Oil Price Will Follow Gold Price Higher

Until very recently, the oil price and gold price tended to follow a similar pattern, as evidence by the below chart. The fundamentals driving these prices differ of course, but over my many years I’ve come to expect the two to rise together, at times languish together and decline in tandem – as illustrated by the following chart:

Gold versus Oil Correlation (Blue is Gold, Orange is Oil)

The price of gold kept rising, while oil prices plummeted. We all know the reasons:

  1. OPEC+ seemed determined to put the shale producers in the US out of business, facilitating excessive production.
  2. COVID-19 managed to upset the supply/demand balance catastrophically

When I first bought a few gold stocks, the sector was washed out and companies were unable to raise any capital. Things have changed dramatically in recent months.

“Canada’s junior gold mining sector is on track for its best year for financing in nearly a decade as companies take advantage of soaring gold prices to load up on cash and advance long-delayed exploration and development projects.”

Globe & Mail July 27, 2020

Lack of investor interest is the best ‘buy’ signal I’ve used over the decades. It was lack of interest that inspired me to look at the gold sector when I did. The price of gold was creeping higher but nobody seemed to care. My own reasoning was that the opportunity cost (interest rates) of holding gold was negligible and that demand would respond.

We’re at that point now in the oil sector – where despite the stability of the price of oil, the stocks are of little or no interest to investors. Junior energy companies are struggling to raise capital – after all crude inventories are bulging (crude stocks are far above their 5-year average levels) and demand is constrained by COVID-19 right?

But all the right right things are working towards stronger oil prices (fundamentals). It’s common knowledge that back in OPEC+ has done a good job reigning in the supply of crude. Back in April, Saudi Arabia and Russia instituted production cuts, and most other OPEC+ nations eventually signed up. The group might be confident enough now to ease those restrictions – creating a buy opportunity for the energy sector.

Saudi Arabia, the world’s largest oil exporter, and other major oil-producing countries are likely to increase their output in August, as coronavirus lock-downs ease and demand begins to rise again. (Source: New York Times).

Most of what they hoped to accomplish has succeeded, with US production having fallen dramatically according to the Energy Information Administration.

What will be the catalyst for the energy stocks to bounce back and resume their relationship with the price of gold? We’re already seeing production and development being curtailed by most companies, and OPEC+ has demonstrated the discipline necessary to re balance supply and demand in due course. Inventories of crude will be absorbed as economies continue to reopen and global trade is picking up steam. It is inevitable that the oil price will continue its climb from current levels and the gold to oil ratio will return to lower levels (i.e. the denominator will rise).

Source: macrotrends.net

What if the gold price (the numerator) declines? Gold has managed to break through the $2000 barrier, and with the seemingly never ending onslaught of liquidity provided by central banks a decline in gold seems unlikely in the medium term. As long as the opportunity cost of holding the precious metal is negligible, it is likely the price of gold will remain firm for the foreseeable future even if the big gains have already been had.

Data by YCharts

My own approach is to take some profits in the yellow gold and invest the proceeds in black gold. There continue to be solid signs that economies are recovering which bodes well for Texas Tea.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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