Pump panic, gold glee

Buttonwood

Sep 13th 2005
From The Economist Global Agenda

Time to roll out the safe havens?

MUCH of England came to a halt on Monday, watching its cricket team win back the Ashes. It may well come to a halt later in the week for quite a different reason. With unleaded petrol now fetching over £1 ($1.82) a litre in Britain, for example, and talk of shortages rampant, truckers and farmers around Europe are ganging up on their governments to cut fuel taxes. In Britain, protests and motorway go-slows are planned from Wednesday onwards. In France, one protest has just ended.

In the face of this nascent revolt, Europe’s finance ministers say they will hang tough (most have budget deficits, hence little choice) and hang together. But no one really expects them to. Five years ago, similar protests crossed borders, stopped trade and caused several governments to make concessions. This time around, Poland has already said it will cut fuel taxes, France is talking of doing so and has offered €30m ($37m) in tax breaks for farmers, and Britain may yet freeze taxes at the pump.

Their preferred ploy, though, is to shift the problem to oil producers—both OPEC and private companies—urging them to expand production and refining, and even to cut prices now. That is harder than it looks. OPEC has already increased investment in oil exploration for the first time in ages: its biggest members drilled 7.5% more wells in 2004 than the year before. Opinions differ as to how much usable oil is left in OPEC and other ground, but it is clear that the cartel is operating near current capacity.

Private oil companies, it is true, have handed back to shareholders rather more of their recent windfall profits than might have been wise politically. But if they are to make the investments necessary now, threatening them with a windfall tax makes little sense. And there are signs that companies are stepping up investment anyway, in response to higher prices.

Oil prices were already feeling the strain before Hurricane Katrina wiped out 1.5m barrels a day of Gulf crude, along with more than a tenth of American refining. But they retreated from their spike of $70.85 a barrel on August 30th to just over $63 on September 13th, as some activity resumed in the hurricane zone, the release of strategic reserves flooded the place with crude, and China said that its oil imports had fallen in August compared with a year earlier. CIBC, a Canadian bank, recently joined the ranks of those who reckon oil will hit $100 within two years. Others, including many in the business, see it slipping back below $40.

Martin Barnes and Elena Gavrina at BCA Research, an independent firm in Montreal, predict that oil prices will average around $50 a barrel over the next five years, perhaps falling below that in the near term as weaker economic growth conspires with high prices to undermine consumption. The International Energy Agency says that high prices have already slowed the rise in the world’s use of petroleum. And Katrina is believed likely to shave up to one percentage point off America’s already slowing GDP growth in coming months. In the longer run, however, demand from Asia’s fast-growing economies will make up for any anaemia on the part of rich countries.

The black and the yellow

So much for black gold. What about the real thing, which fans have been expecting to take off for months, if not years, in tandem with it? After all, the last time oil was on such a ride (in the 1970s), gold tore right along with it, ending up at $850 an ounce in 1980.

Since the second world war, gold bugs say, the prices of oil and gold have followed each other about, give or take the odd lag. An ounce of gold has fetched just over 15 barrels of oil, on average, and whenever that ratio got seriously out of whack one price or the other quickly adjusted. But gold and oil have been drifting apart for at least four years. While oil has blasted up by 60% so far this year, gold has risen only fractionally. These days an ounce of gold, at just under $450, buys a mere seven barrels of oil. In other words, the purchasing power of gold has been badly eroded.

Gold is a strange substance. It is a commodity, an investment and a means of exchange, and its price reflects all those roles.

Like any commodity, it responds to the laws of supply and demand. New figures from the World Gold Council, which groups producers, show that demand for physical gold is growing strongly, up by 21% in tonnage terms during the first half of 2005 compared with the same period a year earlier. Supply, meanwhile, increased less quickly, by just 18%, thanks partly to slowing central-bank sales. Gold supplies are eminently manipulable, however, and if prices rise substantially, a lot more of the stuff will hit the market.

It is from its role as an investment and a means of exchange, though, that gold derives its real mystique. Sentiment is important: in a small market, a few big positions affect prices more than, for example, they could do in the oil market. And that sentiment depends, more than anything, on expectations about inflation and the value of the dollar.

In the past, gold prices rose with oil prices because inflation did too, and gold was seen as a safe store of value. Yet investors have not really viewed inflation as a threat for a couple of years, continuing to buy shares and houses, for example, in preference to gold despite the huge run-up in crude prices. The notion that higher oil prices will tax growth rather than stoke inflation has gained, dare one say, currency.

That idea may itself be taxed by the inflation numbers coming out this week, however. Consumer prices in Britain rose by 2.4% year-on-year in August, the quickest rate of increase since the Bank of England began targeting inflation in 1997. Observers point out that the increased transport and energy costs which produced the hike are not yet being passed through to the final purchaser of goods and services—ie, business margins still have room to shrink. But with the pace of inflation likely to pick up further in September, this is presumably a short-term consolation. America’s consumer-price inflation figures are likely to show something similar later this week.

Just as inflation has, until now, lain low, and gold with it, America’s dollar has also been resisting arrest. Gold is after all a monetary metal, an alternative to the paper currency that replaced it at the heart of the world’s trading system, when times are tough. But they haven’t seemed tough so far. Despite America’s famous twin deficits, everyone else’s currency has been even less appealing, and big exporters such as China have had their own reasons for propping up the dollar. Now, as Katrina heaps billions on a national debt that is already close to $8 trillion, might that perception change? The time is surely not far off.

For at the end of the day, the price of gold reflects confidence, more than anything. When people are confident that their central banks will control inflation while permitting the economy to grow, when they believe that paper assets are worth something approaching their face value, they buy gold to wear but not to put in a safe. Alan Greenspan has achieved the remarkable feat of suspending disbelief in America’s gerrymandered finances for the past few years. On his departure, watch the gold price soar.

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