Gold, silver and the correlation to oil and the US Dollar

The price of oil plays a crucial role in the determination of the price of gold and gold-backed ETFs. Like gold, the price of crude oil is determined in the US dollar.  While the consensus has been that when the US dollar rises, dollar-denominated assets usually drop in price, as investors of other currencies would find dollar-denominated assets more expensive. Because gold and crude oil are dollar-denominated assets, would both fall and rise together. I would however argue that this is no longer the main driving force in the price of oil and precious metals. Despite a falling dollar, precious metals and crude oil have recently fallen off a cliff despite a big drop in the US Dollar.  

The main driver

The main driving force recently has been the market in general and more specifically the biggest market off all them all: The Bond Market.  US Treasury Bond Yields is what is currently driving the price in precious metals along other factors - and they have been rising. Sharply. Whenever Bond Yields are higher than the reported CPI index, investors tend to prefer bonds. The money simply went from the precious metals to bonds.  This correlation is shown in the charts that follows.   

This dynamic however is about to change. The Federal Reserve has recently been downplaying its rhetoric regarding the need for more rate hikes. The recent economic indicators released has been crucial in this change of heart from The Federal Reserve. Especially the Q1 GDP number. Coming in at a measly 0.7 %.  Experts have been blaming this on the seasonality of Q1. Yet no recently released indicator I have seen have given reason to believe Q2 will be much of an improvement from Q1.  If however Q2 turns out to be as bad as Q1 it will be clear to all that the tightening cycle The Federal Reserve started in December 2015 is over. This event would be extremely bullish for gold and silver.  Meanwhile the CPI index YoY has been moving up. Quickly. From a low of -0.2 % in november 2015 to a high of 2,7% in march this year.    

The role of oil regarding precious metals

If the main driving factor between the correlation of rising oil prices and rising prices of metals – base and precious metals, is not in fact the US dollar’s rise and fall then what is it?  It is very simple. The price of oil is a very important factor in the price of goods and services. Our entire economy runs on oil as our main source of energy. When prices of oil goes up, so does the consumer price index.  If that was not bad enough for the precious metals bears, when oil prices rise so does the cost of recovering precious metals of course also.  Technically speaking oil has hit an important bottom recently as shown in the chart below.

Seasonality wise, oil is also more expensive to distillate during summer where also consumption of the black gold is greater.  I am not saying oil will hit 100 dollars a barrel or in the near future. But, a price per barrel at around 70 dollars within a year is not out of the question.   

Summing it up

As inflation rises, and the will to raise rates disappear - something has to give. It is my humble opinion that money is going to flow back into real tangible assets very soon. Such as gold and silver.  I believe the metals are likely to rise over the summer. Could I be wrong about the timing of all this? Absolutely. But, money has to go somewhere and once it leaves the bond market, it will have to choose between a bloated stock market and real tangible assets.