Crude Oil is by far, today's most essential and indispensable commodity. The world would literally come to a halt if trucks, ships and airplanes powered by oil, could not deliver essential goods.
Gold on the other hand has been, since early times, a trusted measure of currency and a safe haven for traditional investors. We are by no means "gold bugs". We are reporting facts as would relate to any other investment. For our purposes, this article will look at how these markets move relative to one another.
With growing worldwide demand for Crude Oil, prices have gone above the $75.00/barrel mark and are currently trading below $60.00. Is the price of Gold riding this wave? By understanding the gold/oil ratio we can determine how to position ourselves in the markets.
What is the Gold/Oil Ratio: The Gold/Oil ratio measures the number of barrels of oil that equate to one ounce of gold. It is calculated by dividing the price of Gold by the price of a barrel of Crude. According to researcher Adam Hamilton of the Zeal Intelligence newsletter, the Gold/Oil ratio stood at an average of 15.3:1 for the 40 year period from 1965 to 2005. The range was as high as 33 with a historical low of 6.6. Looking at the December contracts for Gold and Crude Oil as of the close on 10/9/06 that ratio stood at 9.48 ($582.80/$61.49). Again this simply means that the price of Gold is 9.48 times the price of Oil.
With growing worldwide demand for Crude Oil, prices have gone above the $75.00/barrel mark and are currently trading below $60.00. Is the price of Gold riding this wave? By understanding the gold/oil ratio we can determine how to position ourselves in the markets.
This suggests that prices will eventually realign to a "fair mean". In this instance Gold should move higher unless, of course gigantic new deposits of oil are discovered and find their way to the marketplace rapidly - which is quite unlikely - causing the price of Crude Oil to drop.
In the late 1970s, Gold lagged oil eventually rallying up with to hit its all time highs of $850. Today, the scenario appears poised to repeat itself, however keep in mind that past performance is not indicative of future results. Even when Dec. Crude oil moved up to $76.90 on May 12, 2006, Dec. Gold went to $753.00 bringing the ratio to approximately 9.79:1. Based on the historical average of 15:1, Gold still appears undervalued relative to crude oil. Another factor affecting the price of Gold is the fact that the US Dollar has been trending higher as of late and the correlation between these two markets is negative, meaning that they have a tendency to go in opposite directions.
What will it take for Gold to get back to its historical ratio of 15:1?
Let's examine world events that could contribute to higher Gold prices:
Looking at the chart above, we can see that Gold is clearly not in a bullish stance. Each time Gold has tried to go back up, it's made lower highs followed by lower lows; far from a bullish sign. We can see that since it made its high in May 2006, Gold has retraced back nearly 25%. Short term resistance is at $600 with longer-term is at $630. Support is at $555 and if broken could signal an extended down-trend. Although I am long term bullish on Gold for all the reasons listed above and more,
I believe that we'll see Gold trading in a range well into November at which time, growing demand should push prices back to the highs made in May of this year. In my opinion for the time being, it would be wise to be patient, look for an entry point once prices have established a clear uptrend and proceed cautiously when that time comes. This market carries a lot of risk and daily swings can be gut-wrenching.
Gold on the other hand has been, since early times, a trusted measure of currency and a safe haven for traditional investors. We are by no means "gold bugs". We are reporting facts as would relate to any other investment. For our purposes, this article will look at how these markets move relative to one another.
With growing worldwide demand for Crude Oil, prices have gone above the $75.00/barrel mark and are currently trading below $60.00. Is the price of Gold riding this wave? By understanding the gold/oil ratio we can determine how to position ourselves in the markets.
What is the Gold/Oil Ratio: The Gold/Oil ratio measures the number of barrels of oil that equate to one ounce of gold. It is calculated by dividing the price of Gold by the price of a barrel of Crude. According to researcher Adam Hamilton of the Zeal Intelligence newsletter, the Gold/Oil ratio stood at an average of 15.3:1 for the 40 year period from 1965 to 2005. The range was as high as 33 with a historical low of 6.6. Looking at the December contracts for Gold and Crude Oil as of the close on 10/9/06 that ratio stood at 9.48 ($582.80/$61.49). Again this simply means that the price of Gold is 9.48 times the price of Oil.
With growing worldwide demand for Crude Oil, prices have gone above the $75.00/barrel mark and are currently trading below $60.00. Is the price of Gold riding this wave? By understanding the gold/oil ratio we can determine how to position ourselves in the markets.
This suggests that prices will eventually realign to a "fair mean". In this instance Gold should move higher unless, of course gigantic new deposits of oil are discovered and find their way to the marketplace rapidly - which is quite unlikely - causing the price of Crude Oil to drop.
In the late 1970s, Gold lagged oil eventually rallying up with to hit its all time highs of $850. Today, the scenario appears poised to repeat itself, however keep in mind that past performance is not indicative of future results. Even when Dec. Crude oil moved up to $76.90 on May 12, 2006, Dec. Gold went to $753.00 bringing the ratio to approximately 9.79:1. Based on the historical average of 15:1, Gold still appears undervalued relative to crude oil. Another factor affecting the price of Gold is the fact that the US Dollar has been trending higher as of late and the correlation between these two markets is negative, meaning that they have a tendency to go in opposite directions.
What will it take for Gold to get back to its historical ratio of 15:1?
Let's examine world events that could contribute to higher Gold prices:
- OPEC announced a 1 million barrels/day cut with the intention of maintaining Crude prices above $55.00/barrel; Demand for Crude oil prices is still growing due to expanding economies in Asia, notably China and India; Alternative fuels, though readily available, are years away from mass distribution; Energy efficiency has improved however demand continues to grow;
- N. Korea successfully accomplished a nuclear test and could potentially become a threat to peace in the region; Slowing real estate markets in the US along with growing consumer debt (up $4.99 billion in August according to the Federal Reserve) may cause the consumer-driven US economy to take a hit;
- China's central bank announced its intention to double its Gold reserves after already doubling them to 600 tons. If China were to increase its reserves to only 5% of its foreign exchange holdings, it would have to purchase an additional 1900 tons of Gold making it the 5th largest holder behind the U.S., Germany, the International Monetary Fund and France;
- The Financial Times reported that Germany's Bundesbank will halt its sale of gold reserves for the third year and other central banks worldwide have followed suit while others have beefed-up purchases;
- FT also reports that Italy and Ireland have not sold any gold in the past two years;
- Worldwide concerns over the US Dollar has many central banks alarmed over the currency risk associated with holding the Greenback;
- Russia, Argentina, South Africa, the UAE and several others are adding Gold to their portfolio as a way to offset their risk exposure in the US Dollar;
- The growing national debt in the US (the largest in the history of the world) is sending a message of unease to world economies who are fully aware that their economical welfare is highly dependent on a healthy US economy;
Looking at the chart above, we can see that Gold is clearly not in a bullish stance. Each time Gold has tried to go back up, it's made lower highs followed by lower lows; far from a bullish sign. We can see that since it made its high in May 2006, Gold has retraced back nearly 25%. Short term resistance is at $600 with longer-term is at $630. Support is at $555 and if broken could signal an extended down-trend. Although I am long term bullish on Gold for all the reasons listed above and more,
I believe that we'll see Gold trading in a range well into November at which time, growing demand should push prices back to the highs made in May of this year. In my opinion for the time being, it would be wise to be patient, look for an entry point once prices have established a clear uptrend and proceed cautiously when that time comes. This market carries a lot of risk and daily swings can be gut-wrenching.
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