SERIOUS MONEY:Black gold or oil is back on centre stage. The price of a barrel of oil reached an all-time high in nominal terms in recent sessions, a far cry from the late-1990s when the price dropped for a short period in real terms to half the level that prevailed during the 1950s and one-fifth of the record prices registered more than 25 years ago.
Prices are up eightfold from the lows of the late-1990s and have advanced more than 50 per cent in the year to date, with much of the rise since January occurring in recent weeks as concerns over low global stockpiles ahead of the winter season and possible Turkish incursions into northern Iraq have mounted.
The historical record shows that all but one downturn in the US economy over the past 60 years have been preceded by a sharp increase in energy prices. Is history set to repeat itself or can the most dangerous sentence in investment thinking - it's different this time - finally be believed?
It is important to appreciate the dynamics of the current bull market in oil. The sharp rise in oil prices in recent years is unlike its predecessors in that it has been demand-driven with the world economy posting its strongest and most enduring performance in more than three decades.
Previous oil price shocks have emanated from crises that temporarily removed important sources of supply. The Suez crisis of 1956, the Yom Kippur war of 1973, the Iranian revolution of 1979 and the outbreak of war between Iran and Iraq in 1980 were all supply-side crises.
Furthermore, supply-side crises have typically seen a sudden sharp increase in prices while the current demand- driven bull market has been characterised by a more gradual rise in the price of a barrel of oil, which has given businesses time to adjust to the demise of cheap oil.
The rise in prices in recent years has also taken place against a background of strong economic growth, which allowed households to reduce savings rates to fund the extra cost while productivity gains limited the impact on businesses' cost structures.
It should also be noted that the developed economies of the West are far less sensitive to movements in energy prices than 30 years ago when Saudi Arabia and its Opec cartel first wielded the oil weapon to good effect. The decline of manufacturing and the loss of said jobs to the East combined with greater energy efficiency has seen the amount of energy required to produce one unit of output halve since 1980.
As Alan Greenspan, former chairman of the Federal Reserve, pointed out a number of years ago: "Today's GDP is lighter and smaller."
It is beyond dispute that the price of oil matters less today than in times gone by.
However, it would be a mistake to conclude that the recent surge is irrelevant. Surging oil prices alone are far from sufficient to propel the US economy into a downturn, particularly when an expansion is in full swing.
However this is no longer the case as the economy has recorded an extended period of sub-par growth.
The recent jump in oil prices combined with a severe housing recession, rising food prices alongside a soft and less than encouraging labour market sees the odds of a recession become too high to dismiss.
The oil price at almost $90 a barrel will undoubtedly place further pressure on America's beleaguered consumers and contribute to increasing caution by the corporate sector.
That said, Opec and several commentators believe that current prices do not reflect underlying fundamentals and are subject to speculative buying.
They may be right. Relative value traders - long/short specialists - will be astute to the fact that the price of oil, the world's primary commodity, is inextricably linked to the only currency that cannot be devalued by the whims of central bankers and their printing presses - gold.
One hundred barrels of oil has through time typically purchased seven to eight troy ounces of gold; today oil's purchasing power has risen to more than 11 ounces.
The oil price certainly looks high relative to gold though forecasting its future trajectory has always proved difficult. Relative value or directionless trading strategies have typically proved profitable and the current investment should prove no different.
Higher oil prices alongside other factors mean that further interest rate cuts are assured, thus reducing the opportunity cost of holding gold, which, combined with downward pressure on the American greenback means that the precious metal's performance should outpace black gold.
Long gold and short oil looks like a winning strategy.
charliefell@sequoia1.ie
