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The Push And Pull Of Gold And Oil

Published 07/14/2013, 02:50 AM
Updated 07/09/2023, 06:31 AM
WTI BRENT ARBITRAGE SHOWS THE WAY
On February 8 this year Reuters reported the premium of eastern hemisphere benchmark crude Brent to US benchmark WTI jumped to over $23 a barrel. As of Friday, with WTI prices soaring past $106 a barrel to reach their highest since March 2012, the premium is down more than 90% to $2.15 a barrel. Although it took a while for oil traders to adjust, they did adjust – downward.

The same downward pull of real fundamentals will also apply to the oversized triple-digit dollar prices for both Brent and WTI, but again with time. Another “arb trade”, between physical bullion prices, and “paper gold” ETFs and related instruments is also set to adjust – upward.

In a real sign of the times for oil's longstanding “arb” trading, Goldman Sachs said early last week it had closed its Brent/WTI spread trade recommendation after the ICE Brent-Nymex WTI premium fell below its target of $5 a barrel. Goldman however saved a little face by claiming the premium would be back above $5, sometime.

This may not be the case, due to basic fundamentals. The same surely and certainly applies to gold – where the “arb” now focuses the clash of physical bullion demand, especially strong in Asia, and the supply of “paper gold” ETFs and related instruments.

Oil analysts charting and predicting the now-almost-disappeared Brent premium drew on factors that featured concern about stockpiles of crude at the US Nymex basing point at Cushing, Oklahoma. They also took a look at refinery and pipeline or rail transport infrastructure issues inside North America, but the WTI-Brent spread also reflected big-picture fundamentals, with a major role in determining the directional flow of world crude exports. Bringing in the Baltic Dry Index for shipping freight rates and using the WTI-Brent spread, major Middle-Eastern and African producers decided whether to ship their crude to Asia and Europe, or to North America.

Since 2009, accelerating all the time, the shale energy revolution in the US producing ultra light low sulphur crude and condensates, and the very slow recovery of US domestic oil demand, are signaling a future where eastern hemisphere crude producers will no longer have the luxury of choosing their market. Inside OPEC this threat is taken seriously. Some of the hardest hit members like Nigeria producing very light low sulphur crudes, similar to WTI, are seeing their US-destination shipments fall like a stone – just like the Brent premium.

Brent serves as the benchmark for markets including Europe, Japan, India and China. The long decline in EU27 and Japanese oil demand was more than just compensated, for years, by the ever-growing oil import demand of the Asian Locomotive economies – but that has seriously tailed off. Forward signals are looking negative for Chinese and Indian import demand recovery. Conversely demand recovery potential in the developed countries, we can say, is less unrealistic in the US than in Europe and Japan. The readout is that a discount for WTI has even less reason to exist, taking demand into account.

GOLD UP, OIL DOWN
Gold pushes down and oil pulls up – but pushing or pulling on either of these two strings has limits. In recent weeks we saw gold prices slashed and slashed again. Each recovery was only a false dawn, while oil floated high and free, escaping the commodities carnage. The lifetime for this game, however, is set by fundamentals. Physical gold demand is impressive. Data from Wikileaks and other sources suggest Hong Kong-plus-China buying in Jan 2012-May 2013 printed 1500 tons. Oil demand is conversely a never-ending tale of large stocks, rising output and real world decline in most major markets - countered only by hopeful reports of “recovery coming”, most recently from OPEC.

The potential for a major gold and oil price turnaround is making itself felt. Fundamentals are in no way bearish for gold, but those for oil are even more bearish than they were, for example, in April when prices dipped below $90 a barrel several times. To be sure, once the trading machine runs only in advance mode changes are difficult, as also shown by the big picture of equities, floating high and free from trifling details such as real world economic data, P/Es or the Fed's taper down threat.

Like equities and oil for the bulls, the gold price rout for the bears reinforced itself with the easy money made from the one-way-down story of bear attack.

For oil, the Speculators have added a premium to oil prices and car fuel costs at the pump, maybe enough to seriously influence consumer habits this summer driving season, but they have also set a discount price window for gold. In Asian markets, notably, gold at bargain prices has proven, and is proving attractive – while Chinese and Indian buying of “classic commodities” like iron ore and oil have wilted. Add in China's now serious and open banking solvency issues, plus its “shadow banking” crisis, and physical gold buying by private citizens is easy to understand.

Other blowback from an emerging currency crisis of emerging market economies is a likely boost to the dollar. Surely to the discomfort of Ben Bernanke, a stronger dollar will add its own headwinds for the Brent and WTI price in dollars.

Overall, headwinds for the oil market are numerous. The BRIC-emerging markets commodity supercycle theme, the supposed unstoppable growth of China's oil demand, the supposed unstoppable US dependence on oil imports, the always weak US dollar, the disconnect between supply-demand fundamentals and oil prices - are all under attack and new paradigms are emerging. Current oil prices are unrealistic to say the least. WTI in the high-eighties, Brent about the same, and gold closing back to $1500 are the outlook – but the timetable for adjustment can be rapid - or can be slow.

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