Gold, oil could hold clues to future stock slides

Both The Commodities Are Linked By A Ratio That Has Moved In A Narrow Range Historically

INVESTORS rattled by a burst of volatility in global stock markets this month could find clues about future stock slides by looking elsewhere: at gold and oil. The two key commodities, one traditionally a safe haven for investors at times of stress and the other an engine of global industrial growth, are linked by a ratio that has moved in a narrow range historically. In other words, the number of barrels of oil you need to sell to buy an ounce of gold remains roughly constant for long stretches of time. Gold tends to move in line with oil because high oil leads to inflation, which drives people to buy gold as a hedge, goes the argument. Analysts are wary of linking gold, oil and shares, because shares have risen in the recent past despite a rise in oil prices that should be bad for companies and hurt growth. But if one views gold as a proxy for product prices, and oil as an indicator of input costs, the gold-to-oil ratio takes on a different significance, analysts say. The link could be predictive, if the past four years are any indication: a dip in gold-to-oil has coincided with a fall in share prices, says a strategist. “In periods of risk aversion, the gold-to-oil ratio tends to go down, in line with share prices,” said Lehman Brothers strategist Fred Goodwin. “In equity corrections since 2003, gold tended to go lower with equities. When markets rallied, gold went up faster than oil; when they fell, gold went down faster.” In the period from February 27 to March 5, when global stock markets fell 6.5% — the worst of a stock slide prompted by fears of a crackdown in speculation in China — gold fell 7.5%, or $52 an ounce. Oil moved down 2.2% in that week. On February 27, the gold-to-oil ratio slid to 11.05 from 11.19, and it slipped below the 11-mark in following days, recovering to that level only on March 12, the day a stuttering share recovery peaked. The bigger trend here is that gold has started moving in line with shares, diluting its traditional image as a hedge. The traditional investor view is that gold correlates inversely with what markets are fretting about. If concerns over subprime mortgages worry equity investors, for example, then gold should rise as shares fall. Gold, seen as a refuge for equities investors at times of stress, has been moving in the same direction as shares for the past few years. This has led some analysts to conclude that a rise in the price of gold reflects pricing power, or the ability of companies to pass on raw material price increases. This, the argument goes, should lift the price of companies’ shares. “Our view of gold is counterintuitive, because it’s really less of a financial hedge and more of a reflection on pricing power,” said Goodwin. That could explain why, since the beginning of 2003, gold and shares have moved in remarkable consonance. Both gold and the Morgan Stanley index of world stock markets have risen 92%. The rise in gold could be a result of wealth generated from stocks, or in key markets like the Middle East, oil. “Gold is not just a diversifying asset — people buy it when feeling richer,” said Graham Birch, head of natural resources at investors BlackRock in London. “In the Middle East, if something makes people richer, as high oil prices tend to do, they spend more on gold.” Excluding the past two days’ spike due to tensions in Iran, oil has risen more than 90% since January 2003, in line with shares and gold. Analysts say it is too early to write off gold’s reputation as a hedge, and note that shares, which have enjoyed a multi-year bull run, are also moving for other reasons. “Gold has moved due to an indexation with base metals, and oil follows gold. Shares are rising because of good economic growth and strong earnings,” said Franz Wenzel, strategist at AXA Investment Managers.

Courtesy: EconomicTimes
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