3. Oil, gold and copper: the different information each one carries

Macro 4: Inflation, currencies and commodities

They get lumped together under the label "commodities" as though they were variations on the same asset, and they are not. Each of these three prices answers a different question, and confusing them leads to reading signals that are not there.

Three prices, three questions

Simplifying, but without betraying the substance:

• Oil tells you about the immediate balance between what the world consumes and what can be pumped, with an enormous geopolitical component on top.
• Copper tells you about physical investment under way: construction, the electricity grid, factories, housing.
• Gold tells you almost nothing about the real economy. It tells you about real interest rates, about confidence in money and about official reserve demand.

Oil: the tyranny of inelasticity

In the short run, neither the demand for nor the supply of crude responds to price. If diesel rises 20%, people still go to work and trucks still run. And bringing on new production takes months or years. With both curves close to vertical, a small imbalance in quantity produces an enormous move in price. That, and not speculation, explains the structural volatility of crude.

From this comes the most useful reading you can take from oil: working out whether a rise is coming from supply or from demand. And to do that you do not need a model, you only need to look at what equities are doing at the same time:

• Oil up and equities up: the world is growing faster than expected and consuming more energy. That is a demand signal, and it is benign.
• Oil up and equities down: somebody has broken supply. That is a tax on the consumer and a blow to margins in almost every sector.

It is the same price move with two opposite meanings for your portfolio. The production cuts agreed by OPEC and its allies, or the spare capacity that group holds back, are the variable that decides which of the two cases you are looking at.

Copper: the thermometer of investment

Copper is used wherever there is cable: construction, the electricity transmission grid, appliances, motors, electric vehicles, data centers. In other words, wherever physical capital is being invested. Hence the nickname, the metal with a doctorate in economics.

Two caveats almost nobody mentions. The first is that its supply is as inelastic as oil's but by a different route: from the discovery of a deposit to first production can take ten to fifteen years between permits, financing and construction, and the average grade of the ore extracted has been falling for decades. The second is that its value as a global thermometer has degraded, because around half of world consumption is Chinese and much of that demand depends on the property sector of a single country. When copper falls today, it is worth asking whether the world is cooling or whether it is Beijing that has stopped building flats.

Its cyclical behavior is brutal: in the second half of 2008 it lost around two-thirds of its value, and from the March 2020 lows it went on to double in a little over a year.

Gold: a financial asset dressed up as a metal

Gold is barely consumed. Practically all of it ever mined still exists in bars and jewelry, so its price is not set by annual production, which is a drop next to the accumulated stock, but by somebody's willingness to carry on holding it.

Since it generates no cash flow, its direct rival is the inflation-linked bond. Both are assets that preserve purchasing power, but one pays a real yield and the other pays nothing. Hence gold's most reliable relationship: when the real interest rate rises, the cost of holding gold rises and its price tends to fall, and vice versa. The second relevant variable is the dollar, because it is quoted in that currency. And the third, since 2022, is the sustained reserve buying by central banks, which answers to considerations of sanctions and geopolitics rather than to any calculation of return.

You are not buying the price you see in the headline

A technical detail that ruins a lot of people. Unless you are storing barrels, you invest in commodities through futures, and a future expires. To keep the position you have to sell the near contract and buy the next one. If the next one is more expensive, a situation called contango, every roll costs you money. If it is cheaper, backwardation, it pays you.

The return on a commodity index is therefore the sum of the move in the spot price, the result of those rolls and the interest earned on the collateral. In oil there were long stretches of severe contango after 2008 in which spot rose and the investor lost money anyway.

April 2020: the barrel in negative territory

On April 20, 2020, the WTI contract for May delivery closed at minus 37.63 dollars. That is, you had to pay someone to take the oil.

The reason was not that crude had no value. It was that the contract requires physical delivery at Cushing, Oklahoma, an inland point with no access to the sea, and with demand collapsed by lockdowns the tanks were about to fill up. Anyone holding contracts and with nowhere to put the crude had to close them at any price before expiry, which fell the next day. Brent, delivered at seaborne terminals where you can always charter a vessel as storage, never went negative.

The lesson goes beyond the anecdote: the price you see quoted is the price of a contract with a delivery clause, not of a substance. Confusing the two is what led several oil index funds to lock in historic losses that week.