Gold up hills and to the sky, Oil not so.

Gold up hills and to the sky, Oil not so.

Paris, February 25th, 2011

Would the history of mispricings and ill-timed predictions repeat itself?

Just as many may have forgotten that some respectable and well respected market thinkers-and-movers had shaken the world of investors and punters in the summer of 2008 by predicting that oil barrels would reach a frightening level of $ 180, after it broke $ 120 on the way up… I can’t help but grin today, reading such headlines as “Catastrophy Scenario: $ 220 per barrel?”
I won’t elaborate on the fact that last time around, it tanked from a top of $ 146.78 down to $ 33.20 only 6 month later, and that 5 years ago it was evolving in a tight range between $ 22 and $ 28 per barrel, before steaming ahead up to $ 90 without anybody caring overly.

Agreed, we had to weather a shock of unknown magnitude just as the oil benchmark was reaching new altitudes. But then, didn’t they see it coming? Were they blinded to the extent of ignoring the then-current economic conditions and being long? I don’t think that’s what we got to believe afterwards… Agreed, this time around, irrespective of how corporates are doing and how consumers are going to behave when faced with leverage versus free credits, unemployment versus rebound, we are confronted to another type of unique crisis.

What is spreading in the Arabic World and in the Middle East, what could shake the African Continent and some Asia regimes, is stunning by its speed and its impact. Another few OPEC heavyweights down, and millions of barrels a day could evaporate from current oil production. Point taken.

But then, what about production overcapacity, storage shortages and tankers circling around filled-up to the wazoo? Let’s keep in mind that the global demand has never exceeded the offer and that past tensions came from some mismatches in quality and delivery dates. And while bituminous sands are extensively developed for production at costs of $ 60 to $ 80 per bbl, additional Saudi oilfields can still be put into production at extraction costs around $ 6 per bbl, and within a few weeks. That’s 4 million barrels a day, out of the additional capacity of 5.5 to 6 million barrels that could be pumped daily. Taking a step back, the world equilibrium has changed, while OECD economies have stalled. The drivers of the cycles of the demand for oil and energy are now the economic cycles of the emerging and developing nations. The double digit levels of growth that can be witnessed in India and in China, over 10% when including cash and inflation, create a strong growth in their needs for energy and commodities. Those resources being non-renewable, current oil prices underpin exploration and production programs into oil resources that are much harder and more costly to extract, with a heavier technological content than 10 or 20 years ago.

Oil prices may spike as a reaction to unrest and short-term panic amongst some leveraged players. Nevertheless, oil levels won’t be on the rise predominantly as a reaction to short-term unbalances, but to respond to a constantly rising structural demand and to higher R&D investments and heavier production costs.

On the other hand, Gold prices can keep rising reasonably free and without any geopolitical and macroeconomic considerations and consequences. Gold is a simple and homogeneous precious metal that has no “alternative”, and for which we can only access limited resources, a large part of these still not economical to mine. Furthermore, the stocks of Gold and its historical production to-date are minimal. The price of Gold may temporarily consolidate and take a breath in is ascension, but with the current continuation of a natural strong demand and a limited offer, and underpinned by the swings of volatility, by the inevitable low interest rates and quantitative easing programs, and by a low US currency, the price of Gold may temporarily consolidate its ascension, but will need to its seems most likely to reach $ 2500 per ounce within a year.

E.DRUJON, MD