Gold’s fortunes bound to oil

[] — WHAT you lose on the swings, you gain on the roundabouts. South Africa this week saw the gold price fall to below $600/oz but also saw the oil price decline to levels that were about $13/barrel below the record highs set earlier this year. So, for South Africa, is it a question of the more things change, the more they stay the same?

One of the reasons mentioned for the movements in oil and gold prices earlier this week was a change in perceptions of geopolitical risk. Talk is that managing Iran’s nuclear ambitions might not be as big a problem as originally thought. Moreover, it looks as if Israel’s ceasefire with Hezbollah fighters in Lebanon is holding.

Geopolitical instability in the Middle East is a source of upward pressure on oil prices because the region’s oil producing capacity might be threatened. It causes gold prices to rise because any global instability is a reason to flee to the safe haven of bullion.

The world had barely decided that the geopolitical risk premium built into the price of oil needed to be reduced when there was an attack on the US embassy in Syria on Tuesday. This caused the oil price to tick up, while gold regained about $7/oz, remaining below $600/oz at the time of writing.

Bad news for rand

What the price movements this week showed is that oil and gold are bound together like Siamese twins – where the one goes, the other will follow. Of course, an important reason why gold rises in tandem with oil is the fact that higher oil prices spell higher inflation – traditionally a situation that screams “buy gold”.

Now that it looks as if oil is no longer a one-way bet, the gold price is vulnerable. It’s increasingly unlikely that a hurricane will hit an important oil installation. Opec has committed itself to continue pumping oil at present volumes, and it seems the difficulties with BP’s oil pipeline in Alaska were overstated. All reasons for the oil price to come off the boil and for gold to follow suit.

The question is whether the bull run in commodities prices of the past three years is over. If it is, that bodes ill for commodities-based currencies such as the rand.

Gold and platinum together make up about 20% of South Africa’s exports. If the prices of these metals decline, it will be bad for our balance of payments – and hence for the rand. Lower commodities prices are also usually associated with a stronger dollar – another negative factor for the rand. These were the reasons why the rand weakened to R7.44/$ on September 11.

The currency strengthened 10c on September 12, as the attack on the US embassy in Syria caused the prices of oil and gold to tick up again.

Chinese factor

The International Monetary Fund looks at non-fuel commodities prices in its latest World Economic Outlook, asking the question whether the high prices can be sustained. The high prices mainly reflect metals, as food prices haven’t kept pace with the uptrend in other commodities prices.

The IMF makes the point that metals prices are very dependent on global economic growth. But the rise in metals prices in the recent bull run has outperformed past trends, partly reflecting low investment in the metals sector in the late 1990s and early 2000s that followed a period of earlier price declines. Another factor is the emergence of China as a major source of demand for commodities.

Is the strength of Chinese demand for metals temporary or permanent? The IMF notes that historical patterns suggest that consumption of metals typically grows together with income until about $15,000-$20,000 per capita in purchasing power parity (PPP) adjusted dollars.

At higher incomes, growth typically becomes more services driven and therefore the use of metals per capita starts to stagnate. But China’s current PPP per capita income is $6,400, so it still has a way to go.

No commodities crash

However, the IMF says some of the current demand strength could be temporary, particularly as the Chinese government wants to rebalance growth away from investment to consumption.

Although there will be demand for commodities from other emerging markets, this is likely to have a less pronounced impact than China. China is something of a special case, because of its size and heavy concentration in industry.

Free news alerts: click here to subscribe

The IMF concludes: “Over the medium term, … metals prices are expected to retreat from recent highs as new capacity comes on stream, although probably not falling back to earlier levels.”

So, it seems no crash is in store for metals prices. But commodities prices aren’t likely to scale peaks reached earlier this year and may come under pressure. That, in turn, could mean pressure on the rand. It means that the benefits of a lower oil price will be – at least partly – eroded by a weaker rand.

Greta Steyn is a writer for