Breaking Down the Disparity Between Oil and Gold Prices

by Investment U Research Team
Thursday, December 3, 2009

It’s no secret that the gold and oil markets have boomed this year.

However, while gold continues to climb, hitting a high of $1,218.40 per ounce this week, oil keeps hitting a brick wall. Over the past month, crude has traded in a range between $75 and $82 per barrel and currently sits at $77.50.

What gives?

Put simply, oil and gold prices don’t necessarily move in harmony.

The key difference is that while oil is a fuel that is used for many different products, gold is a proxy for currency. But there are two other big ones…

• Investors are looking to distance themselves from an increasingly limp dollar – and gold serves that function much better than oil.

• Oil prices are much more sensitive to the effects of supply and demand than gold.

And that explains why the yellow metal is outpacing oil by 90% over the past three months.

To a fundamental trader, oil is merely a feedstock for refineries. It churns out heating oil, jet fuel, diesel and gasoline. And right now, traders know that supply and demand don’t support $80 per barrel oil.

On Wednesday morning, for example, the U.S. Department of Energy announced that crude inventories jumped by 1.4 million barrels last week. Plus, storage is filled to the max. And despite the winter heating season, it hasn’t dented inventories yet.

On the flip side, fundamentals don’t bog down gold prices as much. The fact that gold is used as a hedge against a weak dollar (and other unfavorable geopolitical events) makes supply/demand dynamics less significant.

Plus, whenever news like Dubai’s recent debt default hits, people get anxious. And when that happens, they flock to gold, not oil.

So given the current catalysts within each market, don’t be surprised if gold continues to outshine oil. But take notice… the pendulum will always swing back.

Sheena Martin

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