Black gold²

ABERDEEN, SCOTLAND – I told you about my bullish view on oil last week – I think we’re due $100 a barrel this year. Further to that note, there’s a snippet of research from Charlie Morris over at The Fleet Street Letter Wealth Builder that I’d like to print in today’s letter (without revealing any of the goodies that paying subscribers get).

As he’ll show you, the oil price forms half of an indicator which has accurately predicted what is arguably the most important piece of information for any investor: the future value of money itself.

Before we get to that though, a little note on the bitcoin all-time high we hit over the weekend. Sixty thousand bucks, huh? And just think: a year ago to the day, it was less than $5k! As I’ve written in recent letters, I think the final stage of this bull cycle is upon us – a brutally parabolic move higher before the ass falls out of the market and the cycle restarts.

But more on that later in the week – you should take a look at this in the meantime if you haven’t yet.

For now, I’ll leave you in Charlie’s capable hands…

The gold canary in the oil well

An excerpt from a recent issue of The Fleet Street Letter Wealth Builder

Oil and gold prefer high inflation for different reasons. A rising oil price is normally the leading source of inflation in the real economy when the economy is expanding. It has the negative effect of increasing the cost of goods and transport.

In contrast, a rising gold price has little impact on the real economy, jewellery shops excepted, yet reflects monetary inflation. That is, the gold price reflects the future value of money by digesting and anticipating monetary policy. If interest rates are higher than inflation, then cash deposited at the bank will be a store of value. Under these conditions, the gold price will weaken. Yet if rates are below inflation, as they are today, then the future purchasing power of your money will slowly be eroded. Gold performs strongly under these conditions.

Yet these conditions exist today, and the price of gold has eased since last summer. I shall update you on my thoughts. But before I do that, I want to show you how closely the gold and oil combination lead official inflation data. Hat tip to James Fergusson, a former editor of The Fleet Street Letter, who came up with this idea. It’s simple, yet powerful.

Gold and oil drive inflation

If we put gold and oil together into a 50/50 basket and track their price, we find a remarkable correlation: the gold/oil mix seems to have been a leading inflation indicator. Right now, the gold/oil mix is 34% higher than a year ago (RHS), which would historically align with a 3% CPI (LHS). In other words, inflation is currently being underestimated by financial markets, because they are still seeing 1.4% (the last published number), and continue to believe upward pressures on inflation are low, or at least temporary.

I believe the oil price will rise as the world gets back on the move. Oil primarily drives transport, and so it is unsurprising that the price has been so weak in 2020 when we have stood still during lockdown. But once we take off into 2021, the demand for oil will continue to rise. That can be demonstrated by looking at oil inventories. This chart shows the typical annual inventory cycle since 2014, shown by the black line.

You would normally expect to see oil inventories rise into the spring, as demand falls at the late stages of winter. It then peaks ahead of the summer “driving season” when demand rises, and inventories fall into the autumn, when the holidays come to an end. The summer is the period when maximum oil is consumed, as its primary use is transport. Inventories then rise ahead of the winter demand for heating, which peaks in November. And the cycle repeats itself year after year.

Oil inventories are falling

Global oil inventories set new records in 2020 when the world stopped, as the driving season failed to materialise. For a short while, there was a glut. Yet despite that, as 2020 ground on, the record inventories started to creep back down towards the average since 2014. This carried on into 2021.

And that’s the story. Oil inventories are falling sharply at a time when you would normally expect them to be rising. Not only is the glut behind us, but the suggestion is that the oil market is tightening (more demand than supply). If this trend continues, people will realise that low oil prices are not a right, but a blessing.

In part, this is a demand story as the world’s population grows, and the emerging nations become more affluent. But it’s also a consequence of the environmental, social, and governance agenda (ESG). Large oil companies are investing in renewables rather than exploration. It is hard to find many that are still exploring, such is the associated stigma. With less supply, and ever-growing demand, the upward pressure on the oil price may last much longer than many people think.

The good news is that if you want to build a renewable world, high oil prices are a blessing, because it forces change. No longer do we need to rely on government policy to implement change, because it becomes everyone’s problem. When the whole of society changes its ways, things happen quickly. It is oft said in the oil market that the best cure for a high oil price is a high oil price. Eventually, it takes care of itself. But this time, I expect that to be years rather than months…

All the best,

Boaz Shoshan
Editor, Capital & Conflict

Category: Investing in Gold

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