Price Synergies of Gold and Oil Muddy the Water

Gold and oil price are connected uniquely through several different mechanisms. The recent conflict in Iran has created a massive international oil shortage and thrown the FX markets and gold prices around dramatically. While international tensions are often good for the gold market, in this situation, the price of gold experienced some dramatic downward price action. The technical analysis does also not look good for gold in the short term. However, many of the conditions behind the drop in gold’s price are extremely unique and do not change the metal’s long-term trajectory. The higher gas price and greater economic uncertainty increase the value of the dollar through both demand for safety and a need for more dollars to buy oil with. This increased value of the dollar allows gold to sink in terms of dollar value. If the blocking of the strait of Hormuz and the oil shortage are perceived to be short-term, Gold will not gain anything from its role as a safe haven. However, if the war drags out and the oil shortage continues, gold will gradually regain ground as it’s stability will gradually overpower the negative currency effects. While higher oil prices can drive down the price of gold in the short term, the instability the heightened prices will cause, and the increase of perverse debt incentives will ultimately allow gold to rebound.

The international gas market is dominated by the dollar. While the dollar has continued its downward trajectory, the oil market still requires enough dollars that it can have a significant effect when nations are scrambling to stockpile while the price is already high. An increased volume of sales, particularly among US adjacent countries that are not as energy independent as China has given the dollar a momentary upward price shock. Additionally, in geopolitically tenuous times, people still flock to the dollar out of instinct because of what it once was. People still remember when the dollar was a more viable stable store of value, and in their fear they flock to the familiar, even as oil prices and cause it to inflate. The recent increase in use of the dollar has driven gold prices down, but without a change in the structural trend, there will not be a dramatic stabilization of the dollar or decrease in gold price.

Even as they have reverted to flocking to the dollar, investors have not shown the normal enthusiasm that would be expected for gold in this time of turmoil. Most investors assume that this tension will be short-lived and that the oil shortage will be resolved as quickly as it started. The situation in Iran has not caused them to adjust their long-term predictions for the state of tensions in the world. If the war shifts to something that investors believe will be more long-term, gold will regain some of its lost luster. There is no guarantee that this will be over soon, and even though Trump has hopes of peace, the willingness he showed to invade a foreign nation may be carried into his future international actions. A world where the US is always ready to strike is a world where gold is needed, and the dollar is inflating. While the dollar won this war, the supply chain tensions in the gas market will ultimately force us to shift to more expensive domestic production or risk involvement in even more conflicts. Both of these situations would further weaken the dollar and create a pathway for gold to continue the way it has done over the last few years. However, as Trump continues to drag on the situation and the Iranians show no interest in negotiations, the only certain outcome is a destabilized US and international order.

Before you sell your gold and worry about it continuing in its nosedive, it is important to ask whether what happened over the last month is conducive to future inflation, or future strength of the Dollar. Higher energy prices will increase inflation through numerous mechanisms all while destabilizing the United States itself. Our international position has become compromised by the recognition that we are willing to act in violently at any point. Owning dollars will become a liability as they are tied to a potential enemy for most of the Middle Eastern countries that hold an outside proportion of the world‘s oil. There is no reason to believe that this conflict will somehow change the political and economic structure of the United States and restore strength or even slow the descent of the dollar.