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The grim news from soaring gold and oil prices

Gold investors are enjoying their moment in the sun as the precious metal has severed its long-standing ties with US interest rates to trade near record highs.

Gold is now trading at more than $US2360 an ounce, an increase of 15 per cent in the past six months and more than 20 per cent in the past year.

Significantly, the gold price has freed itself from its traditional tie to US interest rates. In the past, high interest rates tended to dent demand for gold, which offers no yield.

But the precious metal has gained more than 20 per cent since March 2022 when the US central bank began its fastest rate-rising cycle in 40 years.

What’s more, the gold price has been able to notch up scorching gains even though traditional investment demand has been largely absent.

Instead, the jump in the gold price has been driven by strong demand from central banks – especially China, but also India and Turkey – which have been hoovering up gold at unprecedented levels since 2022.

Effect of Russian sanctions
China’s demand for gold largely reflects its desire to reduce its US dollar exposure.

It is not coincidental that gold’s heady ascent started in 2022, after Russia invaded Ukraine, which prompted Western countries to impose sweeping sanctions against the Russian government, companies and individuals.

But the effect of these sanctions was cushioned because Russia held more than 20 per cent of its reserves in gold. It appears the Chinese central bank paid close attention.

But the deepening malaise in the Chinese property market has also spurred demand for gold from Chinese retail investors, which is helping to support the price.

Meanwhile, oil prices are again climbing ahead of Sunday’s meeting of the Organisation of the Petroleum Exporting Countries and its Russian-led allies.

Most analysts expect the meeting to decide to roll over voluntary production cuts, which had been due to end in June, for at least another three months.

At the same time, oil markets are on alert amid worsening tensions in the oil-rich Middle East. An Israeli airstrike on the southern Gaza city of Rafah that killed dozens of displaced Palestinians has prompted widespread international condemnation.

According to David Ranson, the run-up in gold and oil prices means ‘the inflation outlook in the coming year is for a large increase’.

The geopolitical situation, combined with the expectation that US demand will increase in the northern summer and OPEC’s continued production cuts, pushed the price of Brent crude, the global benchmark, to just over $US84 a barrel.

Meanwhile, West Texas Intermediate (WTI) – the US oil price benchmark – finished at just under $US80 a barrel, a rise of almost 15 per cent from a year ago.

But the strong gains in gold and oil prices are bad news for inflation, according to David Ranson, the head of boutique US economic research consultancy HCWE.

In a client note, Ranson argues that movements in gold and oil prices provide important signals about the direction of future inflation.

He has analysed annual prices of benchmark WTI crude oil and gold going back to 1986, and compared them to the median price over that time period. He then looked at what happened to the producer price index in the following one, two and three years. (Producer prices are an important leading indicator of price changes through the economy.)

What he found was that when oil and gold prices rose relative to their medians, the PPI climbed in subsequent years. But in the years when oil and gold fell compared to their median, the PPI was muted.

Significantly, since 1949, in the 27 years in which gold and oil both posted year-over-year increases, the PPI for goods jumped by 7.3 per cent on average.

According to Ranson, the run-up in gold and oil prices means “the inflation outlook in the coming year is for a large increase”.

Source: Karen Maley AFR