As oil soars, can gold recover its shine?

06 August 2021

By Jai Lakhani, CFA, London UK, Investment Strategist

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  • Summary
    • Oil prices have recovered from their COVID-19 slump, while gold – often touted as a “safe haven” asset in times of volatile markets – loses its glitter, for now at least
    • The price of oil hit a seven-year high as Opec+ talks fell apart in early July. A subsequent deal saw the oil cartel agree to boost output by 400,000 barrels a day between August and December
    • With oil demand expected to rise to pre-coronavirus levels, we see Brent crude – the international oil benchmark – averaging $75 a barrel in the fourth quarter, before falling back to $68 a barrel in 2022 as supply increases
    • Meanwhile, gold has dimmed this year on the post-pandemic economic recovery. However, if the global revival falters and risk-off sentiment returns, the precious metal may soon regain its lustre.
    • Gold is also often touted as an inflation hedge, and could prove useful if inflation soars.
  • Full article

    With economies reopening and demand recovering, supply pressures on oil have increased while investors have shifted away from gold, for now. How much is the outlook for commodities likely to be affected by OPEC+’s recent agreement and rising cases of the Delta variant?

    Crude oil briefly touched six-year highs in July, with Brent hitting $76 a barrel as a result of strong demand, supply-side constraints and lower inventory levels. However, prices have since moderated as the OPEC+ group of the Organization of the Petroleum Exporting Countries and peers agreed to increase production and renewed COVID-19 concerns as Delta variant infections rise rapidly globally.

    OPEC+ mood music sours

    The mood music among the OPEC+ members was that of disarray, as the cartel abandoned its meeting without a deal. The joint ministerial monitoring committee had proposed to increase production by 400,000 barrels per day (kbpd) between August and December, extending the current agreement through to the end of 2022 versus April next year.

    The objection to this came from the United Arab Emirates (UAE) which opposed extending production cuts to negotiate a higher baseline output level.

    Last April’s initial agreement left the country’s baseline unchanged from previous meetings, with Saudi Arabia receiving an uplift of almost 400kbpd. It has meant that as a percentage of production capacity, the UAE’s baseline level sits at 80% versus Saudi Arabia’s 90%.

    UAE gains output concession

    It is worth noting that setting the UAE’s baseline level at the 90% too, would have released around 450kbpd in July, other things being equal. Either way, the recovery in the country’s oil output since the pandemic struck lags other leading oil producers (see chart).

    Thus, in a concession to the UAE, they have been awarded a higher output baseline, to 3.5mbpd from 3.2mbpd, from April 2022. In order to keep OPEC+ unity, Saudi Arabia and Russia’s baseline was lifted by 500kpd, while Iraq and Kuwait had a baseline raise of 150kpbd.

    This means that there will be a 400kbpd increase in output from August until the end of December 2022, which would restore output cuts from the early days of the pandemic by the end of the period.

    With the US entering “driving season”, supplier discipline from American producers and global demand strengthening, there was much pressure on oil prices and inventories which have been depleted rapidly in recent months (see chart).

    Oil demand set to increase

    The agreement should help stabilise both these factors and avoids a split in the wider group. However, it is worth noting that output for the second half of the year still remains tight given the strength of the global recovery. US mobility data shows US travel far exceeding pre-COVID levels in recent weeks and OPEC data points to a projected increase in demand of 5mbpd in the second half of this year.

    Despite some weakness in China and concerns over rising Delta variant cases, recent policy support from the world’s largest crude importer, strong Chinese refineries (see chart) and the increase in vaccinations suggests a significant demand shock, similar to that seen at the beginning of the pandemic, is unlikely.

    We revise our Brent forecast for the fourth-quarter higher to average $75 a barrel. However, given OPEC’s agreement to release more supply than previously forecast and increased supply from non-OPEC producers next year, Brent is likely to average $68 a barrel in 2022.

    Gold loses some shine

    While oil prices have recovered this year, gold has struggled. Risk-off episodes, central bank purchases and inflationary fears helped support gold prices. However, these were insufficient to offset the impact of a more supportive macroeconomic backdrop and expectations that bond yields would rise.

    With investors questioning the momentum behind inflation, there are some arguments that higher inflation expectations could improve gold’s prospects given its inflation hedge credentials. In years when the US consumer price index has exceeded 3%, gold has returned 15% annually on average since 1971.

    However, should central banks hike interest rates, this would be a negative. But a hike remains unlikely in the near term. Additionally, any increase would probably be small and gradual given the potential harming of a rate hike on the economic recovery.

    A continuation of risk-off sentiment and the recovery may reduce investors’ exchange-traded fund holdings in the yellow metal. However, it may also fuel consumer demand for jewellery, especially in China and India.

    Furthermore, we cannot ignore the uncertainty over the recovery and the pandemic. With cases of the Delta variant soaring and the potential for tighter restrictions once more, to counter the virus, sentiment can turn negative quickly and play to gold’s status as a safe-haven asset (see chart).

    Ultimately, gold can protect portfolios during volatile periods. Complementing it alongside riskier assets therefore makes sense. However, the precious metal is unlikely to provide significant upside in the long term.


Market Perspectives August 2021

Financial markets remain in upbeat mood despite rising inflationary pressures and the increase in coronavirus cases due to the Delta variant.


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