Oil and gold markets diverge

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

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.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This document has been issued by the Investments division at Barclays Private Banking division and is not a product of the Barclays Research department. Any views expressed may differ from those of Barclays Research. All opinions and estimates included in this document constitute our judgment as of the date of the document and may be subject to change without notice. No representation is made as to the accuracy of the assumptions made within, or completeness of, any modeling, scenario analysis or back-testing.

Barclays is not responsible for information stated to be obtained or derived from third party sources or statistical services, and we do not guarantee the information’s accuracy which may be incomplete or condensed.

This document has been prepared for information purposes only and does not constitute a prospectus, an offer, invitation or solicitation to buy or sell securities and is not intended to provide the sole basis for any evaluation of the securities or any other instrument, which may be discussed in it.

Any offer or entry into any transaction requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding transaction documents. Any past or simulated past performance including back-testing, modeling or scenario analysis contained herein does not predict and is no indication as to future performance. The value of any investment may also fluctuate as a result of market changes.

The value of any investment may also fluctuate as a result of market changes.

Neither Barclays, its affiliates nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation..

This document and the information contained herein may only be distributed and published in jurisdictions in which such distribution and publication is permitted.  You may not distribute this document, in whole or part, without our prior, express written permission. Law or regulation in certain countries may restrict the manner of distribution of this document and persons who come into possession of this document are required to inform themselves of and observe such restrictions.

The contents herein do not constitute investment, legal, tax, accounting or other advice. You should consider your own financial situation, objectives and needs, and conduct your own independent investigation and assessment of the contents of this document, including obtaining investment, legal, tax, accounting and such other advice as you consider necessary or appropriate, before making any investment or other decision.

THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.