Which is likely to recover faster – oil or gold? This is an interesting question and it’s not impossible to answer if we apply logic to each situation. However, based on current and likely future trends, it’s not a straightforward answer. Let’s take a look at oil first.

USO ETF

At the time of this writing, oil is trading at $41.15 per barrel. If you look at the popular United States Oil (USO) exchange-traded fund (ETF), it has depreciated 61.69% over the past year. It also has a relatively high expense ratio of 0.72% and no dividend yield. Investors in USO have not been pleased, but what has been the cause for the slide in USO and oil in general? The answer to that question is threefold, but since the U.S. dollar is one of those answers and that concept is basic, we don’t need an entire section for it. Instead, let’s look at the other two reasons. (For more, see: ETF Analysis: United States Oil Fund.)

Lack of Demand

In the United States, the biggest spending generation in history – Baby Boomers – are retiring at a pace of 10,000 per day. Without that consumer spending, the entire economic engine slows, which then reduces the demand for oil. The only reason you have seen equities perform so well over the past six years is because of prolonged record-low interest rates. But that has led to excessive debts for companies that are unable to sustain their growth. When those debts come due and there isn’t enough growth to pay those debts, it’s going to create an ugly situation, which will then lead to deflation. Therefore, oil is likely to continue its descent.

If you look at the second-largest economy in the world – China – you will find an economy that’s even more overleveraged. However, the Chinese government simply will not give up, trying everything it can to keep its economic engine running. This originally began with building ghost cities in order to show gross domestic product (GDP) growth. More recently, it has included using media to encourage investors to buy stocks (this hasn’t gone well), pressuring state-owned banks to make bad loans (this will be even worse), temporarily halting initial public offerings (IPOs), banning short selling and devaluing its currency. Who knows what China will come up with next to prop up equities, but what matters most in this case is that there’s waning demand which, once again, is a negative for oil. (For more, see: China's Crisis Caused by Unhealthy Stock Market Growth.)

If you move down to the third-largest economy in the world – Japan – you will find a 1.6% contraction in the second quarter. And then you have the eurozone, which has shown paltry GDP growth for years and has the European Central Bank (ECB) doing everything it can to stimulate artificial growth. The key word is “artificial.” Central banks have the power to make a difference, but only temporarily. With all these factors, where is the demand for oil going to come from?

Massive Oversupply

Then you have the supply picture. According to the International Energy Agency, the market is “massively oversupplied.” Saudi Arabia is pumping oil like mad in order to defend its market share. It pumped 10.6 million barrels per day in June, and it might increase that production by 1 million barrels per day at some point over the next 90 days. (For more, see: Four ETFs for Trading Falling Crude Oil.)

There is little doubt that oil will continue to move lower. There might be some upticks, but these upticks won’t be sustainable. The tricky part is that due to geopolitical situations around the globe, there could be some big upticks. Eventually, oil should head back down due to the supply/demand picture. (For more, see: Oil: Buy Now or Steer Clear?)

Down the road, we should see organic economic growth and rampant inflation, which could send oils back to $100 per barrel. But this is only assuming economies around the world deleverage and allow for a reset, and that electric cars don’t take over the roads by that time.

Gold Situation

Gold has been performing well recently, but be careful. If you look back at the previous crash, you will see that gold performed well during the crash, plunged when the equity crash was complete and we experienced a short stint of deflation, and then soared again when the Federal Reserve stepped in to stoke inflation. (For more, see: Should You Be Bearish or Bullish on Gold?)

The key to the above paragraph is the short stint of deflation. Gold does not perform well in deflationary environments and we’re headed for deflation. While gold should perform at least relatively well as equities sink, it isn’t likely to perform well after the crash. The difference between this crisis and the last one is that the Federal Reserve isn’t likely to step in for assistance. Even if it does, that aid will not have nearly the power it did back in 2009. It will be nearly impossible to stoke inflation. Therefore, gold could sink to levels well below $1,000 per ounce.

The Bottom Line

Gold should outperform oil in the near future – on a relative basis. But gold will have a longer way to fall after the dust settles and deflation sets in. After that, when both oil and gold are at exceptionally low prices, oil is going to be much more volatile due to geopolitical events and changes in supply. Gold, on the other hand, will remain low for years. Therefore, it depends on what you consider a recovery. If you’re thinking long-term, then due to the always-increasing focus on the reduction of carbon emissions, I would feel much more comfortable owning gold, which will have the potential to see record highs when rampant inflation hits the scene several years from now. Of course, you should consult a financial advisor to get another opinion. (For more, see: The Best Ways to Invest in Gold Without Holding It.)

Dan Moskowitz does not have any positions in USO. He owns shares in LABD. 

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