Gold's Downward Spiral Means a Buying Opportunity

Gold appears to be headed down along with the price of crude oil. Historically there has been a correlation between the price of crude oil and gold -- most gold fans and economic historians peg the ratio between the price of gold to oil at 10:1.

The price of crude oil is currently $65.71 per barrel. Using the 10:1 ratio would mean that gold should be priced at $657.10 per ounce. Gold is currently trading at $590.40. Gold has not been following the historical ratio, as geo-political pressures and concerns over terrorism have contributed to a risk premium in the price of crude. If the historical ratio between oil and gold is to return, either gold has to rise or crude has to drop.

I am more inclined to believe that gold will rise. Physical demand for gold tends to be strong going into the fall.

Some gold commentators believe that the drop in gold and crude is a concerted political effort to improve economic conditions before the elections. Here is a quote from a Kitco article by Doug Hornig:

Bill Murphy, of LemetropoleCafé.com... writes that, “One of my fears was, because of the desperation of those in power in Washington ahead of the coming elections, that they might bomb gold. It seems that was the plan. Now we need the physical market to hold the fort, which is likely to happen.”

In other words, it looks as though there may be a concerted attempt to push down the price of both gold and crude in the last two months leading up to the election, but considering the physical demand that normally comes on strong in the fall, that may be difficult with regard to the metal. And attempts at bottling up demand have a way of backfiring in dramatic fashion.

In these uncertain times, there will be wild swings in the price of commodities and metals. If another Lebanon conflict occurs or there is a future terrorist attack we will likely see the price of crude and gold reaching for new highs once again.

One of my two top gold picks, Tanzanian Royalty Exploration Corp., (TRE) has seen a dramatic drop in price following gold’s recent decline. I intend to load up on TRE if the stock drops below $5. I am monitoring my other top gold pick, Yamana Gold, Inc., (AUY) and I would like to build a position in AUY from $8.50-$9.

Related: More opinion and analysis on Yamana Gold and the Gold ETF.

Disclosure: I currently own 4000 shares of TRE, purchased at an average price of $7.36.

Comments

[J P:]

What period of time did you use to come up with the 10:1 historical ratio for oil to gold? Oil has only been a industrial commodity for 100 years. I'm familiar with the 15:1 silver to gold ratio, which seems to have more history (but what that means for either metal, I have no idea.)

The real thing I'm getting at is-- what's a good proxy for valuing gold that will not be affected by inflation? Gold in dollars will go up as inflation is recognized by the economy... but I wonder about gold vs. steel or gold vs. iron, both of which have been known and used for thousands of years, and iron and steel, unlike silver, are general commodities not precious metals.

2006 Sep 13 02:47 AM