In commodity trading, the two most popular and actively traded commodities in the world are gold and oil. Both have their unique set of economics and their unique features. But the most important thing to know is that they are both related through the US dollar movements. Here is what you need to know about the correlation between gold, oil and the US dollar.
What determines the price of gold in the international markets?
Gold prices are directly correlated with the general levels of inflation. Normally, higher the inflation, higher the price of gold and vice versa. In other words, if the inflation rate shows an increase of 1% gold prices also tend to appreciate by a similar amount.
Actions of the central banks (like Fed, ECB, BOE, BOJ, RBI) of different countries and even the International monetary fund influence the price of gold. It depends on gold demand from central banks and IMF and also how much they are willing to debase their currency by issuing fresh notes.
Demand and supply of gold is also a factor determining the gold prices. However, it is not the jewellery demand but the demand coming from central banks and ETFs (investment demand) that actually drives the price of gold.
Finally, global economic and political uncertainty also has an impact on the price of gold. During the global crisis like in 2008 or in the early 1970s, people lost trust in other asset classes and gravitated towards gold. This led to a sharp rally in the price of gold as we saw after Lehman collapse.
Let us now turn to what drives the price of oil in the global markets?
Prices of crude oil are largely determined by the forces of demand and supply. While countries like India, China, the US and the EU control most of the demand, it is countries like US, Saudi Arabia, OPEC and Russia that control most of the supply.
Interestingly, all the major oil price increases since the mid-1970s can be traced to increased global aggregate demand. That is why a sharp rise in global growth rates or rising consumption spending leads to sharp rise in oil prices. In fact, the increase since 2003 is primarily driven by strong global demand for industrial commodities.
One must not forget that in a global market that is increasingly driven by speculators, traders and investors, the trading in futures of oil contracts and options accumulation also has an impact on the price of oil. It may not be fundamental driver but it drives prices nevertheless.
Finally, let us look at the relationship between oil, gold and dollar
Let us look at an interesting relationship here as both oil and gold are currently denominated in the global markets in dollar terms only. Here are the key takeaways…
If the dollar weakens then gold will remain the same price for the rest of the world but for the US markets people end up paying more for the same amount of gold.
If dollar falls then oil prices will rise for the US but it will fall for other countries. This is because crude oil is primarily traded in US dollar, be it WTI crude or Brent Crude.
There is an interesting relationship between oil and gold. Since oil is used in the process of excavating and refining gold, a rise in oil prices sends up the cost of mining gold and therefore the gold prices also move up.
Let us also see how oil and gold tend to get linked up to each other via the route of inflation. For all the financial assets; and gold is no exception, rising oil price is of particular concern. A positive correlation can emerge between the dollar movement and the gold price. An increase in oil price results in inflation, which affects the countries importing oil. It affects the cost of the finished products and prices in general and the economy. Pricey oil has an impact not only on gold but all other asset classes due to its exorbitant impact on inflation.