Dobbes (< 20)

A Commodity Staged to Outperform Gold

December 14, 2009 – Comments (3) | RELATED TICKERS: GLD , USO , XOM

A Commodity Staged to Outperform Gold

There has been a lot of talk recently about an impending bull rally in gold.  India and China are looking to increase their gold inventories as they attempt to distance themselves from their dollar holdings.  Many investors anticipate gold prices to rally on these demand pressures.  Futures contracts peg contango for gold roughly on par with copper -another metal facing high demand pressures in China and India as buildings are constructed and electrical infrastructures are developed.

However, there is nothing priced in to the futures contracts for either of these commodities that hints of an impending explosion in prices.  Using the January 2010 contracts as a base,  the October 2011 contracts carry roughly a 2% higher price.  That price includes expected inflation as well as storage costs, meaning the expectation of a rally in prices is lackluster at best.

Not all investors increasing their exposure to gold are doing so because they anticipate prices to improve; many are using gold as a purely defensive measure against forecasted inflation and financial panic.  However, there is another commodity that has a similar defensive profile to gold.  This commodity is an integral element in economic development and expansion, and the forward pricing over the same January 2010 to October 2011 period is an incredibly bullish contango of 18%.  That commodity is oil.  

So what exactly is occurring in oil futures that has them priced with such a large expectation of price appreciation?  Net positions for Large Speculators are close to a five year high while Commercial Hedgers hover near a five year low.  Hedge funds and funds like USO are holding large amounts of contracts relative to the open interest, effectively inflating the forward curve for oil.  Does this mean that this is a sucker's rally?  Not necessarily...

At some point, oil producers will have to begin to replenish their derivatives books to hedge their future production.  When that happens, they will begin shorting  contracts.  Producers have a long ways to climb before they reach their historical position levels.  There is an extreme reluctance by producers to lock in prices at this level.  Producers must also be anticipating a rise in prices -a rise above the current speculator-inflated forward rates of 18%!  That begs the question, why bother with gold, when oil has the same defensive qualities and better projected returns?