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Tuesday, September 12, 2006

The Short View: Gold and oil

The Short View: Gold and oil
By John Authers, Investment Editor
Copyright The Financial Times Limited 2006
Published: September 11 2006 19:09 | Last updated: September 11 2006 19:09


September 11 was an eerily inappropriate date for a decline in the global perception of geopolitical risk. But yesterday saw the sharpest fall in the world gold price in three months.

It fell more than 4 per cent, bringing it below $600 per ounce to reach $586, and 18 per cent below its high for the year, as investors assimilated the idea that political risks may not be not as high as they had seemed and that oil is not a one-way bet.

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Oil and gold have been tightly correlated since the terrorist attacks five years ago. With gold viewed as an inflation hedge, the argument has been that increases in tension, such as the conflict in Lebanon earlier this year, lead to rises in the oil price, which in turn spill over into higher inflation. Ergo, buy gold.

Over the past five years, the price of gold has risen 114 per cent, while oil, according to the benchmark West Texas Intermediate contract, is up 121 per cent. Much activity in both commodities – as in many others – has been speculative, as hedge funds piled in.

On oil, various threats to supply – from Lebanon, or from BP’s problems in Alaska – have proved not to be as severe as they at first appeared and so the oil price has come down, by 15 per cent from its peak two months ago, bringing gold with it.

What does this augur? There is a respectable case for gold based on aggregate demand. Gold jewellery demand was up 12 per cent in the second quarter to an all-time record of $11.2bn, according to the World Gold Council.

But the volumes of speculative investments, and the strength of its recent correlation with crude oil, should give “goldbugs” cause for concern. Oil has been in the grip of the almost totally uniform sentiment that normally presages a sharp movement in the opposite direction.

Back in April, Goldman Sachs predicted that oil could reach $105 a barrel. Monday brought a report from Standard & Poor’s speculating on the impact of a $250 oil price.

Sentiment like that suggests it is time to start speculating about the impact of a retreat of the oil price to a more normal level like $40.

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