Time for gold and its virtual cousins

Topics Gold  | Bitcoin | Silver

Let’s suppose a trader focused on gold, copper, oil and Bitcoin — four commodities with different profiles. Gold and Bitcoin vary inversely with economic uncertainty. The more unclear and risky the future, the more bullish interest there is in these two. Copper and crude oil have a direct relationship with growth. 

This quartet has one important characteristic in common: Supply is not easy to change. Bitcoin is designed with a mathematical cap on supply. The other minerals are mined. Even if a vast new source of these three minerals is discovered, it will take large investments and plenty of time before that deposit can be tapped. 

Given inflexibility of supply, prices swing huge amounts for relatively small shifts in demand. Oil is the extreme example of price being moved by demand changes. There's an anticipated global over-supply of about 10 per cent and prices have dropped by 60 per cent.  

In the calendar year, gold, copper, oil and Bitcoin have moved in different directions. Gold is up about 6 per cent in US dollar terms. Bitcoin is back around the same levels it was in early January 2020, after swinging up 30 per cent in January and crashing through the next 10 weeks. Oil is down 60 per cent, while copper is down 18 per cent since January 1, 2020. 

Although there’s plenty of speculative volume in copper and oil, these are essential industrial commodities, which means there is a foundation of fundamental demand. The speculation builds on top of fundamental trends.  Industry analysts can track demand by looking at the order books of electrical equipment and telecom equipment makers and real estate activity for copper. Energy analysts can look at transport sector data, industrial demand for petrochemicals and fertilisers, etc. 

Gold has a tiny industrial profile. Analysts look at trends in the jewellery market, and at central bank stances, which do offer fundamental clues. The speculative element is large. Bitcoin is almost entirely speculative – its major utility is in facilitating cross-border transactions, often of an illegal nature. These two commodities are sentiment-driven to a fault. They are also, of course, tied to currency movements and they tend to gain when there is high volatility in currency markets.  

Oil could stay down for an extended period given that the global economy is clearly suffering. Negotiations for production cuts will continue but the geopolitics are complicated. A simplistic analysis shows oil producers can easily gain by just cutting production. If a 10 percent cut in supply leads to a doubling of price, the math seems to obviously indicate cuts are needed. 

But game theory suggests there will always be an incentive for a given oil producer to pump more. Say, an agreement is reached where the Organization of the Petroleum Exporting Countries (Opec) and Russia cut production and prices rebound. At that stage, every oil exporter will have the temptation to pump more to try and cash in. If any one increases production, the others will also pump more and the agreement will break down.  

There is the added issue of US presidential elections. The oil industry is a major employer in states like Texas, Alaska, Oklahoma, North Dakota, New Mex­ico, Colorado, etc. Low oil prices mean higher unemployment in these states. Texas, Alaska, North Dakota and Oklahoma are Republi­can strongholds. Unem­plo­­yment could hurt Donald Trump's re-election campaign. This factor could influence OPEC negotiations, depending on Russian, Iranian and Saudi preferences.

The geopolitics of copper are much less complex than that of oil. There are fewer producers. China is a key player, as is Peru, Chile and the USA. There is no cartel like Opec. Demand is down but any demand recovery will lead to a straightforward impact on price. 

Any rebound in the global economy will mean a stronger demand for copper and oil. But currency volatility is also likely to continue due to the uncertain situation. This means gold, and its virtual cousins like Bitcoin and Ethereum, will see an upside too, until there is clarity about the type and extent of economic recovery.  

Commodity watchers will be waiting for a rebound in industrial demand and copper is a good generic proxy for that. Oil is likely to go down as there’s going to be over-supply. OPEC is unlikely to be able to negotiate sufficient production cuts. Gold and Bitcoin (and Ethereum) will probably go up.

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