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G. Chandrashekhar

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Washington DC, June 15 Has the longstanding relationship between crude and gold prices broken decisively? Is gold gradually losing sheen as an investment class and is being increasingly replaced by another gold, that is crude, also known as black gold?

It seems so, going by the recent trends.

Historically, gold and crude prices moved in tandem. The value of the US dollar and geopolitics always played a key role in the price action of both commodities. Notwithstanding differences in their utility and unit of measurement or trade (gold quoted in dollars per ounce and crude oil in dollars per barrel), there was certain proportionality in their prices and movements.

For long years, the value of one ounce of gold was largely equal to about ten barrels of crude oil. The gold to crude price ratio never broke 10:1. The relationship lasted from 1983 until the year 2000. Sometime in 2000, the 10:1 ratio broke and has since been persistently below 10:1. Currently it is trading at 6.5:1. Records show, the lowest monthly close in the ratio was 6.29:1 in August 2005. At that time, gold was trading at around $430/oz, and crude oil had just made its then historic high of $70 a barrel.

Interestingly, from August 2005 to August 2006, while crude stagnated in the range of $55-78 a barrel, gold spurted above $700/oz. The latest is that crude prices are at a historic high of close to $140 a barrel; but gold is unable to surge well above $900/oz. Gold has clearly lagged behind the price rallies in energy market.

Has anything gone wrong? Is it mainly due to lacklustre seasonal demand or is there something else underlying the weak trend? What will be the spread be one year from now? Will it be 5:1 or will the precious metal re-establish itself and when? These questions agitate the minds of numerous market participants who have always been betting on gold, and continue to swear by its safe haven investment status.

While some explanations would emerge in course of time, it is becoming increasingly clear that in the ultimate analysis, the utility of the commodity and the potential of the supply to respond to prices would become key issues. Demand for gold is both income elastic and price elastic. It is the admitted position that the recent run of high and volatile prices has actually resulted in demand compression or slowdown in demand growth.

As far as utility is concerned, undoubtedly, gold is an unproductive asset. The utility of gold is rather limited. The world can survive without the yellow metal. Crude, however, is different. Energy is a critical input to fuel economic growth. Given the current station of world development and status of manufacturing and transportation technologies, growth prospects would be seriously hampered without energy.

It is likely this reality is beginning to catch up with market participants. Additionally, unlike gold, in case of crude, the supply response to high prices is expected to be rather limited. The world’s mineral oil resources are finite; and demand continues to outstrip supplies.

The scenario is unlikely to change in the foreseeable future. However, there is one thing that defies explanation. Everyone is talking about extraordinary speculation in the crude market. But a look at the Commitment of Traders report issued by the regulatory authority Commodity Futures Market Commission is revealing. There is a huge speculative interest in gold, as usual.

Currently, on the Comex, in case of non-commercials (non-hedging category also known as speculators) the futures net long position, as percentage of open interest is 44 per cent, the all-time high being 49 per cent. In other words, speculators are holding large ‘long’ positions, hoping to see a price rise for making profit. Crude, on the other hand, has limited speculative interest.

On the NYMEX, currently, as a percentage of open interest, the futures net long position held by non-commercials is a modest 2 per cent (versus the all-time high of 18 per cent). So, contrary to popular belief, the role of speculators in the futures market seems to be limited.

More Stories on : Gold & Silver | Outlook | Petroleum

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