THE INDELIBLE LINK BETWEEN OIL AND GOLD

about 17 days ago
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Right now, equities are down, oil is slumping every day, realty is down. The only price moving up is that of gold. And this is normal – when everything else is down, it indicates increased uncertainty and that means gold becomes the safe haven. So the very same yellow metal which was shunned by everyone and analysts were talking big about price hitting new lows, is now suddenly back in the limelight.

First oil – rising oil inventories in USA, trade war and global slowdown are pushing oil prices lower. On Tuesday, US Energy Information Administration lowered on its oil demand outlook for 2019 to 1 million barrels per day. This comes on the back of EIA cutting its 2019 oil demand growth forecast by 70,000 bpd. Its 2020 forecast for global demand growth increased, however, by 30,000 bpd to 1.43 million barrels per day.

Yesterday, WTI was trading at $51. (-3.67%), while Brent crude was trading at $57.10 (-3.12%) – lower than the psychologically important $60 threshold. What is pertinent to note here is that oil prices are down despite OPEC curbing production, oil tankers being seized near the Strait of Hormuz, and foreign countries ending warships to protect their vessels.

And to top it all off, yesterday, USA reported a surprising increase in its crude stocks by 2.4 million barrels in the last week, compared with analysts’ expectations for a decrease of 2.8 million barrels.

Now to price of gold. On Wednesday, gold prices continued to head north and reached a level of $1500 per ounce. In India's futures market, October futures have already seen levels of Rs 37,800 per 10 gram, and analysts are eyeing the Rs 40,000 level by December-end. And the blame finger is pointed at only one – consistently falling crude oil prices.

There is an indelible relationship between the prices of gold and oil. When oil falls, gold will rise and when oil rises, gold will fall. And this is not just a coincidence; there is a very logical reasoning to this correlation between the two.  Usually gold is used a hedge against inflation which is spurred by oil – when oil prices rise, gold prices also rise. But the anomaly here is that when oil prices fall, along with equity, there is a need for investors to run to something rock solid, which will give it the cushion from the fall. And that is where gold comes in. So when oil slumps, the need to use the yellow metal as a hedge comes down but becomes a tool for safer haven – demand for gold is more out of a sense of security though demand as a hedging tool falls.

But there is another school of thought – if oil price rises, gold price also rises as rising oil price indicates inflation, which in turn leads to increase in price of almost all commodities. Yet, this is again not really a waterproof correlation as in 2014, even when oil was over $100/barrel, gold was down. Thus one cannot really say that oil prices and gold always move either in tandem or inversely. Gold is one commodity which is driven purely by sentiments – the moment there is uncertainty, global turmoil, fear of economies hurting or slowing, gold immediately shoots up. Gold is always an anchor against stormy weather, the go-to metal when the risk is high.

For now, we can only sit and watch – the slump of oil and rise of gold. And equities? Companies which will benefit directly from falling crude prices are mainly upstream oil companies like ONGC, Oil India and less OMCs. These are the obvious gainers. Other big gainer would be paint companies like Asian Paints, Kansai, Berger and Shalimar as 25% of their raw material cost is from a crude derivative and when that price reduces, margins will improve. Analysts say that a 10% fall in crude oil price will boost margins by at least 200 bps. Another gainer will be tyre companies which also uses crude derivatives in its raw material -  in fact it has the double advantage of falling rubber prices too. Sintex is also listed as a big beneficiary as cost of its crude oil polymer, to make plastics will come down. Packaging costs will come down as it also uses petroleum derivative and that means better margins for Essel Propack and even FMCG companies. Airline stocks will also do well as falling crude will help better their balance sheets – a 10% fall in crude will lead to a 300 bps rise in EBITDA margins.

And gold? The prices are expected to be volatile as globally things remains volatile. It is prudent investing norm to have 10-12% of the portfolio in gold. But instead of gold directly, maybe you can take a look at the currently open Sovereign Bond Scheme 2019-20 – Series III, which closes on 9th August. The FV of each bond is Rs.3499/gm and if you apply online, you can get a Rs.50/gm discount.

 

Just for knowledge

Brent crude is a combination of crude oil from 15 different oil fields in the North Sea, lighter than West Texas Intermediate (WTI). ‘Light’ refers to density of oil – lower the density, better is the blended fuel quality. It is best for making petrol. It is primarily refined in Northwest Europe, and is the major benchmark for other crude oils in Europe or Africa.

WTI is the other major global benchmark oil for price setting and is actually of better quality than Brent. It is extracted from wells in the United States and is considered to be a very sweet and very light crude oil. A major drawback is that it is landlocked meaning that transportation is more expensive and more involved than it is for a waterborne crude oil such as Brent. 

Brent blend is generally priced at about a $4 per barrel premium to the OPEC Basket price or about a $1-2 per barrel discount to WTI.

 

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