Written By: Miles Pearson – Forex Focus
As crude oil rallies to its highest level in more than two years, will gold follow suit?
Crude-oil prices have spiked close to 40 percent since June this year, as one crisis after another has embroiled the Middle East over the last few months. The volatility in the region is nothing new as the region’s regimes have been constantly engulfed by internal conflicts, wars and political instability for centuries, mostly triggered by their support for either Shia or Sunni Islamic monarchies, often for personal gain. However, the recent power struggle within the GCC (Gulf Cooperation Council) countries after Saudi Arabia along with the UAE (United Arab Emirates), Egypt, Bahrain, Yemen and four other countries severed ties with Qatar is something not witnessed in a long, long time. In addition, the ongoing war with Yemen, the abrupt resignation of Lebanon’s Prime Minister Saad Hariri from Saudi soil, and the internal power struggle within the Saudi monarchy leading to the detention of a large number of powerful members from the royal family sum up the major ongoing conflicts in the region.
The following graph illustrates the weight of the leading oil-producing countries in the Middle East in 2016, indicating the impact of the present conflicts and the likely outcome on energy prices.
The top seven oil-producing countries in the Middle East accounted for more than 90 percent of the total black gold produced in the Middle East in 2016. Out of the 31 million barrels of crude produced, Saudi Arabia was the largest producer of crude by a long way when compared to the other Gulf States. The most influential country in the region produced more than 12 million barrels of crude per day and was also among the top three producers globally. The other major producers in the region include Iran, Iraq and the UAE correspondingly, with production averaging between 4.0-4.5 million barrels per day. This, in spite of crude-oil prices averaging about $43 per barrel during the year, which is very close to all-time lows for the commodity.
With the rhetoric in the Middle East intensifying every other day, the more moderate countries in the Gulf region divided, the presence of the world’s largest energy reserves in the region has only raised the stakes of a full-fledged war, and unless the international community comes together quickly and finds a diplomatic solution, it could only be a matter of time before the two powerful opposing players, led by Saudi Arabia with the support of a consortium of GCC countries on one side and Iran with support from some of the smaller groups on the other, clash for regional supremacy. The outcome of a war will not only lead to a sharp escalation in human casualties and displaced families, who have yet to come to terms with the death and destruction from the conflicts in Iraq, Yemen and Syria, but the region itself may no longer be the landscape it currently is as most countries in the area will struggle to recuperate from the large-scale devastation caused by a war.
Light, sweet crude oil, which has already spiked close to 40 percent since June this year and is up by more than 100 percent from the 2016 lows of $26 a barrel, will likely see an all-out rally with the 2008 highs paling in comparison. Even in the event of the current crisis not accelerating into a full-blown war, crude prices have certainly found a bottom close to $50 a barrel.
Gold, on the other hand, has not reacted to the extent that crude oil has to the ongoing crisis in the Middle East, although the precious metal, which is still considered a hedge against political instability, is up by more than 10 percent this year. Prices of spot gold, which settled at $1,151 per troy ounce in 2016, were hovering close to $1,270 per troy ounce heading into December after pulling back from the highs of $1,357 earlier this year. Prices of the precious metal have been averaging around $1,257 per troy ounce in 2017, compared to $1,247 in 2016.
The following graph compares the daily percentage changes in the price of gold and crude-oil futures respectively from January 2016:
While gold prices have more or less remained in a tight band from the start of 2016, the escalating crisis in the Middle East has led to massive volatility in crude-oil prices, and at the end of November this year, crude oil has rallied by 55 percent compared to the 20-percent gain in gold. With the two commodities sharing a high positive correlation over the long-term, it won’t be long before gold prices catch up with crude.