Gold
Gold is used in jewellery, in industry, as an investment and as central bank reserves, and it is one of the largest traded commodities on commodity exchanges worldwide. Two ideas explain its behaviour: it is an inflation hedge, and it is a safe-haven asset because it is a store of value. When other asset classes, equities, bonds and currencies, are underperforming in economic turbulence, investors turn to gold. Historically and statistically, the syllabus says, gold carries an inverse relationship with stocks, bonds and currencies.
Demand by sector: jewellery 47%, investment 24%, central banks 23%, technology 6%. Major producers: China, Australia, Russia, the USA and Canada. Major consumers: China, India, the USA, Germany and Saudi Arabia. China heads both lists.
| Positive for gold | Negative for gold | |
|---|---|---|
| Monetary policy | Expansionary (rate cuts) | Contracting (rate hikes) |
| US dollar | Weaker | Stronger |
| Economic data (GDP, labour, manufacturing, services) | Weaker | Stronger |
| Inflation | Higher | Lower |
| Supply | Lower | Higher |
| Demand | Stronger | Weaker |
| ETFs | Buying | Selling |
| Central banks | Buying | Selling |
| Politics | Unstable | Stable |
| Stock market | Bear market | Bull market |
| Bond market | Lower yields | Higher yields |
Every positive on the gold side is a form of worry: weak data, unstable politics, a falling stock market, low yields, high inflation, cheap money. Remember that and the whole table follows.
Crude oil
Crude oil is used for fuel, polymers (plastics), lubricating oil, naphtha and bitumen. The syllabus calls it the mother of the global financial market and black gold, because of its importance to global growth. It is a naturally occurring, flammable liquid found in rock formations. Its products fuel automobiles, trucks, planes, boats and railways, surface roads as asphalt, lubricate machinery and become the plastic in toys, bottles and food wrapping. Distilled at different temperatures it yields bitumen, lubricating oils, fuel oil, diesel, paraffin, naphtha and gasoline. Any supply-demand imbalance in crude raises inflationary concerns around the world.
Crude quality rests on two things: density and sulphur content. West Texas Intermediate (WTI) is a high-quality crude explored and physically traded in the United States, with an API gravity of 39 and 0.24% sulphur, traded on NYMEX. Brent is the pricing benchmark for crude from Europe and Africa, comes from the North Sea in the United Kingdom, has an API gravity of 38 and 0.4% sulphur, and trades on ICE. (The workbook prints the API figures as 390 and 380; the degree sign has been lost, so read them as 39 and 38 degrees. Density is quoted in USD-priced markets as API gravity, the higher the lighter.)
Supply is controlled by the United States and OPEC+, which is the 13 OPEC members plus Russia. The Middle East holds the majority of the world's oil reserves, 48% of all known and identified reserves. OPEC owns almost 40% of the world's crude oil, accounts for 75% of proven reserves, and exports 55% of the oil sold worldwide. Major producers: the USA, Russia, Saudi Arabia, Canada and China. Major consumers: the USA, China, India, Germany and Japan.
| Positive for crude | Negative for crude | |
|---|---|---|
| OPEC production | Limits by the OPEC group | Rise in OPEC output |
| US production | Fall | Rise |
| US oil rig count | Fall | Rise |
| US inventory | Falling | Rising |
| US dollar | Weaker | Stronger |
| Economic data (GDP, industry) | Expansion | Contraction |
| Politics | Unstable, especially the Middle East | Stable |
| Gulf of Mexico weather | Extreme, hurricane season | Stable |
| Stock market | Bullish | Bearish |
A bull stock market is negative for gold (money leaves the safe haven) but positive for crude (growth means demand). Strong economic data likewise hurts gold and helps oil. The dollar row is the same for both: weaker dollar, higher price. Questions that swap the two tables rely on you not noticing.
The day oil cost less than nothing
On 20 April 2020 WTI crude prices fell into negative territory. The May contract was expiring the next day and there was no demand: about 90% of the world was under lockdown to control the spread of coronavirus. WTI is a deliverable contract at Cushing, Oklahoma, and with lockdown restrictions on the movement of oil, buyers holding contracts were not prepared to take delivery on expiry. They sold whatever the price, and the price went below zero, ignoring the cost of production entirely.
A cash-settled contract can expire at a low price without anyone owning a barrel. A deliverable contract obliges the holder to receive physical oil at a specific place. With storage at Cushing full and trucks and pipelines restricted, receiving oil was a liability, so holders paid others to take the obligation off their hands.
The 1973 crisis
Looking back, the syllabus identifies two major oil crises after the Second World War and describes the first. In 1973 OPEC members decided to quadruple the price of oil to almost 12 dollars a barrel, and also prohibited the export of oil to the United States, Japan and western Europe, which together consumed more than half of the world's oil.
- Gold: jewellery, industrial, investment and central bank uses; an inflation hedge and safe haven with a historically inverse relationship to stocks, bonds and currencies. Demand: jewellery 47%, investment 24%, central banks 23%, technology 6%. Producers: China, Australia, Russia, USA, Canada. Consumers: China, India, USA, Germany, Saudi Arabia.
- Gold rises on expansionary monetary policy, a weaker dollar, weaker economic data, higher inflation, lower supply, stronger demand, ETF and central bank buying, political instability, a bear stock market and lower bond yields; the opposites push it down.
- Crude: quality by density and sulphur. WTI, US, API 39, sulphur 0.24%, NYMEX. Brent, North Sea, benchmark for Europe and Africa, API 38, sulphur 0.4%, ICE. US and OPEC+ (13 OPEC members plus Russia) control supply; Middle East holds 48% of known reserves; OPEC owns almost 40% of crude, 75% of proven reserves, 55% of exports. Producers: USA, Russia, Saudi Arabia, Canada, China. Consumers: USA, China, India, Germany, Japan.
- Crude rises on OPEC production limits, falling US production, falling rig counts, falling US inventories, a weaker dollar, economic expansion, Middle East instability, Gulf of Mexico hurricanes and a bullish stock market. WTI went negative on 20 April 2020 because the expiring May contract was deliverable at Cushing, Oklahoma, and locked-down buyers would not take delivery. The first post-war oil crisis, 1973, saw OPEC quadruple prices to almost $12 a barrel and embargo the US, Japan and western Europe.