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There is little doubt that risk aversion and Syrian war fears have fuelled much of the oil and gold price spikes of the past two weeks. But it doesn't necessarily follow that both commodities are now wildly overpriced.
To be clear, I do believe the market's reaction to the prospect of a Western military intervention in Syria will prove overblown. History has shown that only the biggest geopolitical events have any meaningful and lasting impact on broader global economics and markets; limited regional military actions, even in an area as sensitive as the Middle East, tend to only have short-term impacts. (Even in the first Gulf War of 1990-1991, oil prices, which had more than doubled in the run-up to war, plunged once the bombs started dropping.) The uncertainty surrounding Syria is justification for price volatility, but not for sustained higher prices.
Still, how do you gauge how much extra heat the latest collection of fears and risks may have baked into gold and oil prices? One way of looking at it is to gauge the gap between the current price and where underlying physical supply-and-demand fundamentals suggest the price should be. A decent baseline for that is marginal cost of production.
The marginal cost of production is the cost (including capital expenditures) of producing the next ounce of gold or barrel of oil required to meet demand. It essentially represents a price inflection point at which the industry breaks even by increasing production. Move much above it for very long and there's incentive to develop new production; move much below it for long and producers and fields near the margin will be forced into hibernation. Such increases and decreases in the industry output would create underlying fundamental pressures to eventually push the price back toward the marginal price.
The global gold mining industry's marginal cost of production is believed to be in the range of $1,200 (U.S.) to $1,300 an ounce – not surprisingly, a range into which its price fell earlier this year before finding some footing. Today's price of a little over $1,400 an ounce suggests that the market is not wildly overheated, despite the short-term price surge.
As for oil, it looks less expensive now than it did the last time West Texas Intermediate crude topped $110 a barrel, just two years ago. Wall Street research firm Sanford C. Bernstein estimated earlier this year that the non-OPEC marginal cost is now over $100 a barrel, up more than 20 per cent in the past two years. We have the U.S. shale oil boom to thank for that; it's a high-cost, technology-intensive source of new supply that has raised the cost floor for the entire industry. (OPEC's marginal costs are lower – perhaps as low as $50 – but this matters less because the cartel, which produces about 40 per cent of the world's oil, essentially fixes its production levels with formal quotas.)
With relatively modest premiums built into both commodities at the moment, a Syrian resolution would likely result in a price reversal, but not necessarily a plunge. On the other side of the coin, the current price surge could still have considerable room to run as long as the Syrian wild card hangs over the market.
David Parkinson is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow him on Twitter at @parkinsonglobe.
David Parkinson