Oil prices have a meaningful influence on gold prices. Understanding why means first examining how dollar-denominated assets work.
A dollar-denominated asset is any asset priced in US dollars. Gold is an example of a dollar-denominated asset as well as oil. This means that a rise in the value of the dollar is likely to drive down the price of those assets.
The rise and fall of gold and oil prices often occurs in tandem because both assets share this characteristic. However, this relationship is complicated by inflation which is often defined as too much money chasing too few goods.
An increase in oil prices contributes to a rise in inflation. This happens because a rise in oil increases the cost of inputs. This relationship has weakened somewhat in recent decades as oil has become less integral to manufacturing but the influence is still there. Moreover, the transportation of finished goods requires oil which also impacts the prices of those products.
This connection between oil and inflation matters to gold investors because gold tends to increase in value as inflation increases according to research showing that “there is a clear co-movement between the prices of the two strategic commodities, both in nominal and real terms.” This connection is so strong that even a dramatic short-term movement in oil prices reverberates throughout the gold market. The same body of research determined that “the signs of the instantaneous impact of oil price shocks on gold returns are all identically positive.”
This link makes sense. An increase in oil prices will hinder economic growth. Running a business becomes more expensive. This slowing of economic activity often flows through the equities market. As a result, investors tend to move towards “safe haven” investments like gold.
One of the most direct connections between the prices of gold and oil can be seen in mining. The resource-intensive process of mining demands oil for the operation of industrial machinery.
A rise in oil prices can force a mine to go off-line or shut down entirely. Even exploration requires substantial oil resources. This relationship is present within other mined resources. For example, Barron’s explains “the correlation between the daily iron ore price and oil price has been 72%.”
Other academic research supports this link. One study found that “oil is one of the main factors in causing variations in stock prices, exchange rate and gold prices.” Countries experiencing the strongest economic growth are often the largest drivers of immediate surges in oil demand. Consequently, it is plausible that emerging economies have a disproportionately large influence on gold prices in the short-term.
All of this leads to one question for gold investors: where is oil likely to go in 2023?
Today, West Texas Intermediate oil is trading at approximately $80/barrel. Analysts at JPMorgan forecast this to rise to $90 in 2023. Bank of America projects an average of $94/barrel in 2023.
Many of these forecasts are influenced by the uncertainty surrounding the war in Ukraine.
The key takeaway for gold investors is this: there are many factors influencing the price of gold and oil is among the most consequential. A rise in oil prices in 2023 – a likely scenario – should bode well for gold.
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