Oil prices have fallen to pre-Iran war levels, trading at around $70 a barrel, while gold prices have been slowly declining for months. But are these trends correlated?
At first glance, falling oil and gold prices may signal a cooling economy and easing inflation concerns. That’s because both of these products react to economic uncertainty.
But there are more forces at play now, and oil and gold prices are actually not that strongly correlated.
Here’s what you need to know about the relationship between oil and gold prices and what it means for precious metals investors.
Are oil and gold prices actually related?
Although the prices of oil and precious metals such as gold are somewhat related, they do not necessarily move in tandem. Two forces cause this.
First, inflation is the main factor linking the two.
“Oil and precious metals often benefit from the same inflation story. Rising energy prices can drive inflation, which tends to support demand for gold and silver as stores of value,” says Christopher Hodge, former chief economist at the New York Fed and chief economist at Natixis CIB Americas.
Geopolitical conflicts may strengthen this relationship. Conflict can disrupt supply chains and cause oil prices to soar, as was seen at the start of the Iran war. This has caused inflation to rise and more investors to buy gold and other metals as a hedge against rising prices and uncertainty. This increased demand could cause the price of gold to rise.
But that’s not all. Other forces weaken the correlation between gold and oil. While oil prices are primarily determined by perceived supply and demand, gold prices also respond to other macroeconomic factors.
“While oil prices have retreated, precious metals prices remain supported by central bank purchases, large fiscal deficits, geopolitical uncertainty and persistent concerns that we may not be able to fully beat inflation,” Hodge said.
Why did crude oil fall back below $80 a barrel?
Oil prices have fallen to pre-Iran war levels in recent weeks as tensions between the U.S. and Iran ease and the geopolitical risks that drove oil prices decline.
Purba Mukherji, an economics professor at the University of Connecticut and an expert on international finance and trade, said other factors pushing prices below wartime highs include increased supplies from Russia and Venezuela, as well as weak demand from China amid slowing economic growth.
Why is gold trending down?
While oil prices have been falling for weeks, gold prices have been slowly trending lower for months since hitting a record high of more than $5,000 in January.
One macro factor driving this is the prospect of rising interest rates. Rising interest rates make income-producing assets such as bonds and stocks more attractive than gold and other precious metals, which do not pay dividends. “The Fed’s path to higher interest rates has turned non-yielding assets into some debt,” said Darrell E. Fletcher, managing director of products at capital markets trading firm Bannockburn Global.
A stronger dollar also contributes to lower gold prices. Gold is sold in dollars around the world, so a strong dollar makes gold more expensive for overseas buyers and reduces demand. However, fiscal deficits and strong central bank purchases continue to support gold prices in the long term.
What’s next: What the oil drop means for gold
Oil and gold prices have both fallen recently, but for very different reasons. Still, there are messages that can be read from both. “This decline suggests that markets are becoming less concerned about inflation tail risks and major commodity shocks,” Hodge said.
That’s because gold and oil prices both tend to rise during periods of high uncertainty and high inflation expectations, and fall when those pressures ease.
But in reality, the relationship is not so simple. Lower oil prices could theoretically curb inflation and put downward pressure on gold prices, but in reality other factors outweigh this.
“While we believe the decline in oil primarily reflects expectations for near-term inflation relief from the war-related supply shock, the correction in gold reflects the tightening stance of monetary policy and the recent rise in real yields,” said Jordan Rizzuto, managing partner and CIO at Gammalord Capital Partners.
As a result, while oil and gold have both fallen, their correlation remains weak.
Conclusion: What the decline in oil and gold prices means for investors
Oil and precious metals are both affected by inflation concerns and geopolitical tensions, so it’s easy to assume their prices will move in tandem.
But ultimately, “they’re driven by different fundamentals,” Hodge said. “Oil is primarily a story of growth and supply and demand. Gold is more of a story of real interest rates and uncertainty. They sometimes move together, but they often tell different stories about the economy.”
For investors, this means that the downward trend in oil prices does not necessarily determine what happens next for gold and silver. Lower energy prices can help ease inflation and put downward pressure on precious metals prices, but other factors such as interest rates and a strong dollar play a bigger role.
Investors should instead consider oil as part of a larger equation. If lower oil prices contribute to a lower overall inflation outlook, it could determine how the Federal Reserve sets interest rates. After all, this has a bigger impact on gold than it does directly on oil prices.
