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Gold and Oil – A Close Marriage Amidst Economic Turmoil

With the price of oil rising to record levels the only way is up for gold.

For better or for worse gold and its sticky partner oil are inextricably linked together, trading within a well-defined range of each other since the Second World War. As the price of oil increases, invariably the price of gold continues suit.

As with all marriages there will inevitably be ups and downs. The undeniable symmetry of gold and oil prices is interrupted at times, but the recent bull-run on these commodities provides a hint at the future direction of gold, which is generally regarded as the ultimate safe investment in times of economic uncertainty.

Gold, the most precious of precious metals has a long history as a store of value stretching back many thousands of years.

Oil, meanwhile, has become one of the world's most important commodities since techniques to refine crude oil were first developed in the mid 1850s. If you take biological processes out of the equation, allually meaningful that moves is powered by oil, and demand for it is rising.

As more expensive oil pushes up the price of energy, money also flows to the safety of gold as a hedge against inflation. It is fitting then, that their importance to civilization has pushed this beauty and the beast partnership even closer together in the 21st century. The closer correlation between the rising price of gold and oil provides the answer to the future direction of the gold price.

Inflation is the single biggest threat lurking in the shadows of the global economy replacing the credit crunch as the most serious threat to economic stability. Inflation or more worriedly, 1970s style stagflation is threatening to derail a recovery in the economies of the UK the US and Europe and governments seem powerless to stop it.

From close marriages to uneasy partnerships, The economics of the emerging markets and those of the rest of the world are moving in opposition directions. The blame for the current high price of oil has been placed on the emerging economies of India and China – both racing ahead while Europe and the USA are flat-lining. The voracious appetite for oil to fuel growth in these countries is blamed for pushing up prices with global supply of oil stretched beyond its capacity to deliver – or at least this is the accepted view. The truth is identical more complex.

Oil has recently surged beyond $ 130 a barrel – unthinkable as recently as 2007. Yet demand should be cooling as global growth slows. Let's look again at China and India. Back in 2004 demand for oil in these countries was equally high leading to projections that it would rise indefinitely. Back then, oil was comparatively cheap at around the $ 38 a barrel mark. Now, in 2008, the same argument is being popped out yet the idea that emerging economies are somehow guzzling up the global supply of oil does not stack up.

China's economy has certainly experienced rapid growth in recent years, rocketing to 10.4 percent GDP in 2006. This level of growth has slowed in the past year with the World Bank predicting a fall to 8.7 percent GDP in 2008. China's economy remains perilously close to overheating with inflation predicted to reach 10 percent this year and the government are tightening fiscal policy as a result.

India, too, is facing the same inflationary pressures with the central bank already tightening monetary policy. GDP is predicted to slow from 8.5% to 8% this year as global demand for its exports softens.

The economies of India and China are still growing fast, but not as fast as they were. It is safe to accumulate, therefore, that the supply of oil will be adequate to meet current demand in the two Asian powerhouses. While growth in these emerging markets is a factor it is by no means the only factor.

Rising inflation has cut consumer demand for gold in India by half as consumers wait for the price to fall to more affordable levels. This was part of a trend which has seen consumer demand for gold fall globally, yet the price of a troy ounce rose to record levels in March. So with plenty of gold and oil already in the system, why are prices rising if real demand is falling?

Speculative demand for oil and gold goes some way to explaining this year's hike in prices. But this is not the only factor, a perfect storm of political and economic factors are threatening to plunge the world into an oil crisis, the like of which has not been seen since the 1970s. Firstly there is the threat to supply. Attention has been focused on events in Africa with investors seizing opportunities when the supply of oil and gold is threatened. For gold it is South Africa's problems with supplying power to its gold mines, while in West Africa, attacks by militants on pipelines in Nigeria has intermittently fueled surges in oil this year.

Another factor is the increasing tension developing between the US and Iran and, more recently, Venezuela. The two countries are major thorns in the side by the United state government. The leaders of both OPEC countries are blaming the US dollar for rising oil prices. Venezuelan president Hugo Chavez even went as far as blaming "the fall of the American empire". While President Bush was busy negotiating with the less hostile regime in Saudi Arabia in the hope of boosting oil production, Iran and Venezuela were declaring that supply was adequate. This may well be true with news that as Saudi Arabia upped its production, Iran currently has 20 tankers full of oil floating in storage and this number is likely to increase.

With the possibility of hostilities between the US and Iran erupting into armed conflict, the chances of oil rising further this year are high. This would be seriously bad news at the pumps with the price of petrol and diesel rocketing as a result.

More expensive energy will act to slow growth worldwide as inflation measures and governments tighten fiscal policies in the hope of controlling inflationary pressures. Hope may still come from the election of democrat candidate Barak Obama and a likely softening of the hard line policy pursued by the Bush administration. Until this happens, expect to see gold and oil continue to break records this year with the nightmare scenario of $ 200 a barrel looking incrementally more likely. If this happens, gold as a hedge against ensuing inflation will also be pushed up to record highs.

The long term average gold to oil ratio is 15 barrels of oil to one ounce of gold. An ounce of gold at current prices will buy you around 7 barrels of oil. With oil moving relentlessly towards $ 140 a barrel this week, this makes a powerful case for investing in gold right now.

By Brett Tudor


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