Value vs. Price: Trade in Your Gold for Oil and Agriculture Futures 14 comments
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During a large part of the summer of 1979, I spent living in the coastal Italian town of Ladispoli, about an hour's drive from the grandness of Rome. I was just entering my teenage years at the time, but somewhere in the back of my mind I already knew that sooner or later I would be burdened with all the responsibilities of an adult. That time came much sooner than I could have ever expect at the time, but that's another day's story...
Today's story is based on a simple phrase that I learned very quickly in Italy and it is the phrase that is still with me almost thirty years later. That phrase is simply "quanto costa?" or "how much does it cost?" Almost every decision I have made ever since I learned these magic words in Italy depends on the answer to this essential question. Ever since then, I compare the "utility," "worth," or "value" of whatever is being bought or sold to its selling price. Of course, over time my ideas of worth got better formed and started including factors way beyond my naive childhood understanding, but the need to evaluate "worth" vs. "price" - that became a part of my core.
So, why am I telling you all this? First and foremost to admit to myself and confirm to others that I am deep in my soul a value investor. The second reason is that it serves as a good introduction to the following value proposition: sell gold, buy oil. OK, all you gold bugs, I am with you on the intermediate term inflationary outlook that will drive the price of gold ever higher, but on a relative valuation, gold is expensive, oil is cheap and food is dirt cheap.
Oil was especially cheap on Friday, when the expiring January contracts were fetching as little as $33.44 a barrel and Bloomberg was reporting a spot price for a barrel of West Texas Intermediate of $33.87, which was $7.83 below their reported spot price for the sourer Brent! All in all there was a major market disruption. Some will, undoubtedly, attribute it entirely to the doings of the triple witching hour of the third Friday in December. To me, however, it is indicative of an oil market bottom.
Now, I understand all your concerns about the bursting energy bubble and demand destruction. But let’s forget all the noise and simply ask the question "quanto costa?"
Bloomberg tells me the latest prices: gold - $837.40 per troy oz, oil - $39.31 per barrel (average of three), wheat - $211.69 per metric ton. Wheat is actually a bit tougher than simply looking it up. All you get from Bloomberg are the Kansas City and the Chicago Boards of Trade settles for #2 wheat per 100 bushels. So, after averaging the two prices you divide by 100, add 3 cents to upgrade to #1 hard red winter wheat and multiply by 36.7437 to convert to the price per metric ton.
For historic prices, I dug up monthly averages for the past 25 years for the three commodities from Austin Gold Information Network, Kitco Inc. and Index Mundi. If you don’t think these are reputable sources, you are welcome to repeat the exercise with numbers pulled directly from the CIA World Factbook, but by the time you find any data on that website, you will probably qualify as a senior intelligence officer! In any case, massaging the data I learned that for an ounce of gold on average over the past 25 years I could buy 2.6 metric tons of #1 wheat or 16.83 barrels of oil.
However, at today’s prices for gold, I could afford a whole 21.3 barrels of oil or 3.96 metric tons of that #1 wheat! As all things in life tend to revert to their long term mean, I figured this means that either food and oil must appreciate substantially, or gold must similarly fall.
Now, before you go off and attack my simplistic analysis, please allow me to add even more simplicity to the crock pot by reminding you that both oil and gold are depleting resources, while food vis-à-vis wheat is a renewable consumable necessity. Also remember that gold, unlike oil, is not really a necessity, that it is reusable and often easily and quickly substitutable.
Why is any of this important? Well, if you think back to your Macro Economics 101, you may recall that market prices are simply a function of supply and demand and that demand for goods that are not necessities and are easily substitutable and/or reusable tends to be more elastic. This again supports my point of view that oil is cheap relative to gold.
This part of the argument is actually weaker for wheat being relatively cheap, since wheat is a renewable resource, the usable worldwide supply of which has greatly expanded over the past 25 years through science of fertilization, more efficient farming methods and better storage. But the size of the anomaly in the relative price of wheat is so huge right now that it is virtually begging for a correction.
Of course, you could take any aspect of this analysis a whole lot further – I didn’t. Instead, I patted myself on the back for buying a whole lot of OIL - IPath S&P GSCI Crude Oil Total Return Index ETN - earlier in the day Friday for $22.79/share. I left the selling of gold and buying of ag. commodities to next week.
That’s almost the entire story, except that I wanted to answer a question that, perhaps, begs itself. Why am I measuring other commodity prices in troy ounces of gold, instead of $US, or constant (inflation adjusted) $US, or some other currency?
The answer to this question is simple. All paper currency is only worth the amount that the government that issues it says it is worth. Inherently, any fiat paper currency is neither stable nor does it have any worth. It is within the power of any government to increase its currency supply overnight and to otherwise diminish paper money's purchasing power – cases in point: Austria, Germany and Russia in the 1920s, China, Greece and Hungary in the 1940s, Argentina in 1980s, Zaire, Yugoslavia, Russia and Ukraine in the 1990s and Zimbabwe today. Ben Bernanke is now eager to inflate and eventually he or his successor will overachieve.
