Oil boom fuels gold speculation (page 1 of 2)

We have passed the northern winter spell, and have yet to move into the US' driving or hurricane seasons. At this time of year, oil prices usually tend to dip in line with reduced demand, but this is clearly not happening.

If you factor in geopolitical concerns, such as instability in Nigeria and uncertainty over America's intentions towards Iran, oil prices still have the capacity to rise further in coming months. China's and India's meteoric growth will mean that demand for oil will remain strong even if prices rise higher.

On a similar trajectory, gold prices have also been rising, and have increased by 20 percent so far this year. Gold prices touched $645 per ounce this week, their highest levels since November 1980. Gold tends to be seen as a 'safe haven' for investors when they fear other monetary assets will lose value, often because of inflationary pressure or threat of war.

Therefore gold prices tend to rise when the global economy is unstable and inflation is high. Presently though, and despite high oil prices, the consensus is that global inflation is under control. This view is backed up by the fact that interest rates are also low globally. It seems that central bankers do not fear imminent inflation.

So what exactly is driving up the price of gold? It may be because other metals are rising, but unlike copper and aluminum, for instance, gold is not integral to industrial growth. The bull market for gold could also in part be a consequence of the weakening US dollar and America's unenviable and widening trade deficit. The question many economists are now pondering is to what extent, if at all gold is overvalued.

The US dollar has fallen by about 3 percent so far this year against a basket of six other major currencies, and it is becoming apparent that investment funds are looking to hedge themselves against a weakening US dollar. They are doing this partly by investing more capital in commodities at the expense of US Treasury bonds.

A lot of demand for commodities is a result of the fact that currencies in general are 'losing value.' It is not just the dollar, but also the euro, and the yen that are being debased. The price of gold rose against all major currencies last year. Analysts concur that gold prices will continue to move upwards unless there is a major change in the geopolitical situation or oil prices fall sharply.

Demand is the Key Driver

China's and India's stellar economic growth, combined with the tepid recovery of Japan and four years of continuous global growth have all helped fuel demand for commodities. In short, prices are rising because more people are consuming more goods. Global demand therefore may have outpaced supply, which itself has been hindered by a lack of investment and output disruptions.

China, which has over 1.3 billion citizens, saw its economy grow by over 10 percent in the first quarter of 2006. China is now the world's largest consumer of steel, copper, and zinc. According to research by investment bank Morgan Stanley, China accounts for between 25 and 35 percent of global aluminum, copper, iron, and steel demand.

The price of oil has the potential to rise even further this year, and as it is a key ingredient for economic growth, this will cause commodities prices to rise across the board. No major oilfield has been discovered for decades, and increasing output, even in Saudi Arabia, is a costly and gradual process.

On the subject of metals, there is only a finite supply, and few major new mines have opened in recent years.