Is the Black Gold Rally Over?

A weakening dollar will keep commodity bugs aflutter, but what can it mean for commodity prices; gold and oil in particular? The chart below shows my June 22nd annotations for the EURUSD which are still in play. If the dollar was to weaken another 10% what impact will this have?

Looking at the historical relationship between oil and gold prices, any spike into the upper 20s (i.e. when gold trades at 25-30 times the price of oil) has been a good opportunity to buy oil. This has shown itself well on the recent spike.

Prior to 2000, spike lows in the ratio in the 6-10 range have not been a good time to own either gold or oil. But the questions the aforementioned chart asks are:

1. Is now the time to sell the oil given the relationship has dropped to the 1997 spike low at 13.50 when oil prices peaked?
2. Will a further deterioration in the dollar potentially see this ratio fall back to sub-10s (although a weak dollar will boost both oil and gold prices, but would oil benefit more)?
3. What of the elephant in the room from 2001-2008 when the ratio effectively traded in a tight range of 6.00-15.00 as both oil and gold made tremendous gains - oil in particular?

Whatever the short term implications of a weakening dollar the long term picture for oil may not be so hot. Yes, we live in a very weak economic environment but with considerable inflation pressures down the road. However, it is rare for any asset to emerge from a strong trending period to kick straight into another. Oil is likely to spend the next decade trading in a range probably between $30 and $80 a barrel.

As a finite commodity it has a built-in appreciation level so it has excellent potential for future price growth. It is an ideal asset to have in a retirement account (either as a related stock or ETF) where timing short term appreciation is not the goal.

As a trading instrument any drop into the $30s is a buy irrepsective of economic conditions. Anything pushing $80+ is a good reason to take some profits with a psychological break and hold of $100 probably enough to see it challenge 2008 highs.

Gold is a trickier beast. Given the relationship to oil has never cleared more than 28 times its value one could assume gold has the potential to trade up to $2,240/oz if oil traded at $80. However, weak periods for oil over the past 20 years have not been strong periods for gold. Gold bugs will probable argue differently but it seems unlikely for gold to get past $1,000 this time around.

Disclosure: No positions in oil, gold, or stocks related to oil and gold

Comments

[one eye:]

Israel attacks Iran's Nuc facilities this Year, Oil spikes above $100.

Your contention is that Gold will not rise above a $1,000.

Correct?

Jul 02 09:10 AM

[DONE_SONZ:]

You are forgetting about the currency crisis that's going on.

Jul 02 09:30 AM

[Larry House:]

Who knows if the rally is over, but at some point fundamentals will be reflected in the price of oil, which is not now the case.

Jul 02 10:27 AM

[basehitz:]

<As a finite commodity it has a built-in appreciation level so it has excellent potential for future price growth>

IMO this makes sense.

<Whatever the short term implications of a weakening dollar the long term picture for oil may not be so hot>

Assume market pullback creates short term hideout in USD and Treasuries if history repeats. Commodities would then correct.

For long term, I recommend 2 books:
1) "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy" by Matthew R. Simmons
2) "Game Over" by Stephen Leeb (I am currently reading this)

The main theme in both is commodities are being exhausted and will become increasingly expensive to obtain in quantities to support global growth. Given the estimated duration to critically low levels of resources available, these authors expect dramatic escalation in price of energy. Dr Leeb thinks virtually all commodities are in the same camp. I agree with both.

As an investment theme, this is my focus: commodities and those that produce it. I expect an energy pullback near term. The trick for me is to remain disciplined and slowly build a position. Since I think oil will go much, much higher as the economies grow (probably next year), this is tough.

Jul 02 11:05 AM

[The Aft Deck:]

Oil will continue to improve the Dollar is doomed to go much lower

Jul 02 11:21 AM

[one eye:]

Oil is depleting about 6.7% annually, it is Not being replaced at the same pace.

Almost 100% of the So Called "Surplus Capacity" is in the ME. In other words, its not under our Control.

There is No Surplus Capacity that Is under our Control.

Jul 02 02:02 PM

[carloz678:]

"Grassoline" in July issue of Scientific American presents some ideas that may be funded by the stimulus plan and could change everything. Timeframe of 5 to 10 years.

Jul 02 05:16 PM

[one eye:]

In 5 to 10 years, Oil will be above $150 if the present "Energy" Policy continues.

