Oil has had a turbulent 2020 but prospects for the oil markets look encouraging in the shadow of a volatile year for the commodity’s price as the effects of the Covid-19 pandemic hit economic growth expectations.
The price of crude has already seen double-digit gains since the unveiling of vaccines in November. The development lifts hope of a recovery in demand for the commodity this year, as countries roll out vaccination programmes.
When we assess the outlook, it is very important to remember that commodity prices do not anticipate growth but reflect supply, demand, and inventories of oil. On the supply side there are two dynamics to consider: these are the self-imposed supply cut for OPEC+, which we have discussed, and how much the low oil price weighs on the financial health of other producers.
On this front we have seen Brent crude go to its lowest level since 2016. In turn, we’ve seen the number of oil rigs in the US plunge to well below that at the start of 2020. However, inventories are an issue. Despite this, US inventories are still high and in July crude oil stockpiles were more than 20 percent above the five-year average.
They were also over 10 percent above the maximum inventory at the same point over the past five years. We’ve also had production continue now in Libya, and this should add to inventories.
Turning to demand, that in the current backdrop can be tricky to judge. OPEC predicts that demand fell in 2020 to the tune of 9 million barrels per day, and current lockdowns in UK and Europe and surging coronavirus cases in the US are a concern.
However, the vaccine news and the rolling out of it globally, should help oil demand in the second half of 2021.
In sum, short-term investors should look out for a range-bound and volatile oil market, but in the medium to longer term, strong and resilient economic performance in China, the vaccine rollout and economic activity coming back to normal could mean oil ends the year strongly.
We believe that oil prices are likely to remain under pressure until the virus situation turns the corner and demand prospects improve. If we continue the projected patch to market balance, even Saudi Arabia and Russia are unlikely to be immune from the price fallout.
Although OPEC+ grabs much attention as a group when it comes to production, it produces less than 50 percent of crude. With the emergence of shale oil in the past decade, the US has become the largest producing country and, together with other non-OPEC members, they now produce more oil than the cartel.
We imagine that demand is likely to be the most volatile component of the equation in the short term. OPEC believes that the pandemic cut global demand by 9.5mbpd on average in 2020. Furthermore, the hike in Covid-19 cases seen in many countries since November, triggering several European governments to reinstate lockdowns, should weigh on demand. Despite the hopes for a significant recovery this year, there is a risk that demand contracts.
That said, China’s relatively strong economic rebound from the effects of the virus should support global demand this year.
Our outlook is that with oil prices starting the year at around $50 a barrel, we expect them to remain range-bound in the short term as supply cuts partially counter weaker demand. However, in the longer term, supply might be boosted by continued support from OPEC+, with vaccine rollout improving the demand picture. As such, Brent crude is expected to average around $55 per barrel this year, rising significantly under a strong economic recovery and increasingly vaccinated world scenario.
Overall, we remain constructive on oil prices for next year as we see limited potential downside to our demand outlook, primarily due to the evolving response function of governments as well as the general public towards the virus threat and continued OPEC+ restrain.
Gold, on the other hand, is the traditional safe-haven asset. It is little wonder that the commodity’s price had its best year in a decade in 2020, as the pandemic sparked record economic contractions and central banks took historically low interest rates even lower.
After touching $2,075 a troy ounce in August, a record high, gold now trades at around $1,850 an ounce. The question is can the asset continue to provide a return for investors?
The economy could find itself in the sweet spot of accommodative monetary policy and economic expansion. If consumers also regain confidence this year, gold may struggle as investors look to lift portfolio risk. Historically, the precious metal has often experienced mixed performance in the years following an economic crisis.
Since Covid-19, the opportunity cost of holding gold (or the inflation-adjusted rate) appears deeply constrained due to two factors. Firstly, turning on the spending taps to counter the pandemic’s economic effects does not come without its costs and one of them could be demand-pull inflation. Secondly, central banks are more likely to tolerate any inflation overshoots in order to promote recovery, keeping rates lower for longer than usual.
The above factors provide support for holding the zero-interest bearing asset. Furthermore, while investor demand could weaken, pent-up consumer discretionary demand for jewellery could partially offset this. That said, such a world remains contingent on consumers resuming normal purchases akin to that before the pandemic.
With rising infection levels and tougher containment measures by governments, along with the unknown pace and ultimate effectiveness of vaccination programmes, uncertainty may provide a supportive backdrop for the yellow metal. While gold is unlikely to drive long-term growth, it is likely to remain a powerful diversification tool, helping to preserve wealth during periods of turbulence.
Gerald Moser is a chief market strategist at Barclays Private Bank
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