Gold markets have managed to partly pare back losses and reverse a deep selloff over the past couple of days after Friday’s surprise attack by Hamas on Israel, overcoming negative sentiment triggered by the Fed’s hawkish outlook of higher-for-longer interest rates as well as a brawny dollar.
Gold prices have gained 2.3% since Friday to trade at $1,860.30 per ounce in Tuesday’s intraday session, reversing a nearly 7% decline since late September with the yellow metal trading above $1,930 per ounce on September 20.
Gold not only plays an important role in portfolio diversification but can also be an effective hedge against uncertainties. Gold traded near all-time highs for most of last year, with the commodity in high demand as a geopolitical hedge due to Russia’s war in Ukraine and also demand for an inflation hedge. But rising interest rates and a strengthening dollar have both effectively killed the gold rally in the current year.
Thankfully, Saxo Bank head of commodity strategist Ole Hansen has predicted that Middle East tensions may mean the Fed will not"...continue to hike rates into increased uncertainty, and the prospect for peak rates have suddenly moved closer despite the potential inflationary impact of higher oil prices," which could signal a low in gold prices,
Macro headwinds persist
That said, a full steam ahead gold rally is far from assured thanks to a plethora of headwinds. Gold prices have eased a bit in Tuesday’s session even as Israel launched a furious retaliatory attack on Hamas and gold still in oversold territory, indicating that the bears are not about to keel over.
Commodity analysts have reported that tactical investors have significantly cut their exposure to gold, scaled back platinum positioning, but increased silver and palladium exposure. According to the analysts, macro headwinds persist for gold, having built following the hawkish September Fed meeting. They note that gold prices initially held up well, supported by the physical market holding up the price floor. But the decline in equity markets, elevated nominal and real yields, as well as expectations for rates to remain higher for longer all weighed on gold, resulting in a breach of key support levels. Gold is now trading at lows it reached in March 2023,
the last time 2Y yields were trading at similar levels, suggesting gold prices might not have much downside potential either.
StanChart’s FX strategists expect the USD to hold onto its recent strength for a little longer. They note that US economic activity has been stronger than expected and the USD has largely tracked rate differentials, saying the dollar might not weaken materially until mid-2024.
On the bullish side of things, StanChart has observed that whereas other asset markets suggest risk-off sentiment, particularly given the move higher in the U.S. dollar, gold has not benefited from the same sentiment. They have argued that gold markets are not pricing in a significant premium on the risk of a U.S. government shutdown especially after the ouster of Kevin McCarthy's from the House speakership increased the risk that the U.S. government will shut down in a matter of months. Related: Crude Prices Begin Retreat After Monday’s Surge
Meanwhile, concerns remain over the pace of China’s economic recovery, recession risks linger, as well as concerns that inflation could pick up again. StanChart says that these macro factors would normally be supportive of gold price action; however, elevated interest rates and a strong USD have dominated, weighing on recent price action. Indeed, gold prices could be expected to have traded much lower than current levels, but the strength of the physical market, particularly from the official sector, has limited the downside price risk.
Expensive Gold, Cheap Oil? The Gold-Oil Nexus
Oil and gold are two of the world's most-watched commodities, and it’s hardly surprising that where one goes the other frequently follows.
Morgan Stanley has said that although the oil-gold ratio has historically been a poor indicator of future oil prices, it can still be of interest to investors seeking guidance on the direction of oil prices.
So, how’s that trending?
We can go back and see the number of barrels of oil a single ounce of gold could buy at any point in time i.e. barrels per ounce.
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The average Gold-Oil ratio since 1946 has been that one ounce of gold would buy 16.53 barrels of oil. Any time an ounce of gold would buy more than 16.53 barrels of oil meant that either oil was cheap or gold was expensive. Conversely, oil has been regarded as being expensive or gold cheap whenever an ounce of gold would buy less than 16.53 barrels. Knowing this can help investors determine whether they should be buying more oil and selling their gold, or vice-versa.
Looking at more recent timeframes, in 1998, oil was cheap while gold was relatively expensive. In 1999 -2000, oil climbed 66% while gold was basically flat. In the early 2000’s gold was once again relatively very cheap and it went from $271 in 2001 to $1,669 in 2012 when oil was cheap again. Remember, these are just average annual prices, meaning an investor wouldn’t need to get their timing exactly right to hit them.
In 2019, oil averaged $50.01 a barrel and gold averaged $1,514.75, meaning an ounce of gold would buy just over 30 barrels of oil. In 2020, the ratio spiked to an astronomical 54.87 barrels per ounce of gold, or more than 3x the long-term average. The current ratio stands at 21.27, suggesting that either gold is slightly expensive or oil is slightly below its fair value or both.
By Alex Kimani for Oilprice.com
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