May 06, 2020 11:00
Recent developments in the oil market have resulted in a massive drop with the May contract of WTI Crude Oil futures falling into negative territory before its expiration.
The main driver for this development was respectively is that world oil markets face a really big problem with the storage of oil.
And it seems very optimistic to expect the tense situation to have diminished at the expiration of the June contract on the 19th of May respectively shortly in general.
And with the still dark global economic outlook, not only will the demand for oil stay subdued while further deep, historic oil production cuts won’t be enough to balance supply and demand with stabilizing effects.
But, it also seems likely that the trust in the US-Dollar as world-reserve currency number 1 will diminish, especially given the massive monetary stimulus from the US central bank FED while the US government runs a massive budget deficit.
As a result, the demand for physical gold, the secret reserve currency for centuries, will stay high and potentially more and more increase.
The issue with the decoupling of the paper and physical Gold market
Roughly speaking, the situation in Gold is very similar to the one in Oil.
The main difference is, that in the case of oil we talk about a “storage issue” (no demand, enormous supply), while in the case of Gold we talk about a “supply issue”.
In our last article “WTI Crude Oil settles in negative territory for May – will June WTI sell-off again?” we explained that WTI Crude Oil’s futures contracts are physical contracts.
That means that traders who are Long the contract at the expiration have to take physical delivery of the oil they bought on the futures market.
The same is true for Gold: COMEX, the exchange was Gold Futures are traded, has also a “delivery month”.
That means, that these contracts serve as the “front month” for trading purposes until they expire and have to be delivered and where the “rollover” into the next contract takes place.
Given recent developments in the world, economies shutting down, volatility, and thus uncertainty rises.
During such times, especially in times where the reserve currency status of the US-Dollar is in question (which wasn’t probably the case until now), it becomes realistic to see Gold Futures and their Long parts in the contract to go for the delivery through the COMEX.
We have already seen the massive swings in “Paper”- or “Abstract”-Gold in March with a massive widening of the spread between the physical Gold market and Paper-Gold.
That was mainly due to several Gold refineries, mines, and mints being close due to the Coronavirus initiated shutdown and the global demand for physical gold outstripping present Gold supply.
So, we are not looking at a hypothetical development, but a real one.
On April 20th, the day WTI May Crude oil Futures dropped into negative territory, total gold deliveries on COMEX exceeded 3,000,000 ounces.
To put things into perspective: this demand for physical Gold delivery exceeds the usual demand by three times.
And while the parabolic drop in the WTI May Oil Future on the downside was mainly due to no Bids being seen anymore in the order book, the same could occur with offers in the Gold order book with no one willing to take the other side of a Gold buyer since the Short seller could guarantee to be able to deliver physical Gold at expiration.
How to trade Gold in this environment?
The potential result of this described scenario is the exact opposite of what we witnessed in WTI May Oil futures: Paper-Gold going parabolic on the upside.
While it is very difficult to say if such a development will layout that way, it shouldn’t be ruled out since no one could have imagined that we will ever get to see Oil prices in whatever delivery month to be settled in negative territory.
That said, long engagements in Gold should be favored and Short traders should be really careful with Short engagements in general since once they find themselves in the described scenario above, it will be very difficult to find someone to sell their position to.
Source: Admiral Markets MT5 with MT5-SE Add-on Gold Daily chart (between January 31, 2019, to May 1, 2020). Accessed: May 1, 2020, at 10:00 pm GMT – Please note: Past performance is not a reliable indicator of future results, or future performance.
In 2015, the value of gold fell by 10.4%, in 2016, it increased by 8.1%, in 2017, it increased by 13.1%, in 2018, it fell by 1.6%, in 2019, it increased by 18.9%, meaning that after five years, it was up by 28%.
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