What does the slump in crude oil so to the price of gold? Generally, the price of a barrel of oil reflects the state of the global economy. In the last month the price of oil sank from $76 to $56 per barrel. One of the major reasons is the reduced demand and this increase in supply from Saudi Arabia. Some investors believe that this has to so with forecasts by bodies like the IMF. Mostly, it is about Saudi Arabia pumping out more crude oil. Investors also question the sustainability of the current strong economic streak that the U.S seems to be on. The bottom line is that the demand is less than the supply.
The plunge in the price of oil also comes with the sell-off of equities in the developed world. Looking back, oil has had a steady climb up since the 1980 recession in the U.S. During 1981-1982 the price barely moved. However, in 1990, it fell only to significantly jump again half-way through the Gulf war and then plummeted into the recession in 2001. The price of crude oil surged again during the 2008-09 financial crisis and reached highs of 65% right before the news of the Lehman crisis broke. It stayed high for 9 years of what has been called the longest recession in United States recession. Can we then blame a recession for this current oil price and what does it mean for the economy and in particular, for gold?
When it comes to recessions, equity investors are not the first people to see it coming. During all these recessions mentioned above equity investors seemed to not only have been in the dark over what was to come and those that did see didn’t do much of anything. So what about gold when a recession strikes?
Gold does not make the world go round. It is famous for not being useful for productive tasks. There is about 10% demand for gold in industry and then a small percentage goes into the medical industry, the beauty industry, the food industry, textiles, etc. The majority of gold goes to the jewellery industry. The industry that would suffer the most when there is not enough gold is the jewellery industry. That same industry suffers a lot when the economy slows down. People would rather sell than buy when faced with a threat of some sort of financial strife. During the last five years, the US gold price gold fell and rallied up a couple of times. During 1990-1991 it remained unchanged, then in 2001 it rose by 5% and then rose again by 15% in the 2008 crash.
So What does all this have to do with the gold market?
When the oil price goes down hedge-fund managers bet on Comex futures and other derivatives. Most of these derivatives don’t include gold. Comex offers leverage that buying physical gold can’t offer and most hedge-funds like to bet against gold. It makes better sense for money traders to bet against gold if the only way of making a living for themselves is based on speculation of where asset prices will head in a particular period. This year, most major stock market set or almost neared all- time record highs whilst the price of gold is still at one-third below its peak. The highest price for gold was reached back in 2011. The other thing that is affecting the rise of gold prices is the interest rates set by the US Federal Bank which is then followed by Central banks everywhere. Interest rates are like kryptonite when it comes to gold.
The Managed Money category as defined by the US regulators recorded bullish betting on gold that was barely half of its 10 year average. This then meant that the Managed money holds a negative bet that is equal to 220 tones of the national gold. Speculators have held a bearish outlook on gold prices for 4 consecutive months now.
What happens to gold if the US economy slows down? For those bearish hedge funders and speculators a negative GDP growth may not matter much. All that they would need to do is to bet that the gold price will fall, which will have people rushing to exit the market this will in turn drive gold futures high and consequently, the price of physical gold.