Is oil the new gold?

By Money Matters Editors

Is oil the new gold? Perhaps, or at least temporarily, institutional investors (IIs) are making it the new global reserve currency.

The reason? It’s primarily due to the weak dollar, and IIs’ concerns about further depreciation of the buck in the quarters ahead. IIs have bid-up commodities, including gold and oil, on concern the dollar will continue to weaken against the world’s other, major currencies (particularly the euro, British pound, yen, and Swiss franc) due to the large U.S. budget deficit.

But soft buck concerns are not the only reason for oil’s return to the $80-per-barrel range. IIs also are piling into oil as long-term asset play – arguing that crude will outperform certain categories of stocks (perhaps many categories), in the year ahead.

Finally, there’s also some buying of oil for ‘old fashioned’ reasons – the prospect of rising global demand as the U.S./global economic recoveries gain steam. There’s plenty of oil around now – inventories are brimming at 3-year and 5-year highs – but if giga-GDP growth returns to Asia, that could change relatively soon.  Some IIs calculate that this will occur – and the current, adequate safety cushion between global oil supply and demand could dwindle quickly, perhaps in as little as 2-3 quarters.

But is the above enough to begin to think of oil as a new ‘surrogate global reserve currency’? Hardly, Money Matters argues. Oil may be a store of value, and a unit of account (sort of), but it’s hardly a medium of exchange. Here’s an example: If you’re a decision maker at a corporation, try telling a major insurance company you can pay your company’s building liability premium, but only in barrels of oil, or in NYMEX futures contracts, not in cash. See what the insurance company tells you.

Further, IIs’ decisions to buy oil may have a boomerang effect, or what economists’ call a ‘negative feedback loop.’ If IIs buy too many oil contracts and drive the price of oil back to the stratospheric levels it hit during the leveraging boom (as if $80 per barrel wasn’t high enough), those high prices will eliminate what little disposable income is left in the United States, and also choke-off the global economic recovery by increasing the cost of commercial transportation.

And if the latter occurs, IIs’ decisions to buy oil will eliminate the very conditions that accounted for much of oil’s rise from $40 per barrel last year, in the first place. Talk about self-defeating actions. Hence, the argument from Money Matters is, ‘IIs – invest in oil, but don’t push its price up too high.’