Gold to Oil
Investment Research for Online Investors

by John Dalt

01/29/09

We have been following the price of oil and gold for a few weeks. Trading both for quick profits.   We have GDX in the long-term portfolio with a gain in two weeks of 23%. There is a theory of the historical relationship between the price of oil and the price of gold. It is an interesting theory.  

How many barrels of oil to buy 1 oz. of gold

As you can see, historically it has taken about 10 to 12 barrels of oil to buy one ounce of gold.  Last summer this ratio augured that gold was too cheap and had to increase to over $1500 an ounce based on oil at $140.  Little did we know, oil was going to get a lot cheaper, and gold was going to go on a bull run.  Fast forward to January 2009 and oil is at $40 and gold at $900.  We are now at the other extreme.  It now takes over 22 barrels of oil to buy one ounce of gold.  How will the gap close? 

The current gold price is not justified by present circumstances.  The Fed is fighting deflation not inflation.  The dollar is strong.  Gold is priced on the likelihood of future events.  Fear of rising inflation and a weak dollar are making gold a safe harbor for investors. 

The current price of oil is realistic for the present circumstances.  World economic activity has slowed, cutting demand for energy across the board.  OPEC has announced production cuts, but members historically cheat on their quotas.  Inventories have been growing and are currently at their highest level in over a year.  When you have a whole lot of it, and people are not using as much, the price comes down. 

One of my trading maxims is that extremes correct.  On the surface this looks like a great pair trade; ie short gold, long oil but….   I also recognize the truth that the market can stay irrational longer than I can stay solvent.  I think inflation is going to take longer to show than the fear crowd in gold right now believe.  Oil will mark the beginning of economic recovery, which is also the beginning of inflationary pressure.  The wild card is terror premium returning to the oil trade. 

Conclusion:  Gold is presently too expensive, expect a correction short term, then higher.  Oil is too cheap it may get cheaper short term, then head higher.  When oil starts higher, this signals an eminent climb in the price of gold as inflation becomes a reality. 

The fight for a stimulus bill is on in Washington, the lobbists are working overtime. 

“Democracy is the theory that the common people know what they want and deserve to get it good and hard.” 

H.L. Mencken 

I don’t know about you, but I think we are getting it! 

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions. It may contain errors and you should not make investment decisions based solely on what you believe you have read here. Do your own research, it is your money. If you lose it, it is your responsibility, not ours or your grandmothers! The editor may or may not have a position in any securities discussed. The editor may have held a position in a security earlier, or in the future.

HOME

Back to Top