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Why are gold and crude oil prices going up?
09/04/08, Peter McGuire, Commodity Warrants Australia
What are your views for the price of gold and crude oil over the short to medium term, what drives these markets, and how can I get exposure to the physical market rather than just buying shares in mining stocks?
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Today's expert: Peter McGuire, Commodity Warrants Australia
| To examine the factors currently moving commodity markets, especially gold and crude oil, investors must realise that the state of global financial markets are playing a significant role. Since the global credit crisis began filtering through financial markets in late 2007, there has been a deluge of market analysis and media coverage discussing whether the United States is entering a recessionary stage, and what the flow-on effect will be for economies around the world.
This has been even more pronounced following the consecutive interest rate cuts enacted by the US Federal Reserve Bank in an attempt to inject some much needed liquidity into the market and ease fears that have broadly eroded investor confidence.
Over the last several months, the US dollar has been steadily declining against a basket of global currencies and according to the available data; inflation is gaining as a result of the rising price of staple agricultural commodities amongst other key contributors. Further exacerbating the decline in the greenback is the Fed’s bailout of Bear Sterns last week leading to even greater fears of imminent stagflation, and a perception that printing money is diluting the remnants of fundamental value left in US paper.
One of the key indicators of inflation is the price of crude oil which has been tracking upward over the last few months recently breaking through $100 USD per barrel. Conversely, to offset inflation and volatile foreign exchange markets, investors are buying gold as a safe-haven or risk-mitigation tool, as it is perceived by the market as a stable store of value.
It is difficult to account for all factors impacting global gold and crude oil markets, but to gain a birds-eye-view an investor can look at the key macro price drivers. In terms of crude oil markets, although the supply and demand fundamentals point towards a price increase, and generally the slowing of global economic growth (as we are currently seeing) negatively impacts prices, the CWA outlook is that we see some volatility but no pronounced up or downside.
With this said there are several factors that may lead to short to medium term price movement. First, seasonally speaking, prices tend to decline at this time as the northern hemisphere winter passes. Further, the likelihood that OPEC members, in particular Saudi Arabia, will unofficially pump more oil in order to ward off the risk of an oil price shock exacerbating the US into recession, could negatively impact prices.
Contributing to the possible upside in crude prices is unprecedented demand from the world’s most rapidly growing economies (such as India, China, and South East Asian nations). This is placing upward pressure on prices.. Another key driver is the geopolitical elements impacting the supply of crude from key producing regions such as Iran, Nigeria and Northern Iraq (namely in the Middle Eastern region).
With respect to gold, prices have been supported by a range of positive price drivers including concerns over the state of the US economy, possible further Fed rate cuts, the dollar dropping to record lows against many major currencies, and general inflationary fears. We have seen gold race through the $1000 USD mark, although coming back recently.
If gold has more upside to run, I would say that the rate at which it has reached these highs is not currently sustainable, and if we see the US dollar bounce back then we may see a downturn in gold prices. There are other factors that could push the price down in the short-to medium term. For example, Central Bank gold sales can pressure prices lower although in recent months the amount of central bank selling has lessened. This may change with the possibility the IMF will sell gold to finance its activities.
For investors looking to expose themselves to physical commodities markets there are a number of avenues available. Historically, the most viable option available for the retail investor wanting to benefit from the boom in the resources sector was to buy shares in companies involved in the exploration or production of commodities e.g. BHP, Rio Tinto, Zinifex and the like.
However, while these companies’ performances are certainly influenced by commodity prices, it isn't pure or direct exposure as management issues and capital markets volatility affect the company’s performance and share price.
Traditionally, commodity market trading was left to more sophisticated investors such as futures traders and hedge fund managers. However, these mechanisms can be quite complex and perhaps not suited to your average retail investor. Today there are a number of financial instruments and structured products that have been stripped of some of the inherent complexities and designed with the retail investor in mind – warrants and CFDs are good examples.
While it would give me great pleasure to run through the pros and cons of each trading instrument, this probably isn’t the appropriate platform for me to do so. What I would advise however to anyone interested in gaining direct exposure to the commodity markets is to do some research to find out which method is best suited for them. Two key factors to keep in mind are complexity (matching your level of expertise with the trading instrument) and your tolerance for risk, as the various mechanisms will expose you to varying levels of possible loss.
So in conclusion, for both gold and crude oil prices it would be prudent to watch the market to see whether the fundamentals align to push the prices in a certain direction. With a backdrop of economic uncertainty, we will see some volatility as investors look to hedge inflation and volatility in foreign exchange and equity markets. For investors looking to take advantage of price movements through direct market exposure, investigate appropriate structured financial vehicles that are geared towards your level of financial acumen.
Peter McGuire, Managing Director, Commodity Warrants Australia
Disclaimer:
The information in this article is general in nature and does not take into account any investor's particular objectives, financial situation or needs. In considering its appropriateness, investors should read the relevant product disclosure statement and consult a financial adviser before making an investment decision.
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