January 7, 2020 / 1:43 PM / 20 days ago

Breakingviews - Iran will decide if oil bulls outdo gold bugs

An Iranian man holds a picture of Qassem Soleimani during a funeral procession for Iranian Major-General Qassem Soleimani, head of the elite Quds Force, and Iraqi militia commander Abu Mahdi al-Muhandis, who were killed in an air strike at Baghdad airport, in Tehran, Iran January 6, 2020.

LONDON (Reuters Breakingviews) - All that glitters is not gold. The price of oil shot up even more than that of the yellow metal after a U.S. drone strike on Friday killed Iranian military commander Qassem Soleimani. Tehran’s response will dictate which of the two commodities ends up on top.

Concern that an escalation in Middle East tensions might disrupt oil supply boosted the price of a barrel of crude by nearly 7% from Thursday’s close, to a high of $70.74 on Monday. Safe havens like high-grade government bonds, the Swiss franc, and gold also rose. The price of an ounce of the precious metal on Monday hit $1,582.59, its highest in nearly seven years and up almost 4% from where it had closed on the eve of the drone strike.

A Goldman Sachs model suggests the jump in energy prices can be interpreted as traders pre-emptively pricing in an outage of 800,000 barrels per day (bpd) for three months, or factoring in a 30% chance of a 2.7 million bpd outage for three months. But the Organization of the Petroleum Exporting Countries has some spare capacity. The group only last month agreed to cut an extra 500,000 bpd, and Saudi Energy Minister Prince Abdulaziz bin Salman said at the time that the effective reduction could be as much as 2.1 million bpd, given Saudi would carry on cutting more than its quota. Bringing that supply back on stream would be easier than increasing the supply of gold, which was in high demand even before geopolitical risks flared.

That means the shiny metal, whose price rose about 18% last year, could start outperforming oil if Middle East tensions persist, as looks likely. All the more so since there is no sign of the sort of upswing in the U.S. or global economy that might spell higher interest rates. The lower rates are, the smaller the opportunity cost of holding gold.

The only thing that would scupper the precious metal’s chances of outpacing energy prices is an Iranian attack on Saudi oil fields or an attempt by the Islamic republic to disrupt traffic in the Strait of Hormuz, a major shipping route for crude. Still, even if gold bugs are beaten by oil bulls, their consolation will be that such a dramatic escalation in tensions would also give the precious metal a big leg-up.

Breakingviews

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