With all the sniping and arguing in the media lately... you might be a bit confused as to whether oil or gold is the best hedge in the current climate. The answer’s quite simple... let me explain...
Both gold and oil are hedges against inflation... but which one is the best?
The divergence between the prices of gold and oil has been the subject of much speculation over the last few months. The FT waded into the argument this morning with two opposing views on the front page of Companies & Markets.
The first came from Ian Harnett at Absolute Strategy Research. He noted that an intriguing feature of the current oil price spike was that it brought the price of WTI to a 40-year high when compared with the price of gold.
"Only briefly - back in the late summer of 2005 - has an ounce of gold purchased fewer barrels of oil. We expect such a situation is unlikely to last for long... so it may be time to be long gold and short black gold," he said.
Then there was the view from Julian Jessop of Capital Economics. He argues that the ratio between the two commodities was not stable over time and he reckons that gold has its limitations as an inflation hedge.
He thought gold’s recent slide was down to the fact that the dollar is set to undergo a slight recovery and the rise in the oil price was down to expectations of emerging market growth. The fledgling economies need more oil than gold. Based on this argument, he reckons that the gold price will not get moving until there is evidence of significant inflation in the US.
So where do I stand?
Well, I lean more toward the view from Julian Jessop. My argument is that the gold price fall was driven by the realisation that the US Fed was running out of rate-cut ammunition. They can’t cut rates much below 2%.
However, I am also sure that inflationary pressures are building in all economies, driven by food-price inflation and rising raw material costs. I think significant inflation is here already, so Jessop’s trigger that will get the gold price moving again is actually with us now. When markets will wake up to this fact I simply do not know... but I believe they will.
I also reckon that supply and demand dynamics in the oil industry will keep the oil price above $100 for the rest of this year... but I cannot ignore the speculative element of recent gains.
The view that gold will not start moving again until US inflation ratchets up is commonly held in the market - this has made investors seeking a hedge favour oil. Recent US inflation data has been tame, but regular readers know that I do not believe inflation figures released by governments... they are all damned lies.
US consumer prices rose a smaller-than-expected 0.2% in April and everyone breathed a sign of relief. I reckon this was a mistake.
Governments manipulate figures. They change the way unemployment is calculated to flatter the figures and they massage inflation data to meet their own ends. I therefore don’t believe the US inflation data - and anyone who buys food or gas in the US (that’s, almost everyone) could see that these figures are essentially a lie.
Fortunately, shadowstats.com calculates CPI the old-fashioned way. It uses the methodology applied before 1990, when Bill Clinton started playing with the way these figures are worked out.
Pre-1990 methods indicate a US annual CPI rate of just below 12%.
This is much more believable. I think the same is the case in the UK too... just think about how much your electricity bills, petrol costs and food bills have gone up. That’s not even considering soaring council tax bills and Gordon’s underhand stealth taxes.
The reality is that we are in a very serious inflationary environment. We are also seeing accelerating oil demand from emerging economies.
Investors seeking a hedge against inflation can choose between gold or oil. Over the last few months, oil has won out and investors seeking a hedge have put money in oil futures as a momentum trade. Harnett’s argument was that this was about to be reversed and you should sell oil and buy gold.
I disagree...
You should buy oil AND buy gold...
Demand will support the oil price and inflation will eventually get the gold price moving.
There may be time in the coming months and years when the market favours gold as a hedge and when it favours oil. By owning both, you can let debates such as the one seen in the FT today play out, safe in the knowledge you are hedged against the ebb and flow of these views.
Long-term, however, the price of oil is heading higher and the price of gold is as well, so the which-is-a-better-hedge debate is irrelevant to those with a long-term view.
These commodity-price rises will be caused by rampaging inflation, by the demise of the dollar as oil is priced in other currencies and by soaring demand from Asia.
You need to own both gold and oil. Then you can ignore these debates about which is the better hedge.
Remember: We are investors not traders... the long term outlook for both commodity classes is extremely bullish.
The only problem you should be facing... is deciding which oil and gold stocks to buy. With the prices for both certain to rise... and give a great hedge... what does it matter which stocks you buy?
Such thinking is nonsense... there are a multitude of wrong moves to be made in these markets. Discover what all the right moves are now...
Regards
Garry White
Editor
Smart Commodities UK
