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The oil price follows the gold price higher

Until recently, oil prices and gold prices tended to follow a similar pattern, as evidenced by the table below. The basic factors for these prices differ, of course, but over my many years I have come to expect the two to rise together, sometimes disappearing together and decreasing in pace – as illustrated by the following diagram:

Gold versus oil correlation (blue is gold, orange is oil)

The price of gold continued to rise while oil prices fell. We all know the reasons:

  1. OPEC + seemed determined to take out the slate producers in the US without facilitating excessive production.
  2. COVID-19 catastrophically managed to disrupt supply / demand

When I first bought some gold stocks, the sector was washed out and the companies could not raise any capital. Things have changed dramatically in recent months.

“Canada’s junior gold mining sector is heading for its best year of financing in almost a decade as companies take advantage of rising gold prices to recharge cash and advances with long – delayed exploration and development projects.”

Globe & Mail July 27, 2020

Lack of investor interest is the best “buy” signal I have used in decades. It was a lack of interest that inspired me to look at the gold sector when I did. The price of gold crept higher but no one seemed to care. My own reasoning was that the opportunity costs (interest) to hold gold were negligible and that demand would respond.

We are at that point now in the oil sector – where, despite the stability of the oil price, the shares are of little or no interest to investors. Junior energy companies are struggling to raise capital – after all commodity stocks have swelled (commodity stocks are well above their 5-year average levels) and demand is limited by COVID-19 right?

But all the right things work against stronger oil prices (basic). Back in April, Saudi Arabia and Russia began production cuts, and most other OPEC + countries finally signed up; reigns in the supply of crude oil. The group can even be confident enough now to ease these restrictions – create a buying opportunity for the energy sector.

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

Most of what they hoped to achieve has succeeded, as US production has dropped dramatically, according to the Energy Information Administration.

What is the catalyst for energy stocks to bounce back and resume their relationship with the gold price? We already see that production and development are declining by most companies, and OPEC + has shown the discipline necessary to rebalance supply and demand in time. Commodity stocks are absorbed as economies continue to reopen and global trade picks up steam. It is inevitable that the oil price will continue to rise from current levels and the gold to oil ratio will return to lower levels (ie the denominator will rise).

Gold-to-oil Graphics

Source: macrotrends.net

What happens if the gold price (the numerator) falls? Gold has managed to break through the $ 2000 barrier, and with the seemingly never-ending onslaught of liquidity from central banks, a decline in gold seems unlikely in the medium term. As long as the opportunity costs of holding the precious metal are negligible, it is likely that the price of gold will remain fixed for the foreseeable future, even if the big gains have already been made.

ChartData from YCharts

My own method is to take some profits in the yellow gold and invest the proceeds in black gold. There are still solid signs that the economies are recovering, which is good for Texas Tea.

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

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