus the US dollar by hoarding dollars they receive, or even buying dollars to keep their currency low and promote exports. An incredible imbalance has taken place over the past 20 years, and the US has had the luxury of exchanging paper for goods and services, and until recently the dollar maintained its strength. The writing was on the wall as the US dropped the gold standard in 1971, consequently causing inflation and the first gold price spike. The Fed was clever to stop reporting the M3 money supply just before Greenspan left, easier to hidewhat they were going to do. Reports and Senators testimony have shown that in the past 2 years the M3 has grown over 30%! That is obscene,people holding 10 year US treasuries or dollars are feeling pretty stuck and stupid. Time to buy something real and useful like Commodities, which is what China is doing and is a net seller of US treasuries as of 2007, very smart.
The transition in exchange rates may be violent and unsettling and is the fault of the foreign banks being naive but in the end the bright spot is that the US can inflate their way out of deficits (bad for bond holders) and the low dollar will also accelerate exports and give them a chance to repay those goods and services in kind, creating jobs at home and that will allow for a happy ending, however the ride will be very unpleasant and scary. People who can hold on to Gold during bumpy rides, (when talk of a world wide depression spooks commodities) should be richly rewarded.
Just based on monetary inflation as measured by the M3 Gold should appreciate 15% a year, and there is way more upside than that if dollar holders get spooked and chase hard assets. However in absolute terms you are not making money if you buy gold, rather you are just not losing value if you hold onto cash, however gold is obviously undervalued at these levels.
Eventually you will want to own real estate again but not just yet. Congress and the Fed are trying to inflate housing prices as they can not afford a deep recession. They will succeed eventually even if all other asset classes go along for the ride.

Posted by Greg Vance | Report as abusive

Gold has always been a hedge when paper capital gets injected into the system, or when oil begins to leap. Some speculator are currently camping supplies of the yellow alloy in hopes that the price will break the $2000 point. It is yet to be seen where the price floor is.


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