Both gold and oil recently made price history. But gold may be the superior investment currently; it is at half its real 1980 peak, while oil has breached its real 1980 peak. Further, while oil’s price elasticity is low, gold’s may be negative.
The 1980 gold and oil price peaks had different shapes. While oil prices remained within 25% of their peak for several years, gold prices dropped back rapidly. That reflected limited speculation in oil compared with highly speculative gold markets.
This time, similar dynamics may apply. Oil has a relatively low price elasticity, between 0.1 and 0.2. Thus, if oil rises 20%, to $120 (Rs4,836), global demand will drop only 1-2%, or less, if countries subsidize petrol prices, as India and China do, currently. Nevertheless, were oil prices to rise sharply, a combination of reduced demand, increased supply and possibly government controls would dampen the price move.
For gold, rising prices appear to increase demand and decrease supply. In 2007, the gold price averaged 16% above 2006 levels, yet demand volume increased 4%. Supplies dropped 3%, with mining supply down 3%, scrap gold recycling down 16% and only a 32% increase in official sales balancing these effects. This suggests a gold supply/demand price elasticity of minus 0.4; if prices increased 20%, demand would increase 5% and supply would drop 3-4%.
That cannot be true long-term, otherwise the gold market would explode, swallowing the world economy. Nevertheless, while real global interest rates remain low, gold should retain its current dynamics, with speculative demand increasing as prices rise. Since the pools available for speculative investment are much larger than in 1980, the gold price “spike” may move well beyond that year’s peak of $2,250 in today’s dollars.
Of course, this is only a dollar phenomenon. For Japanese investors, the current position is unexciting. Gold is half its 1980 high of 180,000 yen per ounce, while oil is only 12% above its 1980 high of 9,000 yen. That’s not surprising; yen prices are only 30% above 1980, so inflation hedges are unnecessary. Both oil and gold probably have a 50% downside in the event of a recession. However, gold’s potential for a price explosion seems more exciting.