There’s an idea in chaos theory that the flap of a butterfly’s wings could create a hurricane on the other side of the world. The global financial marketplace isn’t so different. Asset classes don’t exist in a vacuum and unpredictable results occur on a fairly regular basis.
When it comes to commodities, two stand out above the rest: oil and gold. Even though there are plenty of other commodities that have a global impact, these two have a deep and complex relationship with each other and other asset classes that goes beyond basic fundamentals.
All That Glitters Is Oil and Gold
Right now oil is dominating headlines with the crisis involving OPEC’s refusal to cut production despite a worldwide glut in oil reserves and multiyear record low prices. As a leading indicator of the global economy, low oil prices mean lower demand and therefore an economic contraction. And when the economy turns south, investors who had been long on stocks and oil turn to a more conservative asset.
Enter gold. As the long time go-to for wealth conservation during hard economic times, gold generally does well when the market and oil prices fall. The safe-haven asset of choice holds its value better than fickle stocks and currencies, making it a safe option for investors who might be afraid of increased volatility.
At least that’s how it works on paper.
A quick look at how these two have been behaving in real life tells us a different story. Gold has struggled to gain any ground despite oil’s precipitous fall. The answer lies in the details of how the economy is actually doing.
The data is mixed with plenty of evidence to suggest that we’ve finally hit the peak and are headed back down again. Traditionally, it would be a good time for investors to pour into gold and flee growth-oriented assets but there’s one more variable to the equation this time: inflation. In order for gold to truly be a safe-haven asset that protects wealth, it needs to outpace other conservative assets like bonds. If inflation is higher than yields, then money essential gets diluted over time. Gold doesn’t dilute like that, making it the ideal parking spot while the economic storm rages.
But inflation is very low and the yield on the 10-year Treasury is considerably higher. That makes it a better choice for investors who are seeking a conservative investment since it will still appreciate in value. Gold’s value lies in its ability to hold steady, so if something else can still produce returns over time, it will win out.
The Bottom Line
Now that the Federal Reserve is slowly raising interest rates, yields will almost certainly go up, or at the very least stay stable. That presents a challenge for both oil and gold, both of which will have a hard time gaining ground against other more desirable asset classes. Thanks to the strange confluence of events happening, its the U.S. dollar that reigns supreme right now. This newly minted safe haven has few challengers and as long as it continues to stay strong, neither gold nor oil will make a strong move upwards.