By Barani Krishnan
Investing.com -- Aren’t oil and gold both inflation-sensitive commodities? Then, why do prices of crude rally with barely any restraint now, while those of bullion fall almost indiscriminately?
Shouldn’t the pressure of rising U.S. wages and bottlenecks in global supply chains lift both concurrently, though maybe not equally.
Yes and no.
The inherent nature of commodities is that their prices go up when the dollar’s purchasing power comes down from higher costs. Note that in this cycle, the dollar is vulnerable in either situation. Commodities start the cycle from rallying to supply-demand pressures; the dollar then gets hit from rising inflation and commodities react to the inflationary cycle by going even higher.
The strongest case for commodity prices as a leading indicator of expected inflation is that commodities respond quickly to widespread economic shocks.
Systemic shocks — like this year’s Hurricane Ida, for instance — can decimate commodities supply (in this case, oil) and subsequently increase their costs. By the time the commodity reaches consumers, overall prices would have increased — Ida alone boosted U.S. crude prices by almost 10% — and inflation would be realized.
But history also shows that commodities with high energy content are more correlated with headline inflation than commodities composed of metals and agriculture.
Kevin L. Kliesen, business economist and research officer at the St Louis Federal Reserve, finds this after studying moves on the S&P GSCI, Thomson Reuters CRB, Bloomberg and FIBER commodity indexes and their impact on inflation over a 25-year period.
This logic tells us that we shouldn’t be surprised by the 72% rally in U.S. crude this year versus the 6% slide in bullion.
Here’s The Alternative Story
Whatever’s printed above is true, but there are also caveats to be mindful of.
Yes, oil is seemingly in terrible short supply now versus demand, a situation we’re told will only get worse during the winter as more of the commodity is used to generate power and heat from an expected lack of sufficient natural gas and coal.
That’s not even considering that Americans might suddenly have the impulse to drive more in the winter than the past summer, as crazy as the world is getting. And while we’re considering wild contingencies, let’s consider real ones too: that the flying population will literally hit the skies in the new year as all pandemic restraints for travel are lifted.
We heard earlier this week from the chief executive of the world’s largest oil producing company that "spare capacity is shrinking" ahead of the international lift-off for travel and it was a "huge concern" for the company. “If there’s aviation pick up next year, that spare capacity will be depleted,” Amin Nasser of Saudi Aramco (SE:2222) told Bloomberg. “It’s now getting to a situation where there’s limited supply — whatever is left that’s spare is declining rapidly.”
Nasser has the gall to say that when the kingdom of Saudi Arabia, which runs Aramco and also OPEC+, will not let the global alliance of oil exporters increase production by more than the 400,000 barrels per day agreed to months ago — when the supply-demand situation then was a lot less dynamic than it is today.
Each OPEC+ meeting this year has been an opportunity for the cartel to talk up the market, to the extent that crude prices now are well beyond pre-pandemic highs.
And right on cue on Friday, a delegate of OPEC+’s Joint Technical Committee, speaking ahead of Thursday’s meeting of the alliance’s oil ministers, said there will likely be “a tighter Q4 oil market” as reopenings from the pandemic intensify and more supply is held back than necessary. In case of any ambiguity on how OPEC+ would respond to the situation, Algeria was out with the cartel’s megaphone to reinforce the mantra: 400K and no more.
Gold, on the other hand, continues to plummet in value despite being branded as a hedge against inflation. Bullion’s safe-haven standing has been turned into a joke this year by short-sellers of the yellow metal, who’ve been allowed to run riot by traders not just tolerating but actually coddling inflation thanks to the policies of the Fed.
The eye-watering debt America has gotten into since the first Covid-19 outbreak — and will get into in the coming years — seems of no consequence for bulls chasing ever-higher prices on the equity and energy markets, all in the name of “hedging” against inflation.
Meanwhile, the one asset truly set up to provide investors a store of value against a potential crumble in fiat currencies is itself crumbling. Since its early run to record highs above $2,000 an ounce in August 2020, gold has never been allowed to achieve its true price potential, with Bitcoin often outstaging the centuries-old yellow metal these days in the race for inflows despite arguments about cryptos’ inherent value — or lack of.
Besides plowing into virtual currencies, investors are, of course, chasing either Treasury yields or the dollar higher, on the bet that the Fed will fail to reign in galloping inflation with the tools it has (those on the bond markets are certainly working to ensure the central bank fails and fails miserably). The aim is to force the Fed’s hand in raising interest rates faster and higher than it intends and deliver a massive win for the bullish T-yield and the dollar positions in play.
There are also some theories that the Fed is intentionally willing gold to be suppressed, in order to keep the Dollar Index above the key 90 level. A Forbes article from 2019 and also a more recent Money Metals article from February this year outline how this is possibly being done.
