Gold and Crude Oil Could Prove to Be Next Winning Couple

December 19, 2014
MainStreet

Source: MainStreet

Author: Ellen Chang

As prices for both crude oil and gold have declined recently, the regular correlation between the two commodities appears to be ending, according to precious metals experts.

While gold and crude oil prices have had a strong relationship in the past, the recent massive drop in oil has broken that correlation, said Scott Carter, CEO of Lear Capital, a Los Angeles precious metals firm which sells physical gold, silver and palladium to retail investors.

Crude oil’s rapid decline occurred because of the “severe” economic slowdown occurring in Europe, China, Japan and Russia, which are fighting deflation, he said. Central bankers in those countries have turned to printing more fiat currency or money that is not backed by gold or other currencies to fight deflation.

Gold investors view this as a “predictable response” from the central banks and are maintaining their gold and silver positions, Carter said.

“If the Central Banks of Europe, Russia, China, Japan, and the U.S. continue to keep interest rates at zero and also begin to print fiat currencies to spark their respective economies, then gold and silver should appreciate materially,” he said. “If the printing presses start up in every major country, gold will increase by 15% to 20% in 2015.”

The correlation between gold and oil is really more of a function of the U.S. dollar, said Bob Alderman, the head of wealth management for Gold Bullion International in New York, an institutional precious metals provider. The collapse of oil prices is a “very deflationary force” on the economy.

“The price of gold has little impact on oil, but the price of oil has a major impact on gold,” he said. “Central bankers will seemingly avoid deflation at all costs and will likely use monetary policy to ‘reflate’ asset prices – benefiting both oil and gold.”

Several metrics indicate that the market is headed for “major volatility,” said Alderman. Since 1990, every time one ounce of gold bought more than 20 barrels of crude oil, the result was an occurrence of a “crisis.” At the moment, that metric is just below 19, but it is rallying quickly, he said.

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U.S. equities may not be affected since historically the market finished even higher despite geopolitical issues.

“The European sovereign debt crisis in 2011 triggered an 18% correction, but the S&P 500 finished 15% higher on the year,” Alderman said. “The same thing happened in 1998 when the Asian currency crisis led to a significant decline, but the U.S. market finished the year 27% higher.”

The Federal Reserve will also push back its plan to raise interest rates in 2015 because of its concern of how it would impact equities and the economy, Carter said.

“Despite what they say in speeches, the Fed knows that the economy is relying on their extraordinary intervention to continue,” he said.

In the past, gold and oil have often traded in the same direction, said Roy Friedman, executive vice president for Dillon Gage Metals, a Dallas-based precious metals trading company. Investors should not be surprised about the current trend of both crude oil and gold prices moving lower.

After a ten-year bull run, gold prices have declined dramatically declined since 2012 to its current level of $1,190 per ounce from a brief high of $1,900 in 2011.

“Gold has often been thought of as a hedge against inflation and an alternative to a traditional portfolio of stocks and bonds,” he said. “If you believe that is true, the recent selloff in crude oil has certainly had a negative impact on the continued selloff in gold over the last couple of months.”

When inflation does not appear to be a risk because of a lower cost of living and energy prices, the market is less interested in investing in gold, Friedman said.

“Since inflation is running very low, there appears to be no urgency for investors to be putting their assets in precious metals, but that could all change tomorrow,” he said.

Gold remains a good investment for long-term investors and can offset negative investments in a well-diversified portfolio, Friedman said.

Since interest rates are likely to rise in 2015, which will strengthen the U.S. dollar, gold could trade down to $1,000 an ounce, he said. A geopolitical event or conflict could change that rapidly and could push gold prices sharply higher to $1,450.

The Curious Relationship of Oil and Gold 

Oil and gold prices have moved together in large swaths over long periods of time, but in shorter periods they are not always in step, said Mike Chadwick, CEO of Chadwick Financial, in Unionville, Connecticut.

“It seems that since central banks have turned on the printing presses, gold has suffered,” he said. “Some argue central banks are manipulating it. I see no good logical reason for it to be down with what is going on in the world.”

The two commodities should not impact each other in 2015, Chadwick said.

“I think gold will be based on people’s faith in central banks, money printing and quantitative easing-type nonsensical strategies,” he said.

If investors lose faith, gold will go crazy. If they maintain faith gold will likely vacillate in a trading range.

A stronger existing correlation is occurring between equities and gold, said Carter. The equity markets are rising due to cheap money and are bullish for both equities and gold.

“However, when the cheap money ends and fear enters the equity market, gold will stand alone as a great hedge against devalued currencies,” he said.

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