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Coronavirus part 2: Pandemic sets gold against oil

March 23, 2020 at 4:31 pm

Coronavirus part 1: Should Russia really declare an oil price war against the Middle East?

Gold prices have risen while that of oil has slumped due to the coronavirus pandemic. The pandemic has taken the lives of over 14,000 people and infected more than 330,000. The death toll in Italy is especially devastating, nearing 6,000.

The value of gold is the highest it’s been in over 5,000 years this week, but this is not a surprise. Due to coronavirus, gold is seen as a safe haven by investors. Therefore, gold’s relative value to copper has surged to its highest in more than a decade and its worth versus silver is the highest on record as the spread of coronavirus hammers metals with industrial applications.

The rapid change in the value of these metals shows the scale of the economic damage investors fear that coronavirus containment measures are causing, putting markets into deep recession.

On the other hand, when we look at black gold – oil – the price of a barrel of oil is lower than $30 and we are witnessing the lowest price of oil per barrel since the Iraqi invasion of Kuwait in 1991. This is mind blowing.

In 2019, experts were saying the demand for oil will increase in 2020. But this pandemic has affected demand. A wise chairman for energy in the Asia Pacific at Wood Mackenzie, an international energy consultancy firm, Gavin Thompson said “2020 has hit us like a fist.”

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Oil prices in last 10 years Source: West Texas Intermediate (WTI)

Oil prices in last 10 years Source: West Texas Intermediate (WTI)

Why does the price of oil keep falling?

Literally, the oil market has been buffeted by three calamities:

More competition: From the relentlessly expanding US shale industry to the endless oil wells of the Saudis, oil has never been more plentiful.

Lack of demand: Oil prices were ok in 2020 even though there was a rift between Iran and the US after Qassem Soleimani’s assassination. But now, the travel ban and global quarantine have severely exacerbated this. People need toilet paper more than they need oil.

Oil price war: When Saudi Arabia, the most influential member of OPEC, decided at its latest meeting in Vienna last week to break its recent strategic oil partnership with Russia and adopt a new policy to maximise production levels, oil prices were at their lowest, the biggest slide since the Gulf War in 1991.

This new policy of the Saudis, which recalibrated global oil markets, gives Saudi Arabia a long-term advantage. This step is very unpopular with most oil exporting countries, international energy companies and American shale producers because collapsing prices will drastically decrease their revenues and, maybe in some cases, push them into bankruptcy.

In addition to this, Saudis can cope with lower prices and can sustain very low prices for a long time as they are producing the cheapest oil in the world at $8.98 per barrel, according to the Saudi oil company ARAMCO’s report. But, in comparison, US shale oil costs $23.35 per barrel while Russian production costs an average of $19.21 per barrel, according to the Energy Information Administration. Therefore, this price war will hit the US and Russia more than Saudi Arabia.

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Therefore, it seems that gold, the most actively traded precious metal, is considered one of the safest investments in the world right now.

Both traders and investors are interested in how its price changes and the factors that drive it.

On the other hand, the movement of the US dollar is one of the critical determinants that influence the price of gold. Gold and the dollar have an inverse relationship: when the US dollar weakens, gold prices go up and vice versa. There are two reasons for this behaviour. Because, like other commodities, gold is priced in dollars. A weak dollar makes gold cheaper, which in turn attracts more demand for it.

In reality, gold is traditionally seen as a less risky asset in uncertain times and the first two months of 2020 have shown a resurgence in geopolitical volatility. Stuart Clark, portfolio manager at Quilter Investors, said investors have been seeking asset classes where they can find some protection against global worries.

This virus shows us that uncertainty, fear and emotional decisions are part of everyday life in financial markets, too. Our habits have started to change due to coronavirus. As human beings we are deeply influenced by the herd. Faced with uncertainty our decisions tend to be more emotional.

In my opinion gold prices will fall even more as investors stockpile cash with a rising number of coronavirus-led national lockdowns threatening to overshadow stimulus measures from global central banks to combat economic damage.

The only positive thing of this pandemic when you compare it with the latest similar versions is that COVID-19 is less deadly than the severe acute respiratory syndrome (SARS), as the fatality rate is 3.3 per cent, compared to 9.6 per cent for SARS. But it is important to remember that the biggest economic costs of pandemics come not from the death rate, but from whether people panic or not. Therefore, do yourselves a favour and don’t count how many days you are into quarantine, it is not prison.

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The views expressed in this article belong to the author and do not necessarily reflect the editorial policy of Middle East Monitor.