It is arguable that there has been too much emphasis in recent weeks on the plummeting oil price and the effect that this may have on inflationary – or disinflationary – pressures in the economic system. Oil is less significant with respect to inflation than might appear at first glance and the knock-on impact with respect to gold is nowhere near as bearish as some might argue. Indeed, financial dynamics indicate that falling oil is, in the longer term, supportive for the gold price. This should not mean, however, that it is outright bullish.
Gold’s role as a hedge against inflation has been very much in the background in the Western Hemisphere over the past 20 years, with US inflation, for example, running at an average of 2.3% per annum over the period, effectively making gold redundant in that specific regard. The massive injections of liquidity into the financial system since the start of the Financial Crisis, with the United States injecting $3.7 trillion (federal credit market debt at end Q3-2014, when QE was stopped, was $12.8 trillion), and with Europe, Japan and potentially now China following similar routes, argue for a longer-term set of inflationary pressures that, when global economic growth is again in place, point to a bullish long-term outlook for gold. Meanwhile, although gold has further downside risk over the next few months, the knock-on effects of weaker oil are actually supportive for gold on a fundamental basis in the latter part of 2015 and into 2016.
“The world’s largest gold consumers are India and China with an estimated market share of just over 25% each for 2014.”
The slump in oil certainly helped to keep gold under pressure from August through November of 2014, partly due to fears over disinflation, but also because of the boost that, initially at least, weaker oil gave to the equities markets. The subsequent re-emergence of healthy physical gold demand in parts of Asia saw gold significantly outperform oil in the fourth quarter, with a net flat performance overall against a fall for oil of 50%. In the first quarter of 2014 both traded in broadly sideways ranges.
Looking forward we need to differentiate between the role of the oil price in the inflationary matrix and its contribution to economic activity.
Oil is a much less significant contributor to inflationary forces than at first might be believed; the Energy sector has over the past two decades contributed only 7.9% towards the US CPI, and in 14 out of the past 20 years energy’s contribution to the All Items Price Change was negative. In the longer term it will be labour costs and the excess liquidity in the system that will be more important in driving inflationary pressures.
Of more significance to fundamentals of the gold market is the impact of falling oil prices on economic activity among the major gold consumers. The world’s largest gold consumers are India and China with an estimated market share of just over 25% each for 2014 (this on the basis of jewellery, investment products and industrial usage). The Middle East (excluding Turkey) follows with 9%, with the United States and Germany commanding 6% and 3% respectively. Russia comes in at approximately 2.5%.
Oil rents (revenues less costs) in India, China, the United States and Turkey, which between them account for 62% of world gold jewellery consumption, are all below 3% of GDP, while International Energy Agency (IEA) figures show that in 2012, the US was responsible for 22% of world total net imports, with China at 13% and India at 9%. So 41% of the world’s net oil imports in 2012 went into countries that account for approximately 58% of world gold demand.
The position is especially pertinent with respect to India. The 80:20 rule, imposed in July 2013 and under which gold importers were required to ring-fence 20% of their imports for re-export with value-add (generally, lightly fabricated jewellery) has now been rescinded and imports – after an initial hiatus born of confusion – have picked up very smartly. The rebound did prompt some concerns that the government might re-impose restrictions, but the fall in the oil price may come to gold’s rescue. The whole point of trying to reduce gold imports was to aid the current account, which has been running a deep deficit. In calendar 2013 India’s import bill was $465.8 billion, of which oil was by far the largest component at $164 billion (35% of total), with gold second at 8% or $36 billion – this with oil at an annual average of $105/bbl and gold at $1,281/ounce. In 2014 the import bill was $461.8 billion, with oil comprising $159 billion or 34% and gold, $30.5 billion or 7%. A very simple linear extrapolation suggests, on the basis of the IEA forecasts, the Indian oil import bill could be down by as much as $60 billion in 2015, which should provide a sound underpinning for economic growth. This will not have a linear impact on gold demand as demand is in good measure a function of the harvest, but it will help urban demand – as well as boost other uses of the leisure rupee, of course.
Substantially reduced oil import costs are expected to have a beneficial effect on both the Chinese and Indian economies in particular – or at least in the case of China, should help to counteract the reduction in the rate of growth. As this cascades into these economies as a whole and helps to improve consumer confidence and discretionary spending, this should bolster gold purchases in these nations. Of course, it is never that simple, as the Indian harvests are all-important in terms of how much money the Indian rural population has to spend on gold in any one year, but on a pari passu basis, lower oil is, in the longer term, supportive for gold purchase levels, especially jewellery.
We are expecting the dollar to remain strong at least through to 2016 so currency considerations will remain important.
On the flip side, IEA figures suggest that OPEC members (excluding Iran) were likely to earn approximately $700 billion in net oil export revenue in 2014, 14% down on 2013 and the lowest since 2010. Earnings for 2015 are forecast at yet 46% lower, to $446 billion, based on a forecast $68/bbl, against $100 in 2014 and $109 in 2013.
“Substantially reduced oil import costs are expected to have a beneficial effect on both the Chinese and Indian economies in particular.”
Independent analysts are estimating that the Saudi Arabian budget for 2015 looks as if its benchmark for Brent is somewhere between $55 and $63/bbl. The Russian budget (prior to sanctions) is broadly balanced at $100-105/bbl. The bleak outlook for the Russian economy has prompted some suggestions that the Russian central bank may cease its gold purchases (which amounted to a record 173 tonnes in 2014) and that it could even become a net seller. We do not expect this to happen, as the revenues from gold sales would be minimal by comparison with the shift in the current Russian account deficit. This is not to say, however, that countries suffering from severely depleted oil revenues may not start more actively managing their gold reserves.
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