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Commodity Commentary: Oil & Gold


Summary • While WTI crude oil traded negative, energy stocks rallied • For a number of reasons gold has been going in the opposite direction

• Despite the volatility and headlines, we see opportunities in commodities

What a few weeks it has been in the commodities markets. Crude oil fell 50% from early April to its current price while gold has continued its march higher.

Looking longer-term, we had to adjust our y-axis on the continuous prompt-month WTI chart below as the May contract collapsed below $0 for the first time in history. It swung wildly for easily the biggest daily dollar and percentage move since the EIA has been tracking data back to 1983. The May contract is gone, but June is showing signs of similar volatility.

What have oil stocks done in the meantime? They’ve gone up – a lot.

I like to monitor two oil & gas ETFs: XOP & OIH.

XOP is the domestic oil & gas exploration & production industry fund. It consists of well-known energy producers such as Apache and Hess. The ETF is an equal-weight product, so it has more a small-cap tilt, adding to risk. OIH is the major oil services ETF with Schlumberger and Halliburton making up more than a quarter of the assets.

Investors may be familiar with XLE – the energy sector ETF. Chevron and Exxon make up almost half the space now, so I like to drill-down to the smaller guys to get a better sense of the sector.

Energy stocks moved in lock-step with WTI for the last several years – generally downward. Things have changed recently though. Since mid-March oil prices have cratered, but XOP & OIH have seen massive moves – beating the S&P 500’s dramatic rise.

The E&P ETF is among the very top performers in the last several weeks. All the while, the fundamental backdrop for oil & gas exploration companies is horrific – the market expects bankruptcies and is already digesting news announcements of heavy capex cuts. So the stocks are rallying hard in face of collapsing crude oil and the most bleak business outlook in the industry’s history. Hmm.

While WTI prints all-time lows, gold is at its highest price since 2013 amid immense global stimulus as a result of COVID-19’s devastating near-term economic shock. For a brief few days, gold and precious metal stocks had a capitulation moment of their own in early March – which by now seems like ages ago.

The April gold futures contract dropped 15% after peaking on March 9. Gold mining equities, rarely dull in price action, crashed 49% from a peak near $32 in late February to near $16 on March 16. In a matter of days GDX hit a 7-year high AND a 4-year low. GDX has since doubled back into the low-mid $30s.

We get it – commodities have been volatile. But what does it mean going forward?

From a technical perspective, these are generally bullish developments. It appears we hit a watershed moment for oil & gold and the related equities. Perhaps it was a final washout. When a stock group drops 50% in a few weeks then rebounds to fresh multi-year highs, that’s something to pay attention to.

For the energy sector, when oil stocks rally huge as the commodity sinks into unchartered territory, that can be bullish for the equities. Stocks are forward looking while the prompt-month of oil is focused solely on how supply & demand will go within the next month.

Keep in mind - If you’re going to be an investor in commodities, you must pay attention to what’s happening with the US Dollar. Intermarket analysis is perhaps most important in this asset class.

The DXY has been remarkably sideways over the last 5 years, ranging from 90 to 104. Oil likes a weak dollar, but gold can do its own thing sometimes. Recency bias elicits the commodity bull market of the 2000s when the USD dropped from 120 to under 80.

I concede the movements in energy and gold have been short-term. But they are important. These events help build long-term opportunities. Here’s the point - we are constructive on the commodities space and believe this left for dead asset area could provide solid risk-adjusted returns for a diversified portfolio.

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Topdown Thomas Thoughts: I would say I have higher conviction on commodities overall as an asset class (e.g. the GSCI Light Energy Index, or any other broadly diversified commodity index) because there has been a big reset in valuations, positioning, capex outlook, and technicals... but I wanted to share this chart from the latest Weekly Macro Themes, it shows a couple of valuation metrics for the S&P500 Energy Sector. Relative valuations have gone off the scale, and absolute valuations briefly reached a new record low. While the sector does face a number of very real challenges, I always say my process is anchored in valuations; and the strongest signal from valuations comes when valuation indicators reach extremes. When valuations reach such extremes they tend to speak for themselves, and investors should probably listen...

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