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Aggressive investors need to 'favor oil over gold' - Goehring & Rozencwajg

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(Kitco News) Oil will significantly outperform gold in the next five years, which is why aggressive investors need to start favoring the former over the latter, according to Goehring & Rozencwajg Associates.

“Oil has never been priced cheaper relative to gold and the underlying trends that have forced the massive divergence between gold and oil are about to be reversed,” said Goehring & Rozencwajg managing partners Leigh Goehring and Adam Rozencwajg. “For aggressive investors, we believe now is the time to continue favoring oil over gold.”

Oil’s plunge this year presents a rare opportunity to get into the space as it has never been so undervalued relative to gold. Only twice in history has oil been similarly cheap — in February 2016 and in 1934, Goehring and Rozencwajg wrote on their Q3 market commentary.

“In response to COVID-19 back in March and April, the gold-oil ratio hit levels that were truly ‘black-swan’ events. Using West Texas Intermediate oil prices, which went negative in April, the gold-oil ratio went to infinity. Switching to Brent oil prices (the benchmark price for North Sea crudes), the gold-oil ratio surged to 80x,” they wrote.

Going forward, the two managing partners see the gold-oil ratio significantly contracting in the next five years, which means that they see oil massively outperforming gold.

“When the supply of gold grows faster than the supply oil, gold underperforms oil … When the oil supply grows faster than the gold supply, oil underperforms gold,” Goehring and Rozencwajg said. “We will see five years of extremely disappointing oil supply growth. Because central banks are now showing signs of slowing their decade-long torrid pace of gold buying, we believe that total gold supply, when adjusted for central bank activity, will show significant growth as we progress into the upcoming decade,” the two noted.

Goehring and Rozencwajg are carefully watching potential central bank gold buying, which has slowed significantly this year.

“It is hard to predict how central banks will act given the strain now being placed on all governments’ budgets throughout the world, they could very well turn into net sellers in the next several years as they seek sources of liquidity,” they said.

In contrast to this, non-OPEC oil supply is likely to slow. “Once U.S. shale oil production growth begins to decline, we believe we will see large declines in global non-OPEC production.
Together, this suggests we will see a contraction in the gold-oil ratio,” Goehring and Rozencwajg wrote.

The report pointed out that many investors have put oil “into what we call the ‘un-investable’ bucket.” This is why the sector presents such a unique opportunity, the managing partners noted.

“What happens when you buy into a radically undervalued, un-investable asset class? If history is any guide, the answer is: ‘Great things’,” they said. “Today’s indisputable un-investable asset class is energy broadly and crude oil specifically.”

Demand for oil will eventually recover and pick up during this decade, driven largely by emerging markets, Goehring and Rozencwajg added.

“Our analysis tells us that oil and oil-related assets, remain the buy of a lifetime,” they said. “Even with the COVID-19 lockdown, Chinese oil demand for the first eight months of 2020 is running 1 mm b/d above 2019 levels. EVs will never achieve the penetration promised by the industry for the very same reason that we all didn’t fly to Europe on the Concord: energy efficiency. Furthermore, supply, which everyone assumes will keep growing strongly, is about to disappoint greatly in the coming years.”

For those investors who do not wish to get into oil, Goehring and Rozencwajg suggest buying the dips in gold.

“Even though we believe the first leg of the gold bull market has ended, we remain very bullish on gold prices as we progress through this decade,” they said. “Even a small allocation to this sector will help fulfill its roll to diversify returns and help maintain long-term value.”

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