Turmoil In The Oil Market Has Pushed Gold Prices Up; Is The Rush Sustainable?

Turmoil In The Oil Market Has Pushed Gold Prices Up; Is The Rush Sustainable?

The weekend started with a drone strike against Saudi Arabia's oil-processing facilities and ended with an unprecedented turmoil in the oil market, as Brent Crude Oil futures spiked approximately 20 per cent. This turned the global market in the expected direction, with bonds rising, Gold surging, stocks plummeting, and investors taking a more risk-averse stance.

Before the drone strike hit Saudi Aramco's oil facilities, September 2019 has so far witnessed a classic trend reversal, with stocks outperforming bonds, the bond yield curve moving out of the inversion and yellow metal on course to paring gains which it accumulated amid heightened trade spat and increased prospects for a recession-like situation. In simple words, it was a shift toward optimism.

Soon after the drone strike jolted the investors’ sentiment, Gold prices registered a trend reversal on the daily price chart and started moving higher, and the Oil-shock compelling investors to bag the safe-haven yellow metal. Gold Futures for delivery were trading 5.85 points or 0.39% lower at $1,505 an ounce at the Comex Exchange as on September 17, 2019 (at 09:46 AM GMT), and Gold Spot was quoting 5.13 points or 0.34% higher at $1,503.56 an ounce against the previous closing price of $1498.43 an ounce. However, Yellow metal prices were slightly changed during the early trading session of September 17, 2019, as market participants are largely waiting for a quarter basis point rate cut by US Federal Reserve on September 18, 2019.

Spot Gold eased slightly, after rising approximately 1 per cent in the previous trading session in the wake of trade tensions panning out in the Middle East.

However, the market is eyeing for new catalysts; mere 25 basis point rate cut is already priced in, but market participants are looking towards the forward guidance. The next rate cut will be the central bank's second such cut post a rate cut recorded in the July 2019 for the first time after the financial crisis hit in 2008.

The market will examine Federal Reserve's new economic projections closely, and If it turned against expectations, there are strong possibilities that we may witness a near-term reversal in the yellow metal prices.

Attacks on the Saudi Aramco's oil-reserve facilities in the weekend is also weighing on the policy decision equation, which has prompted US President Donald Trump to put more pressure on the Federal Reserve to lower interest rates. On September 16, US President wrote on Twitter, "It looked like Iran has exercised this drone attack against Saudi Arabia’s oil facilities but emphasised that it did not want to go to war.”

However, during the September 17, 2019 market session, the international crude oil benchmark Brent Crude Oil Futures eased marginally by 0.53 points or 0.77% to $68.49/bbl after registering a day’s high of $71.95/bbl in yesterday’s trading session. And the United States crude benchmark West Texas Intermediate (WTI) eased by 1 point or 1.62% to $ 61.68/bbl.

Oil prices have been notably volatile this year. This was driven by the United States’ sanctions on Iran and Venezuela. These countries have warned cutting oil supplies. Saudi Arabia is the largest crude oil producer in the Organisation of Petroleum Exporting Countries (OPEC) block. It has worked hard to fix oil prices, with little success. The OPEC and its allies, particularly Russia in December 2018, said they would reduce the oil output by 1.2bbl/day, and Saudi Arabia has reduced its own output by more than it promised as other OPEC member countries have kept up the pressure. Despite that, the oil prices have witnessed steep volatility. The rise of shale oil supplies in America, which has as the world’s largest oil shale deposits at 301 billion metric tons, has made it even harder for OPEC to control global oil prices. This has also accentuated the tense relationships between Iran and the United States. However, President Donald Trump of the United States also said that there is plenty of oil, and if needed, he is authorised to release the emergency oil stocks in an effort to cool down prices.

FTSE 100 vs Gold

The broader equity benchmark of the UK, the FTSE 100 index is a portfolio of 100 large-cap companies by market capitalisation listed on the London Stock Exchange. Following a drone strike against the Saudi Aramco's Abqaiq oil-processing facilities, located in the eastern Saudi Arabia, which resulted in oil prices skyrocketing in a single trading session, the FTSE 100 index  ended the September 16, 2019 trading session 46.05 points or 0.62% lower against its previous closing level. However, as oil prices eased on September 17, the index was quoting 9.65 points or 0.14% higher against the previous closing level. Oil and Gas sector has 20.3% weight on the London’s FTSE 100 index, which indicates it is highly exposed to the volatile crude oil market.

However, the index has not surged in proportion to the surge in gold prices over the year-ago period, but still at this juncture an investment in FTSE 100 companies is relatively lucrative bet against investment in the yellow metal. The broader index is trading at lower valuation against the global peer indices like S&P 500, DAX, and Hang Sang with substantially higher dividend yield.

The return on Gold only depends upon appreciation in its prices, and gold investors cannot earn any recurring income from gold investing; also, the metal has recorded a humongous price surge in the past couple of months, so the potential upside is very limited.

The root cause behind steep surge in Gold prices in 2019, is trade spat between the world's two large economies US and China, which invoked fears of a global meltdown similar to the 2008 financial crisis. Recently, a positive development between US and China trade war began to push Gold prices down, and since the start of September 2019, Gold was on the course of a decline, but on September 14, 2019, after the attack on the World's energy market, the gold prices began to surge as investors continue to shift to safe-haven assets amid heightened trade tensions in the Middle East. But this is going to be temporary, and Gold will sooner be on the course to correction.

So, investing in Gold at this point of time cannot be lucrative as it is at $1,500 an ounce level. On the other side, FTSE 100 index companies are carrying the high potential to reward investors with decent capital appreciation and dividend income as well. There are many fundamentally strong FTSE 100 constituent companies, which could provide higher capital appreciation and higher dividend income. They are already trading at a discounted valuation against their global peers. Also, the downside risks with the FTSE 100 is limited as compared to the S&P 500 stocks.

Stocks across the globe, except in London, have participated fully or partially in the recent bull rally, but UK stocks were by far laggards during the recent bull run, as Brexit related headwinds dragged them down. Also, the UK's stocks have also discounted to a large extent the ongoing US-China trade spat, which makes us believe that the investment in the UK's stocks at this juncture is by far much better suited against Gold, with relatively lower downside risks vs Gold.

With Bank of England reducing the interest rates to a historic low level, the spotlight is back on diverse investment opportunities. 

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