Gold Rises Along With Oil Prices as Dollar Value Falls
(image: businessnewsforkids.com)
(image: foxbusiness.com)
It’s a bad time to be a dollar bill, but a good time to be an ounce of gold…and it’s becoming a better time again to be a barrel of oil. In yesterday’s trading, gold futures were up 1.4% to $976.70 an ounce, oil rose 1.8% to $66.30 a barrel, but the dollar fell 1.1% in value. The rise of gold and oil prices at the same time that the dollar is falling is not a coincidence—commodities prices are rising because the dollar is falling. They are, however, rising due to different mechanisms:
• Gold prices often rise because gold is an “alternative currency.” Gold is not literally a currency, of course, but it is a very liquid, easily tradable, high-value and low-bulk commodity that serves many of the same purposes as currency. When the value of the dollar—one of the world’s benchmark currencies—is falling, gold is an attractive alternative in which to park your money. Doing so lets you hedge, or guard against, reductions in the dollar’s value. This is particularly true during a global recession—especially one coupled with a decline in real estate values in many markets—since so many other investments are losing value. Precious metals, like gold, are a safe place to put your investing dollars. As more people seek to invest in gold, the price goes up—that’s the law of supply-and-demand in action.
• Oil prices rise because oil is priced in dollars. As The HEAT Zone has reported, when the value of a dollar falls, oil producers have to raise the price of oil to compensate. Otherwise, they would be getting less “bang for their barrel”—selling a barrel of oil when dollars are worth less gets them less buying power in other currencies.
So, since gold is used an alternative to dollars, its price would rise as dollars become less attractive, putting gold in higher demand. And since crude oil is priced in dollars, the price of a barrel of crude has to rise to compensate for a decline in the dollar’s value. It’s not surprising that both commodities would rise when the dollar falls.
Not surprising…but also not inevitable. There is an added complication to crude oil pricing that may sometimes push it lower as the dollar also falls. There’s a saying in statistics that “Correlation does not equal causation.” This means that sometimes, when two things happen together, one is not causing the other—instead, they are both responding to a third factor. If the decline in the dollar’s value is caused by a weakness in the U.S. economy—i.e. the recession—that underlying economic weakness can also lower demand for oil. That recession-driven reduction in demand can in turn reduce the price of a barrel of oil. That was why in February, oil was at only $34 a barrel while gold was at $1,000 an ounce—a 25-to-1 advantage in gold’s favor, in terms of the value of the commodities’ benchmark quantities.
Now though, the ratio is down to a more reasonable 14.7 to 1. That can be explained by a growing belief that while more painful months await us, the recession is—or least is in the process of—bottoming out, and that economic recovery may begin in 2009. Once the economy starts showing signs of picking up, investors, oil producers, refiners, etc. will all anticipate coming increases in oil demand, and that hopeful anticipation will be factored into the pricing of crude oil for future delivery. Thus, if and when things look up—and knock on wood, that “when” is around the corner—the depressive effect on oil prices of reduced demand should weaken or even end. And when that happens, it’s likely that oil prices will resume their more familiar countercyclical movement with dollar values—rising in price when the dollar falls, falling when the dollar rises. That would put “black gold” more in sync again with the pricing movements of yellow gold, as we’ve seen recently.
Here’s hoping that the economic optimism is well founded and will be sustained. As The Heat Zone has reported, higher oil prices can be a good thing (within reason!) if they also herald economic recovery.
