Price puzzle

Price puzzle
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First Published: Thu, Jan 03 2008. 11 15 PM IST

Updated: Thu, Jan 03 2008. 11 15 PM IST
The Indian stock market is not alone in flirting with new heights these days. Oil prices flared up to touch $100 this week. And gold has crossed its all-time high of $850 an ounce.
What does one make of this? Rising oil prices suggest that investors expect the global economy to shrug off recent concerns about an incipient slowdown. Peak gold prices mean that they think inflation is around the corner.
This is a circle that may be difficult to square. Higher inflation will eventually force central banks to raise interest rates and thus hurt economic growth.
In this sense, the synchronized rise in oil and gold prices is puzzling—unless this is a final dose of confusion before we move into a messy era of stagflation.
Price trends could offer us some clues about what to expect in the months ahead. First, consider the prices of oil and gold. Let’s step back a bit and see how the relative prices of these two benchmark commodities have moved over the years. It could help us read the tea leaves a little bit better.
Currently, one ounce of gold buys 8.5 barrels of crude oil. That’s too low by historical standards. There have been times when this ratio has been as high as 32; for example, oil was at $11 a barrel and gold was around $350 an ounce in 1986. On the other hand, the ratio was a mere 6.3 in 2005 (oil at $69 and gold at $435). But an ounce of gold has usually bought around 20 barrels of oil.
Assuming this relationship between the prices of these two commodities will hold in 2008 and 2009, either the price of oil has to collapse to $42.5 a barrel or the price of gold has to shoot up to $2,000 an ounce or there is some intermediate equilibrium to maintain a price ratio of around 20.
What will it be? We will not hazard a forecast. All we can say is that oil has to get far cheaper in terms of gold in the next year or two.
How this will happen depends on how the global economy performs in the year ahead. Will there be a severe slowdown that will pull down oil prices? Or will there be a burst of inflation that will push up gold prices? Or will we see a dangerous cocktail of stagnation and inflation that will send both sky-high?
It’s hard to tell. But there are clear signs that higher inflation is lying in wait just around the corner.
Take a look at some other prices this week. Wheat, soya bean and other food prices have been on fire last year, and there are no immediate signs that these fires are about to be doused. The Wall Street Journal says that “in his well-known annual list of 10 surprises for the New Year, Byron Wien, chief investment strategist of Pequot Capital Management Inc., predicted corn will rise to $6 a bushel this year; it closed at $4.625 a bushel on the Chicago Board of Trade.” Higher commodity prices could feed inflationary expectations across the world.
On the other hand, prices of various industrial metals such as zinc and aluminium have been soft over these past few weeks because of fears that a slowdown in the global economy—and especially in China— will reduce demand for them. The price trend in the clunky minerals used by industry suggests a slowdown is likely.
These are signals for the near future. However, most economists, analysts and commodity traders seem to agree on the fact that high prices of natural resources are here to stay.
The global commodities boom—be it food, minerals or precious metals—has been driven by strong economic growth in India and China. There could be occasional hiccups along the way. But unless there are new technological revolutions to increase crop yields, create new materials and make alternative energy cheap, the world will have to live with high prices.
Do rising commodity prices suggest that the world faces the threat of higher inflation? Write to us at views@livemint.com
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First Published: Thu, Jan 03 2008. 11 15 PM IST
More Topics: Oil | Gold | Commodities | Inflation | Stagflation |