And if you can keep the Developed nations in Recessions for the Next 5 years, it will allow the Growing world enough time to develop themselves.

Maybe thats what Obama's all about. Lets give those poor folks a chance. Its time for Change.

Jul 02 10:11 PM

[Tom Colangelo:]

As many of the above notes state: Oil is not growing in supply as fast as demand.

BUY OIL & UTILITIES NOW. Neither have ever gone out of business or stopped paying dividends, unlike banks, auto, pharma, media, etc..............

In the short term, China, India and Japan will take the opportunity to buy reserves for when their economies start up again, as they know they will. Also gets rid of depreciating dollars which they have too much of.

They don't care that it might be in 2 or 4 years. This is a strategic decision. And like our protecting our oil sources in the mid-east, they will protect their oil reserves in Africa and elswhere. It is a matter of survival.

This provides a support for oil pricing at $50-65 which is the calculated fair value given extraction and depletion compensation.

Jul 02 11:03 PM

[jerrydd:]

Too think oil will go only between $30-80/bbl is wishful thinking.

While it will go down soon, it's only because of the recession. Once we come out of the recession oil will spike again to $130-150/bbl late next yr until it kills the uptick, then down some and then up again even higher until about 10 yrs when we have finally wised up and went a good way to being independent on oil.

At that point oil will be constrained by other much cheaper sources of energy like RE, NG, BTL. EV's here are the key along with much more eff cars, trucks by then mostly plug in hybrids for those still running on oil for longer trips.

Then as the energy prices stabilize on sustainable sources that can't be exhausted oil will come back to about $80/bbl in todays $ at best.

I'm already there happily driving my EV's that get 250-600mpg cost equivalent at $2.50/gal gasoline costs. Many will join me as they pay $100/tank for their cars will focus their minds. Sadly the only way for me to get an EV is build my own. Luckily many EV's will be on the market in 2 yrs. And because they are so simple will drop in price to less than ICE's

Good investment should be in companies like Tesla, BYD.

Jul 03 10:45 AM

[tc1:]

I agree with many of the posters that, because of Peak Oil, we must expect a higher price for oil, though perhaps not for the short term as a price correction on oil sets in due to this recession. But supply is already being pressured in some quarters, so i see the correction as very short term.

In any case, one should beware taking too seriously these "historical ratios," such as the "gold-oil ratio."

Circumstances change with differernt eras, and we are now on the precipice of Peak Oil, made even more problematic the last dozen years by the MASSIVE new oil demand from the two fast-developing and over-populated China and India.

Everything is different. Historical ratios like "gold-oil" can no longer be reliable measuring devices.

Jul 03 11:35 AM

[Jimbo:]

Question for jerryDD: can you drive you EV very far out of town?

Jul 03 03:53 PM

[Ryu Mei Co:]

Anybody read this ?

"LONDON (Reuters) - PVM Oil Futures Limited said on Friday Steve Perkins, a senior broker based at the firm's London office, was responsible for unauthorized trades earlier this week which landed the firm with a loss of nearly $10 million.

The London-based brokerage said Perkins had taken the positions in Brent crude futures early on Tuesday.

The heavy buying during the Asian trading day when volumes tend to be lower caused global crude prices to spike to their highest level this year. Traders and analysts initially struggled to explain the price move.

Brent was trading at about $66 a barrel on Friday, down from the high of $73.50 struck on Tuesday.

After discovering the trades, PVM said in a statement on Thursday it had closed them out "in an orderly fashion," resulting in losses approaching $10 million.

It said its brokers were not authorized to take positions in the crude oil markets. Oil brokers generally help to match up trading counter-parties such as banks and hedge funds rather than dealing themselves.

PVM confirmed Perkins was a Brent crude futures broker, but declined to discuss his possible motivation for the unauthorized trades.

The brokerage said on Thursday PVM was conducting a full investigation and it had informed the Financial Services Authority (FSA), Britain's regulatory body, as well as the InterContinental Exchange (ICE), where the majority of Brent futures trade takes place.

PVM is the world's largest independent broker, trading more than 100 million barrels of over-the-counter and oil futures a day on average. The company said it had met all margin calls caused by the unauthorized trades and was conducting business as usual."

www.reuters.com/articl...

There were more, so just follow the link.

Jul 03 09:55 PM