Yellow gold likely to track black gold

A market, said Kenneth Chang, “is the combined behaviour of thousands of people responding to information, misinformation and whim.” Right now, the gold market is dancing to the tunes of whimsical decisions of heavily leveraged funds. Owe it to them that during the week, gold went down in spite of the scare of London bombs, and the continuing fight in the Middle East.

Its fall and dollar’s rise on Friday was attributed to a meagre 0.8% rise in retail sales; yet another proof of how tech funds are becoming awry and unpredictable, often beating common sense.

As a result, gold spot in New York ended the week at $633.30 per ounce, while silver ended the week at $11.87. In India, on the MCX, Gold October finished the week at Rs. 9707 per 10 grams, while Silver September delivery clocked Rs 18,579 per kg.

So where does gold go from here? A cursory look says the trend is up. Apart from geopolitical problems, Middle East, and terrorist attacks being planned here and there, one of the most bullish reasons for gold right now is oil.

Oil price is going up steadily, and not without reason. In 1997, the world consumed almost 74 million barrels of oil per day. By 2002, that had risen to 78 million. More recently, the growth in demand for oil has been rising by about 1.5 to 2 million barrels every year. This year, the demand is projected to hit 86 million barrels of oil a day, or 1,000 barrels per second.

When prices explode, producers typically ramp up the production. This time, however, despite a huge price increase, production is not growing.

In July 2006, crude oil production by OPEC declined 0.8%, down an average 250,000 barrels per day (bpd) to 29.61 million bpd. June production was also revised lower. And this has been the trend for months. Looking back, one finds that OPEC’s production actually peaked in October 2004 at 30.54 million bpd.

Why am I talking so much about oil? Because gold is related to oil. Gold price has historically moved in sync with oil. Throughout the history, the mean ratio in oil and gold price has been about 15-16. That means one ounce of gold is sufficient to buy 15-16 barrels of oil.

During the last couple of years, however, there has been a disconnect, and the price of gold and black gold have taken different routes. While gold has appreciated considerably, oil has become much more expensive. As a result, the ratio between the two today stands at a measly 8.67 (oil at $75 a barrel; gold at $650 an ounce).

This ratio must change sooner or later. And since there is little chance of oil coming down, the only logical option seems to be appreciation in the price of gold. If the ratio of
15 was to be applied to oil price of $75, gold should be valued at $1125.

Goes without saying, gold has lot of upside left to it. One can’t predict how long it will take to happen, but certainly, it won’t be long from now. The market doesn’t like aberrations, and in case they get embedded, it likes to shake them off.

This week, gold is likely to try to cover the lost ground, i.e., reach $650, provided oil continues to provide the lead. Once that happens, we may see a renewed buying by the tech funds, which can easily add a quick $20-25 to the price.

Shailendra Kakani is the research head of Commodity Research Group, Mumbai, and the managing editor of www.commodityresearch.in. He can be reached at
editor@commodityresearch.in or at 98678 33034.