But there’s a more acceptable reason for gold’s behavior. And that, according to Lance Roberts of investment consultancy RIA, has “absolutely nothing” to do with gold itself and everything to do with investors who have gotten too brazen with price pressures under a Fed that still calls inflation at 30-year highs “transitory.” These are people who’re too deeply ensconced in the comfort zone of a S&P 500 whose last meaningful correction was a year ago.
What ails gold is the absence of fear among this crowd who’ve become as dizzy as the financial system that’s been erected upon the beach sand of easy, artificial credit, Roberts said in a September post.
I would argue something else: that gold also lacks a megaphone as loud as OPEC’s, to look after the interest of safe-haven seekers.
Oil Market & Price Roundup
Oil bulls saw their multi-week win on Brent come to a close but still managed to deny bears joy over U.S. crude, which finished up on the day and just a little lower than a week earlier.
With producer group OPEC+ gearing to talk the market up again at its monthly meeting next Thursday, there is only so much room for crude prices to correct in an environment where traders are perpetually reminded of the cartel’s attempt to keep supplies abysmally low against demand.
In a pre-meeting holler, Algeria said on Thursday that crude output should not increase by more than the 400,000 barrels per day that the Organization of the Petroleum Exporting Countries and their allies had agreed to months ago. Energy experts say the total addition of 2 million barrels planned by OPEC between November and April is akin to a drop in the bucket for a market needing at least a million barrels more each month.
“The oil market deficit might only be 300,000 barrels a day this quarter, but the risks of a demand surge remain elevated,” said Ed Moya, head of research for the Americas at online trading platform OANDA.
Stephen Brennock, oil broker at PVM, concurred, telling Reuters that OPEC+ is “intent on continuing to act as a key pillar of price support” with its strangle power over supply.
London-traded Brent, the global benchmark for oil, finished Friday’s trading up 6 cents, or 0.07%, at $84.38. For the week though, Brent fell $1.15, or 1.3%. It was Brent’s first week in the negative after seven straight weeks of wins. Brent, however, still rose 7.5% on the month and is up around 61% on the year.
U.S. West Texas Intermediate crude settled up 76 cents, or 0.9%, on the day at $83.57 per barrel. That made WTI take a nominal loss of 19 cents, or 0.2%, on the week. For the month, WTI was still up 11% while rising 72% on the year.
Crude prices fell earlier in the week on the possibility of Iran holding nuclear talks with Western powers amid Tehran’s bid to free itself from U.S. sanctions prohibiting the sales of its oil to the world.
A weekly build in U.S. crude stockpiles also weighed on the market as the Energy Information Administration reported an inventory level double to market expectations. The rise came as refiners boosted raw oil imports last week to make more products like gasoline and diesel, while exporters of crude shipped out less.
Gold Market & Price Roundup
Another week and another failed attempt to advance beyond $1,800.
Gold’s fate of being stuck — for now at least — in $1,700 territory seems real as the Federal Reserve heads for its monthly meeting on Tuesday and Wednesday, where the noise of U.S. stimulus tapering is likely to get louder.
If that isn't enough, the U.S. jobs report for September is due next Friday, and any growth number in that might be enough for Fed Chair Jerome Powell and his coterie of policy makers looking to snip $15 billion each month from the central bank’s monthly bond buying of $120 billion.
U.S. gold futures most active contract, December, settled down $18.70, or 1%, at $1,783.90 an ounce.
For the week, it was down 0.7%, its sharpest loss in six weeks. For the month, however, gold rose 1.5%. Gold has gained in three of the past months but remains down 6.4% on the year.
“Gold is not finding any love with European sovereign funds or for that matter any of the major institutions,” said Phillip Streible, precious metals strategist with Chicago’s Blue Line Futures. “It’s like the moment it hits $1,800, people hit the sell button. That’s what happened today, and the cascade of sell stop orders below just acted like falling pins.”
“This is just the end of a bad week for gold that isn’t going to get any better next week with the Fed meeting and jobs numbers looming. I’m looking at a retest of the $1,750 level and possibly much lower.”
The dollar’s spike to a two-week high also weighed immensely on gold in Friday’s trade as the yellow metal suffered at the advance of its biggest rival.
The dollar surged after data on Friday showed the Fed’s annual inflation gauge hitting a 30-year high in September, keeping the pressure up on the central bank’s policy makers as well as the Biden administration in reigning in surging costs.
U.S. consumer sentiment also remains at risk from soaring inflation although Americans seem resigned to higher costs from economic upheavals caused by the coronavirus pandemic, the University of Michigan said on Friday in the latest iteration of its closely-watched consumer survey.
While gold is supposed to be a hedge against inflation, it has barely lived up to that billing this year as expectations that the Fed will have to raise rates at some point has weighed on the metal.
Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold a position in the commodities and securities he writes about.