Brent has been in triple digits for the last couple of weeks as tensions in the Middle East have flared. But, the pice of crude has declined over the last couple of sessions as Saudi Arabia restores pipeline production. The question for traders is whether the trend will continue, and brokers seem to agree that crude prices will decline amid volatility over the next couple of months.
At the same time, gold prices are starting to firm up, bouncing off of the 50-day MA this week. This is a reversal in the downward trend seen over the last three weeks. The shift comes even after the Fed raised rates, and yields have reached decade highs. Is gold moving in opposition to crude, or is there another factor at play?
Crude and Energy Prices Disconnect
Crude prices were elevated after Houthi attacks on the Saudi pipeline, threatening about 4% of the global supply. Markets were shocked when some European deliveries were cancelled. But supplies were rerouted, and there was an increase in inventories, which helped assuage fears of a supply crisis.
What is notable, however, is the higher price of distillates. Diesel prices in the US hit new highs, and have not followed the decline in crude prices. Refiners have been operating at capacity since the war started, and are still struggling to keep up with demand. While the bottlenecks in Hormuz and Bab el-Mandeb are strategically significant, refining is becoming a critical constrai,nt pushing prices higher. As Ukraine continues to target Russian refineries, demand for Chinese exports rises, putting pressure on the global market.
Demand Destruction and Gold’s Rise
Traditionally, crude is seen as having fairly inelastic demand because any available substitutes are already being used to capacity. However, higher energy prices translate into higher headline inflation and suppressed economic activity as global central banks raise rates. This slows overall demand growth, and a narrative that is gaining traction among analysts is that demand destruction might be the main theme to drive crude prices through the end of the year.
A high-inflation, slow-growth environment is generally positive for gold, despite higher rates. The market is currently pricing in back-to-back rate hikes from the Fed, expecting further tightening at the November meeting. It would be very difficult for the Fed to be even more hawkish than it currently is perceived, and that could be putting a floor under gold.
Crude Prices Coming Down, Good for Gold?
The consensus among most major forecasting agencies is that Brent will end the year around $90 per barrel, although experience volatilty in the meantime. That still implies a geopolitical risk premium, as it would be trading at least $20 above the pre-war level. Goldman Sachs is more pessimistic, suggesting $80 while Morgan Stanly sees a level of around $100.
The effect on gold is that higher crude would be a price shock but likely would not generate persistent inflationary pressure. Once crude peaks and the price increase is absorbed by the economy, then inflation would likely decline. If the economy is cooler as a result of higher rates, then gold prices could see further upside as the market prices in a more dovish Fed next year.