Some people like to use currency adjusted by inflation, as measured by CPI, in their analysis, but there are many well known criticisms of CPI as a measure of inflation and of the methods used for such adjustments. In any case, these adjustments, at best, would introduce an error into the measurement. So, why not just use gold for comparison, a traditional, universally accepted and widely used measure of value? And, please don’t tell me that Central Banks, in coordinated efforts, manipulate the price of gold. That’s an interesting and maybe even viable theory, but counterbalancing it are facts of outright paper currency manipulations by world governments.
Hope this answers all of my critics before they even get started!
Disclosure: Long OIL and GLD.
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TIA!
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I kind of like the idea of buying oil and wheat. Is there a good investment vehicle for wheat? Agricultural companies? Which ones?
When the dollar collapses all of these things - oil, gold, wheat are probably good to hold. I personally think people will run to gold first and it will take off before oil and wheat. At that point I think I'll be able to get more than 21 barrels of oil or 4 tons of wheat for an ounce and I probably will.
I agree with your observations; oil is cheap now and gold is expensive.
Historically, the oil to gold ratio has been around 12-15 bls/oz. Oil is the place to invest and has many advantages over gold as an investment vehicle.
1) Most people can live without gold, very few can live without oil. Besides transportation, oil is used to make thousands of different products.
2) Oil and gas Canroys or MLPs are good place to invest. Gold does not pay interest or dividends, Canroys/ MLPs continue to pay good dividends (anywhere from 5% to 15%) despite the new low price of crude oil. After we get out of current economic malaise, oil demand will resume and Canroys/MLP will enjoy good capital gains as well.
3) Realistically, we won't any serious transition to alternative energy for the next 30 to 40 yrs. So oil will only become more valuable for the next 10-20 yrs at least.
Sold my gold in the mid-900s and my silver in the low 19s before the absolute highs, bought gold back in the low 800s and luckily sold again when it rallied back up into the high-800s and before gold and silver dropped off the cliff. Can't claim any genius there, just happened to trade out and stay out while they fell.
Started buying silver back gradually and averaged down, my average cost being about $12 now. Still haven't bought back into gold, worried that it will also drop like: silver, platinum, and palladium did. Platinum and palladium look very attractive at current prices, though, but I don't know the best way to invest in them.
So, I've started looking at oil, general metals and commodities ETFs, and the agricultural ETFs. Just took a small position in USO today. Will start looking harder at the commodities ETFs. Even with price deflation, I cannot see food prices dropping much. And, if the high future inflation scenario that so many are predicting plays out, food prices should be a safe bet to rise.
Who knows though? My general rule is the greater the certainty of the analyst, the more full of sh** they are. Sometimes common sense beats out the most sophisticated analysis, and sometimes the unexpected beats the he** out of common sense. You never know for sure.
If you are bored one day, could you see how far back you can get data on the price of gold/oil/wheat and compare going back further than just 25 years? Only if you really want to - don't just do it for me, lol. Though that data might not matter - either way I'm bullish on agriculture, oil and gold... They can all appreciate in dollars proportionally and still stay in lockstep with each other...
> 3) Realistically, we won't any serious transition to alternative
> energy for the next 30 to 40 yrs. So oil will only become more valuable
> for the next 10-20 yrs at least.
>
You may be right, but commercialization progress in alternative fuels will depend on subsidies from world governments. My guess is that best case we will start seeing new viable self sufficient green energy making a meaningful (5%) commercial impact on world wide supply in 10 years and that 30 years from now it will still only account for less than 40%. This is actually pretty scary, if you think about it...
On Dec 22 04:53 PM Rokjok777 wrote:
> what's a good ag futures ETF? or managed ag futures fund? would like
> futures, not equities
I like DBA, but I have not invested in it yet.
On Dec 22 05:20 PM greywacke wrote:
> Jake: Gold is not a depleting resource. All the gold that ever
> was is still here. Oil is a depleting resource. However, both are
> finite resources versus wheat which is renewable. Is this what you
> meant?
Yes, I meant finite (depleting mineral supply) resource, of course.
On Dec 22 07:18 PM Robert Nabloid wrote:
> Is the last 25 years the best data to use to find the average? What
> was the last 100 years like? I'm just wondering... it would be interesting
> to see if it is much different. The last few decades we've had a
> lot of cheap credit being flung around and I expect there have been
> some pretty big diversions from what the "real normal" would be...
> but I'm not sure.
>
> If you are bored one day, could you see how far back you can get
> data on the price of gold/oil/wheat and compare going back further
> than just 25 years? Only if you really want to - don't just do it
> for me, lol. Though that data might not matter - either way I'm
> bullish on agriculture, oil and gold... They can all appreciate in
> dollars proportionally and still stay in lockstep with each other...
I have seen data that indicates that over longer period of time (40+ years) the steady state value is even lower (under 16 barrels per ounce) and that the further out in time you go beyond that, the lower is the ratio. The older data was not quite as good, which is why I didn't want to use it, but it does make an even stronger point.
On Dec 22 10:22 AM mikebrah wrote:
> Does anyone know of an ETF for cattle futures?
>
> TIA!