Oil or Gold — Where to Invest?

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Kal Kotecha PhD

Is Saudi Arabia still the King of the world oil supply? The market forces have changed so that the world’s dominant producer is no longer the big kid on the block. Even though they boast the lowest cost of production, I argue that the floor will be set by the American shale producers. It depends how much they will produce as they have a higher production cost. The cost varies but the all in cost includes the capital costs spread out over time. To continue to make marginal revenue, they must continue to produce at lower prices since the initial capital outlay is so large. In conjunction, the management of these shale companies (and management in general) can only get paid if there is production, even at a total break even cost, therefore as the colloquial statement reads, “the show must go on!” At the current price of about $50/barrel, many shale producers can at least break-even.

The European Central Bank is striving to avert a deflationary spiral in the region and announced a program to buy 1.1 trillion ($1.2 trillion US) of bonds. This may be a great sign for gold and silver in general. Any type of stimulus package generally bodes well for a price increase in the metals but I argue that inflation caused stimulus doesn’t necessarily increase the price of precious metals. Take for example QE, QE2 and QE3 in the U.S., the increase prices of the metals based on inflation (which has not taken place except in real estate) didn’t really occur. In turn, a deflationary environment as the economy is currently in is generally not bad for gold either — many ‘analysts’ reckon that a deflationary environment is ‘bad’ for precious metals and inflation is ‘good.’ When in actual fact deflation hasn’t been “really” negative for precious metals the past 2-3 years, especially when you take the price of gold in Japanese Yen and in Canadian Dollar terms.

What does the result of the higher US$ against the CDN$ mean for investors? It is excellent for Canadian companies that produce gold in the US — they just essentially received a 20% increase to their bottom line. These are the sorts of companies I am investing in expecting a huge payout as the price of gold starts to rise.

On an economic note, even though the CDN$ is low comparatively, meaning that the standard of living is being lowered for Canadians due to rising import costs, the manufacturing sector seems to be elated. The problem lies in the fact that most of the manufacturing jobs in Canada that left for cheaper producing countries are no longer present. Does that mean that GM and Chrysler are going to make their way back to St. Catharine’s and Windsor just because the dollar fell — I highly doubt it! And with many white collar jobs leaving i.e. Tim Horton’s, Target, and MEXX, the Canadian economy seems to be in a tail spin. Canada West isn’t elated due to low oil prices and lack of demand for base metals and I believe Canada East is still in a recession. The lower dollar should help the Eastern Canadian economy but I do not think as much as is being let on. The monetary policy issue is whether the Bank of Canada should raise rates or lower them. By lowering rates, you encourage borrowing and spending but continue to have a lower valued dollar. By increasing rates, our dollar rises which makes imports cheaper and helps to alleviate the pressure of the dollars free fall mainly caused by lower oil prices. But I do not believe the Minister of Finance should be increasing rates despite the hot housing market. By increasing rates, the tax payer would be paying more to pay off the interest on the Canadian debt.

In summary, deflation is not necessarily ‘negative’ for the prices of precious metals. Lowering interest rates in Canada to even negative interest rates might be the most prudent step to continue churning the Canadian economy. As to whether to invest in Oil or Gold—I choose the latter.

Happy Investing!

Kal Kotecha PhD

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