File image: IOL
File image: IOL

Oil could start to outperform gold sooner rather than later

By Ryk de Klerk Time of article published Mar 30, 2020

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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.

The speculative element of investment demand is very much event-driven and it is the behaviour of the speculators that set major moves in the gold price. To neutralise the impact of the external value of the greenback I use a weighted gold price index. The current gold price index indicates that speculative demand (gold bars, coins and ETFs) could come in as high as 600 tons in the current quarter or 300 tons more than in the fourth quarter last year.

Graph 2: The increased speculative demand and the resultant spike in the gold price index has most likely crowded out price sensitive central bank purchases which are likely to be virtually unchanged from the final quarter last year.

Jewellery demand for gold is also very price sensitive and coupled with the impact of Covid-19 on consumer finances and extremely weak confidence, demand from this source probably fell by more than 100 tons in the current quarter.

While mining supply of gold probably remained steady in the first quarter, the spike in the gold price could have led to a significant increase in the supply of recycled gold. How much recycled gold entered the market due to the shutdown in many countries around the world is uncertain but at this stage it seems that it can be up to 100 tons.

The longer the gold price remains at the current levels, it is likely that more recycled gold will enter the market - as it did during the European debt crisis in 2011/12. So, yes, the increased investment demand will be satisfied by an increasing supply of recycled gold.

Central bank purchases and jewellery demand are the most important factors to underscore the gold price and both of them are subdued.

Furthermore, due to the current flight to liquidity some central banks may turn sellers of gold. So, yes, the fundamental factors are stacking up against gold. How and when they will play out is anybody’s guess.

The oil producers are currently experiencing a demand shock, forcing prices down. On the other hand, the gold market is undergoing a supply shortage, forcing prices upwards. But gold’s fundamentals are slowly but surely weakening, while oil’s fundamentals are improving.


Historically, when the oil price bottoms during a major crisis, gold starts to underperform emerging markets in terms of US dollars. There is light at the end of the tunnel.

Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. He has no direct interest in any company if mentioned in the article. You should consult your broker and/or investment adviser for advice.


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