Linking gold and oil prices

A crisis in the Middle East, an American president who did not inspire confidence overseas, rising economic powers in Asia and instability in global monetary policies.

In the early 1970s, these destabilizing factors combined to helped to push gold prices steadily upwards towards the peak price of more than $800 per ounce that was reached by the end of the decade.

Today, in a world that seems in many ways to mirror that of three decades earlier, gold prices are hovering in the $400 per ounce range. By some standards that price is quite high; by others, though, the precious metal is a relative bargain - especially compared to oil prices, which are a traditional indicator of the value of gold.

Historically, the ratio of the price of oil to the price of gold has been relatively fixed: the number of ounces of gold required to buy a barrel of oil has averaged .06 ounces. As oil prices soar past the $50 mark, however, gold prices have not kept pace.

For gold to reach the historical standard - with oil prices at a more modest price of, say, $42 per barrel - the precious metal would have to trade at $700 per ounce. Put another way, by historical gold-price standards, oil should be selling at just $24 per barrel.

By most measures, then, buying gold is currently a smart investment. Which would make Kuwaitis the savviest investors in the Middle East. In terms of value, the emirate saw the greatest surge in gold consumption in the second half of this year, recording growth of 28 percent. Saudi Arabia, the largest market in the Gulf, saw growth of 23 percent, followed by the UAE at 21 percent, Bahrain at 20 percent, Oman at 18 percent and Qatar at five percent.

Overall, second-quarter demand in the region was up by eight percent. Not everyone who buys gold, of course, is concerned with historical standards - or, for that matter, with any standard beyond their latest bank account balance. And the seemingly inexorable rise in oil prices means that, across the Gulf region, those balances are currently looking very, very healthy.

Hedging bets

So will the regional buying trend continue at least for the rest of the year? That seems likely, although the end of the summer tourist season will result in an inevitable short- term decline.

Worldwide, Goldman Sachs argued recently that buying by hedge funds and an expected continued decline in the dollar against the euro means that gold prices will continue to inch up for the rest of 2004. (Investors historically purchase gold as a hedge against declines in US assets when the dollar is falling.)

Its worth recalling that, barely 18 months ago, the outlook for the gold market was extremely bleak, with merchants at Dubais gold souk lamenting a 50 percent drop in sales. Many shops, despite running any promotion they could think of, were reportedly on the brink of going bust.

Our business has shrunk substantially, Joy Alukkas, managing director of Dubai-based Alukka Jewelry, told Arabies TRENDS in March 2003. There is no hiding the fact that the gold jewelry business this time around is very poor. At the time, there was hardly a consensus about the direction gold prices would take.

Some industry analysts argued that prices would inevitably decline, as speculative investment dried up and what they saw as a price bubble finally burst. A rapid sell-off would result in a drop as large as the increase we have seen, said the chairman of one gold trading group in Dubai at the time.

Paradigm shifts

Others analysts strongly disagreed. Leonard Kaplan, a gold analyst with Prospector Asset Management, told Arabies TRENDS more than a year and a half ago that a drop in gold prices was out of the question.

As the US dollar continues to falter, as the equities markets continue their slide, as the paradigm shift from paper assets to hard assets builds a bit of momentum, as the budget deficits of the United States swell - it becomes apparent that gold must rise in response.

At the time, there were fears among some regional bankers of gold hoarding - driven by instability surrounding the war that had just been launched in Iraq - leading to a cash-flow crisis, a proposition that seems laughable today. But in March 2003, despite the fighting in Iraq, oil prices remained well below $30 per barrel, and there was no way to predict the surge that would take prices above the $50 mark.

So what to make of all this? Is the current gold-buying boom in the Gulf a sign of increased or decreased confidence in the future? Are regional shoppers hoarding hard assets based on a fear of future instability, or does the trend simply indicate that so many people have so much money to burn?

The latter is far more likely, of course. But the real test wont come for Gulf consumers until the gold:oil price ratio finally settles to its historical levels. After all, the last time the world looked like it does today, gold prices were on their way to $800 an ounce.