Gold may hit $1,000/ounce if oil stays above $140

3 Jul, 2008, 1831 hrs IST,Mandar Nimkar, E.T
MUMBAI: Usually, gold and crude oil prices move in tandem with inflation and almost proportionately. However, the sudden and unprecedented spurt in crude oil price over the last six months has left gold flagging.

Besides acting as a hedge against inflationary pressures, gold adds diversity to a financial portfolio and acts like an insurance policy against the economic forces that may affect stocks and bonds.

The factors that determine gold price are different from, and, quite often, in direct opposition to those which influence the other markets.

“The global markets are making new lows and crude making new daily highs makes gold an attract investment. If oil remains firm at these levels then gold may spurt suddenly to new highs in couple of days,” said Surendra Khanna, a gold analyst with a foreign bank.
Over the past 25 years, an ounce of gold bought, on average, 15 barrels of oil. Thus, when an ounce of gold could buy 20 barrels of oil, gold was said to be expensive and due for a fall. But when it can buy less than eight barrels of oil, it’s cheap and due for a rise.

In the current scenario where gold is at $945 per ounce and oil at $144 per barrel, an ounce of gold buys you just 6.55 barrels -- less than half its traditional purchasing power.

The US dollar’s recent weakness against major currencies also warrants a rise in gold prices, as both are negatively co-related. And in spite of cries of the oil price rise being “all supply/demand”, the negative correlation between oil and dollar has never been steeper in 15 years than in recent months.

Today the dollar was trading at 1.5821 against the euro. And with European Central Bank raising its benchmark interest rate by quarter basis points from the current 4 per cent, the greenback would weaken further against the euro and, in turn, push oil higher.

This oil and gold ratio has been stretched to the highest extent (as seen in graph below) and either needs a bounce in gold prices or correction in oil.
The oil/gold ratio hasn't been this high since the summer of 2005. If oil remains steady above $140, one may see a sudden rally in gold prices which may take it to the March high of $1,000 per ounce or even beyond.

Today, oil touched a record above $146 a barrel after a drop in US crude inventories raised supply concerns.