Is gold set for a correction?

Food

Given the choice between defending the dollar and saving the stock market, Ben Bernanke did what you’d expect of any acolyte of Alan Greenspan – analysis by Moneyweek's John Stepek.

He ditched the dollar without a second’s regret. Last night’s quarter-point interest rate cut took the greenback to a new record low against the euro and saw the pound briefly tip above the $2.08 mark.
There was some dissent however - one member of the rate-setting Federal Open Market Committee wanted to keep rates at 4.75%. Such rebellion is unusual in the States, unlike our own somewhat tempestuous Bank of England meetings. It's little wonder that some FOMC members are worried. The price of both oil and gold are testing record levels, a sure warning sign of inflation. But the gains in oil and gold are about so much more than mere dollar weakness…

The dollar’s decline has of course sent the price of oil and gold higher. Both are priced in dollars - if the supply of dollars rises, and the supply of gold and oil stays broadly the same, then the dollar price of each rises. But neither commodities’ strong gains are purely down to dollar weakness. The pundits have been out in force recently to carp about the oil price being fuelled purely by speculation. Oil cartel OPEC has said that it has never seen the price so disconnected from the supply. And Goldman Sachs recently issued a report suggesting that the price is set to fall back. All this downbeat speculation took its toll on the oil price yesterday - at least, until the latest US inventories data for last week was published. Everyone had been expecting crude stocks to rise by about 600,000 barrels - in fact, they fell by 3.9 million barrels. This sent the oil price to a new high of over $95 a barrel in New York, while Brent headed above $90 a barrel once again. According to the FT, “technical analysts said there were few significant resistance points restraining a move to the $100 level.”

What was behind the decline?
Well, there was a big fall in stocks at Cushing, in Oklahoma, a key delivery point for crude. Stocks there - at 15.1 barrels - are at their lowest since October 2005, just after Hurricane Katrina hit. Meanwhile, imports were hit by disrupted production in Mexico. It’s the usual story with the oil market. Stocks could well rebound next week, and prices may fall. Unless something else happens. Like a bomb on a pipeline, or escalated tension in some part of the Middle East, or a tropical storm picking up somewhere inside the Gulf of Mexico. At the moment, the oil market is jittery and looking for any excuse to push higher. Our feeling is that - like anything - betting on the short-term movements of the markets is exactly that - pure gambling. But in the long-term, it seems pretty certain that we can rely on the oil price averaging much more than the $40 a barrel that until very recently almost every analyst expected it to return to.

That has a lot of knock-on consequences. Inflationary pressure is one. High oil prices don’t just have an impact in terms of energy use - just now, they are also forcing up the price of food. Both corn and soybeans rose in tandem with oil yesterday, on speculation that rising oil costs will drive up demand for biofuels such as ethanol and biodiesel. A side effect of that, of course, is that your breakfast, lunch and dinner also become more expensive. So even with all the fiddling that politicians inflict on inflation figures it will be hard to hide the fact that many aspects of our lives just continue to become ever more expensive. And the rising gold price is evidence that investors are coming to understand that. Now nothing goes up in a straight line forever, and several commentators, whose opinions I respect suspect there might be a correction in gold in the near future.

Does that matter?
Well, not really. It may mean that now’ is not the best time to top up your holdings – but then again, if you believe, as we do, that inflation will continue to rise, and that gold will go above $1,000 an ounce in the not-too-distant future, then who cares if you buy at $800 now and it dips?

Just before I go – on the topic of gold, I constantly get emails (quite understandably) pointing out that gold is priced in dollars. If we’re so bearish on the dollar, readers ask, then how can you recommend gold?
The simple answer is, I expect gold to rise by more than the dollar falls, which has so far been the case. The yellow metal has risen 28% in dollar terms in the last year – but it’s still climbed 18% in sterling terms, and is sitting at around £380 an ounce. If you want to keep an eye on how much gold has risen in sterling terms yourself, just go to www.kitco.com and scroll to the bottom of the page, where you can find gold’s price in a range of currencies. (moneyweek)

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