Oil and gold markets diverge

01 May 2020

5 minute read

By Jai Lakhani, London UK, Investment Strategist

With a massive drop in the price and demand for oil piling the pressure on producers, when might a sustained recovery in the price provide some respite? Meanwhile, what next for gold after risk-averse investors returned to the commodity in droves last month?

The COVID-19 outbreak and the costs of containment on global growth has significantly impacted the demand side of the oil market this year.

The Organisation of Petroleum Exporting Countries and allied producers (known as OPEC+) agreed 9.7 million barrels per day (mbpd) production cuts for May and June. However, this does not appear sufficient to offset the staggering fall in demand seen from global quarantine measures designed to counter the effects of the COVID-19 pandemic. Indeed, with many economies idling, demand has collapsed by as much as 30mbpd according to some estimates.

The world of negative oil prices

In a first, oil producers have been paying others to take the commodity off their hands: a barrel of West Texas Intermediate (WTI) oil closed in negative territory on 20 April. What does this strange and significant event mean?

First, the quoted negative price refers to a specific futures contract traded on the New York Mercantile Exchange, which in this case was for May delivery, and reflected the spot price at a given time, not the medium-term outlook for the commodity.

Second, the plunge in prices took place because of a very specific set of factors that are unlikely to reoccur. Indeed, against a backdrop of weak demand, oil suppliers have been seeking to store oil, hoping for prices to recover, once demand stabilises. As a result, Cushing, America’s key storage hub and delivery point of the WTI contract, is quickly approaching maximum capacity with inventories having jumped by 50% in just two months, to 61m barrels (compared with a 76m barrel capacity).

Storage concerns

The constraints on oil inventory storage are less urgent for Brent crude, as tankers usually shipping oil around the world can be used as additional storage vessels. This explains why Brent, the other major oil benchmark that is based on oil extracted in the North Sea, was trading above $25 per barrel when the WTI price was negative.

In financial markets, investors with May delivery futures contracts on WTI faced having to take physical delivery of oil in Cushing for barrels that no one wanted and that could not be stored. As such, as the May contract approached expiry, they looked for an exit at (almost) any cost, pushing the price of the futures contract below zero.

Whether oil prices are negative or positive, the longer term outlook for the commodity remains uncertain. The agreed OPEC+ production cuts don’t compensate for the demand destruction experienced since March, leaving the market unbalanced and with very large inventories.

Curve ball

In addition, the shape of the oil curve, whereby the price of futures contracts due in a month is significantly lower than those due in three months or later, is a concern. This makes going “long oil”, and looking to profit from an increase in the price, a challenging investment proposition.

Golden diversifier

Gold can still be a good diversifier in broad, multi-asset portfolios

Unlike oil, the gold price recovered in April after a difficult month in March, when most financial markets fell. As we argued then, the performance was the result of mass selling of assets in a rush to boost liquidity.

Gold can still be a good diversifier in broad, multi-asset portfolios due to its typical low correlation with many other assets. The price should continue to be supported by exchange-traded fund net purchases from risk-averse investors, very low interest rates, improving the opportunity of holding a non-interest bearing asset like gold, and central banks’ actions to lift liquidity. While gold won’t drive long-term growth, it should be able to better preserve wealth during periods of turbulence.


Market Perspectives May 2020

Financial markets have rebounded strongly from a vicious sell-off, following an exceptional policy response to the COVID-19 outbreak. But volatility is likely to be high for some time.


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