Oil could start to outperform gold sooner rather than later

JOHANNESBURG – Gold is a spectacular winner in the carnage on most markets as a result of the Covid-19 outbreak. In stark contrast, oil is the spectacular loser.

The gold price has been in a rising trend against the oil price since 2004, but what is remarkable is that the deviations from the trend follow the trend of CBOE VIX – a popular measure of market risk and investor sentiment as it is based on market volatility. 

Yes, sometimes it is more pronounced than other times due to underlying supply and demand factors. Currently the deviation from the long-term trend is at the highest level since 2004 and matches the elevated VIX which find itself at similar highs as during the global financial crisis in 2008/09.

Graph 1: It is impossible to estimate the potential duration of the Covid-19 crisis. All I know is that stock market volatility will remain at elevated or anxiety levels. The big question is will gold continue its superior performance relative to oil?

According to Rystad Energy, an independent energy research and business intelligence company, the weighted average break-even Brent crude oil of producing fields in May 2019 was $26 (R458) per barrel in 2019 money terms. Yes, spot on the price at the close of business on Friday. I will not dispute the fact that the current glut of oil in the market due to falling demand may push prices lower. The range of break-even prices is between $12 and $40 per barrel. It can therefore be expected that production will soon be curtailed due to financial difficulties. Yes, supply will adjust to demand and prices will stabilise. Bear in mind that the oil price is currently at a 17-year low – so, how low can it go?

One of the ratios I use as an indicator of equity market risk is the gold price in US dollars relative to the MSCI Emerging Markets Index in terms of US dollars.

Not only is the ratio highly correlated to the CBOE VIX but it also gives an indication of the investment demand for gold, made up from gold bars, coins, exchange traded funds and central bank purchases. The ratio currently exceeds the highs during the euro crisis in 2011/12 and indicates demand of up to 700 tons in the first quarter this year, up from about 400 tons in the final quarter last year.

Source: iol.co.za