Gold-Oil Relationship Flips as Deflation Risk Increases

Gold’s relationship to oil has been turned on its head.

Investors who saw little value in the metal last month, as plunging energy costs curbed inflation, have started buying in January even as crude continues to tumble. Bullion is off to its best start to a year since 1980 while West Texas Intermediate is trading near the lowest since April 2009. The correlation between the two commodities that reached a 16-month high in December is now the weakest in five months.

The about-face reflects an investor shift in focus away from the benefits of cheap fuel to the risk of economy-damaging deflation. Oil costs are so low that gold buyers are seeking a hedge against prolonged declines in consumer prices. They’re also bracing for currency volatility from more stimulus measures as policy makers in Europe and Asia look for new ways to revive growth. While the U.S. is expanding, the World Bank says that won’t be enough to buoy economies elsewhere.

“It’s clear that potential dislocation of what the falling oil prices may do to the market is bringing people to gold,” Quincy Krosby, a market strategist based in Newark, New Jersey, at Prudential Financial Inc., which oversees more than $1 trillion in assets, said by phone Jan. 14. “Worries about political instability because of falling oil prices and attempts to induce inflation are helping gold. Some of my investors are moving to gold.”

January Rally

Gold futures climbed 9.9 percent in January to $1,301.40 an ounce as of 12:29 p.m. on the Comex in New York, heading for the biggest monthly gain in three years. The increased appeal of haven assets has boosted silver futures in New York by 18 percent this month, the best start since at least 1974. At the same time, WTI crude fell 12 percent, while the Bloomberg Commodity Index of 22 raw materials slid 2.4 percent.

Gold may rise to $1,420 by the end of 2016 amid increasing physical demand, Australia & New Zealand Banking Group Ltd. said Dec. 17. Standard Chartered Plc expects the metal will rally to $1,320 by the fourth quarter as strength for the dollar fades, according to a Jan. 20 report.

Global assets in exchange-traded products backed by the metal are heading for the first monthly gain since July. Open interest in New York futures and options is at the highest in eight weeks, and money managers have increased their net-bullish position to the largest since August.

Crude Slump

While crude’s 55 percent plunge since June 30 will help boost the global expansion, the rout also added a “new risk dimension” to the world, with deteriorating trade balances among exporting countries, the International Monetary Fund said Monday. The World Bank on Jan. 13 cut its 2015 global growth forecast as well as its outlooks for China, Europe and Japan.

Cheaper energy is creating more room for central banks to increase stimulus measures, boosting the appeal of gold as an alternative to currencies that are being revalued.

European Central Bank President Mario Draghi announced plans today in Frankfurt for 1.1 trillion euros ($1.3 trillion) of asset purchases. Japan’s central bank cut its inflation forecast and kept its unprecedented monetary easing unchanged this week. Bullion priced in euros jumped 25 percent in the past 12 months, and 19 percent in yen. The metal rose 5.1 percent in dollar terms.

Bearish View

Some analysts say gold’s rally won’t last. Societe Generale SA predicted in a Jan. 14 report that prices will decline to $1,000 by Dec. 31.

Futures fell 1.5 percent last year, after a 28 percent loss in 2013, the longest slide since 1998. A surge in equities and an improving U.S. economy prompted some investors to lose faith in the metal. Domestic employment gains have increased speculation that the Federal Reserve will raise interest rates this year, cutting the appeal of bullion, which generally only offers returns through price gains.

“It does not seem that the Fed will come off their planned path of raising rates just because oil has come off,” Sameer Samana, a global strategist at Wells Fargo Investment Institute in St. Louis, said in a telephone interview Jan. 14. The fund oversees $1.6 trillion in assets. “What usually influences gold is not working now. Things have not changed, and it’s only temporary.”

Revised Outlooks

Some central bankers are starting to reassess their outlook for the economy as the rest of the world slows. The cost of living in the U.S. fell in December by the most in six years, leaving consumer prices up 0.8 percent from a year earlier. San Francisco Fed President John Williams said last week he will trim his U.S. estimate, and the Atlanta Fed’s Dennis Lockhart said Jan. 12 that he advocates a “cautious” approach to rate increases.

The Bank of Canada surprised investors Wednesday with an unexpected interest-rate cut. Crude is the nation’s largest export, and the Canadian dollar fell against all 31 of its major peers as the central bank reduced economic forecasts. Switzerland shocked markets by scrapping the franc’s cap against the euro, spurring investors to move to gold amid swings in currency markets.

“Falling oil prices are not an enemy” to gold any more, Donald Selkin, who helps manage about $3 billion of assets as chief market strategist at National Securities Corp. in New York, said in a telephone interview Jan. 14. “People need a flight to quality as there is so much uncertainty in Europe, and at the moment, gold looks like one of the safest assets.”

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