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Mathew Ingram

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Still going strong

Mathew Ingram

 

TORONTO (GlobeinvestorGOLD)—As the tide of the war in Iraq ebbs and flows, the demand for war-sensitive commodities such as oil and gold has risen and fallen in unison. In fact, many investors have ignored significant economic news that might otherwise have swung those commodities higher or lower, instead choosing to play the war card. But what happens when the war is over and markets begin to return to normal?

In the early days, when the war looked as though it would be relatively swift, both gold and crude oil prices sank. Crude in particular dropped by more than 25 per cent in just a matter of days after getting close to the highs it hit in 1991 before the Gulf War. When that initial euphoria faded, crude oil futures and gold prices climbed.

Many investors are now trying to position themselves for when the war ends, which has in turn contributed to the volatility in the crude and gold markets. No one wants to sit out any gains, if there are any, but at the same time there is a risk that the end of war might not be a good thing for crude and bullion, both of which tend to thrive on adversity.

When it comes to the oil market, part of what sends crude lower when the war appears to be going well for coalition forces, is the fear that an end to hostilities will result in a market awash in crude, as a result of increased production by Saudi Arabia and some other members of the OPEC cartel. Saudi Arabia alone has been producing about a million barrels a day above its quota in case Iraq burned its oilfields or Kuwait was attacked.

Supply and demand

The problem now is that Iraq's oilfields appear to be in relatively good shape and the majority of them are under U.S. control. That means the extra oil being pumped by the Saudis and others in preparation for the worst possible outcome is going to be slopping around in the system for awhile, and even though the summer driving season is approaching, there is a risk that there could be a short-term oversupply problem.

As far as oil stocks themselves are concerned, major producers have seen their share prices experience a lot less volatility than crude has. In large part, that's because investors don't want to make any significant bets based on short-term factors such as the war. Those who have been buying and selling shares, however, are convinced that major producers such as EnCana Corp. and Imperial Oil Ltd. are likely to advance after the war, and share prices have been creeping up in anticipation.

Although there is concern about oversupply of oil, OPEC is likely to scale back production if necessary, and there is still the reality of low inventories in the U.S. to deal with. On the natural gas side, meanwhile, analysts say the gas situation is still one of under-supply, and that will likely keep cash flows strong at producers such as EnCana and Canadian Natural Resources Ltd. EnCana was recently raised to "buy" by Banc of America Securities.

Fool's gold?

As for the gold market, it too has been rising and falling on hopes and fears about the war. The yellow metal soared to a six-year high of $388.50 (U.S.) per ounce in February as the war began, but then slid as the hostilities seemed to be going better than expected. On April 4, gold hit its lowest level in four months.

Some gold traders are warning that bullion could plunge if there is news that Saddam Hussein is dead or there is a definitive victory, just as gold fell in 1991. Once the war is over, however, the long-term picture for gold is still good, many analysts say, thanks to such lingering problems as the ballooning U.S. deficit. Some estimates predict deficits of $300-billion a year over the next several years, which gold bugs say will weigh on the U.S. dollar (a weak dollar is bullish for gold).

That means producers leveraged to spot prices should do well, with Newmont Mining Corp. one of the favourites. Although the share price has climbed in recent months, the company is one of the largest producers as a result of its merger with Normandy and Franco-Nevada and has a relatively small hedging program. A dark horse is former gold star Barrick Gold Corp., which has come under fire because of its large hedging program. Some analysts say Barrick has been overlooked of late, and that its stock is undervalued.

Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.

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