Crude Oil and Gold: Not Worth Worrying Over

This essay is based on the Premium Update posted October 23rd, 2009

The crude oil market has lost most of its popularity since it is no longer near $150 per barrel (no longer do oil-related topics dominate the main financial websites), but nonetheless I’m sure that nobody can deny crude oil’s importance in today’s globalized economy. It is vital for both businesses and individual consumers, as fuels are derived from it. Most of us need to drive and purchase goods that also need to be transported to us directly or indirectly.

Since crude oil is so vital to the modern economy, it should not surprise anyone that it influences many markets, and virtually none of them can be completely free from oil’s influence. Therefore, this week I will analyze this particular market, from the precious metals' perspective. I will use the scatter chart in order to focus on the trend and the average shape of the correlation.

As you may see on the above chart, the price of gold/oil has been trading considerably above the dotted trend channel in the past few months. The reason was that most commodities were reacting to the deflation scare that was being hyped by the media about a year ago, and crude oil was no exception. Gold did not suffer that much. One of the reasons might have been that it was perceived as a form of money and during deflationary periods “cash is king”. I’m not suggesting that we are in one right now – this is just a brief reminder of what was popularly heralded in the mass media. I’m not saying that this was done on purpose so that the powers that be could get away with printing more and more money, but that is definitely a food for thought.

Anyway, crude oil dropped much more than gold and the gold/oil price combination moved far from the trend channel on the chart above. Generally, prices sooner or later tend to reverse to their means, and I don’t expect this time to be much different.

However, this time, I do not expect gold to form a long consolidation while crude oil soars. To the contrary, I believe that the fundamental and technical factors are in place for a substantial rally in the metals. So, if the relative value of crude oil to gold is to rise, and go back to the previous trendline (it would mean oil at about $130 given today’s gold price), I would see this process to take place by oil slowly catching up, in a similar way to what we see today. Consequently, the gold/oil ratio rose significantly, and is now moving lower, which has important implications for PM stocks, but I will leave this part of the analysis to my Subscribers.

Another possibility is that metals are going to take off regardless of the situation on the crude oil market. This is probable, but most likely will not take place untill we are in the third stage of the bull market – please keep in mind that this is what took place in the previous bull market – PMs outperformed other commodities.

Before summarizing, I would like to comment on the short-term situation (charts courtesy of http://stockcharts.com) in gold.

The situation did not change much since the previous week. We are still in a trading range after a significant rally, and I still view the short-term correction after a brief rally as the most probable scenario for the following weeks. The red-rectangle marks the probable topping area. It is based on the size of the rally predecing the September consolidation (history tends to repeat itself, particularly during the ABC upswings/downswings), and the Phi (1.618) multiplier used on it.

The question that I’m often asked recently is how low would the correction take us. The answer is that although the September correction did confirm the breakout, the size and significance of the move suggests that a one more re-test of the previous high of $1,033 is likely, but nobody can rule out a decline to $1,000. The media buzz that was caused by gold breaking into four digits caused many momentum chasers to enter the market that don’t want to stay in it for longer. As soon as the rally runs out of steam (for instance we will see declining volume during days when PM rise), they will dump their gold and silver positions thus igniting the decline.

The history often repeats itself, but even more often it rhymes, meaning that the analogy is not ideally precise, but is still present. This is why I marked the whole area, instead of focusing on just one point.

The dollar is in the lower part of its trading range while precious metals are likely to move a little higher before the post-$1000-breakout rally runs out of steam. Since the U.S. Dollar is one of the most important drivers of PM prices in the short run, the temporary effect a small upswing would indicate a decline in gold and silver, however that is not in tune with what gold chart is suggesting at the moment.

My best guess is that we may have a very quick (few days at most) drop in the value of the USD Index – below the short term support line, but it fails to close below that level for three consecutive days and once again rallies above this level to test the upper border of the declining trend channel. Should this take place, I don’t expect the resistance – the upper border of the trend channel – to be broken. As mentioned in one of the previous essays, I expect the USD to trade sideways before finally breaking much lower. This action would correspond to a decline after a brief rally in gold.

Summing up, although many commodities declined sharply in 2008, we are still in the secular bull market in the commodities. The most important commodity – crude oil – has also been hammered and – contrary to gold – did not pass its previous highs yet. Although oil’s underperformance to gold might put the commodities‘ bull market into question, I believe the situation is slowly moving back to the normal state. In other words, I don’t think that one must be worried about the fundamental situation in gold, nor in the crude oil.

The precious metals market has been trading sideways this week, and points raised in the previous Premium Update are still relevant today. The most likely scenario for the coming weeks in my view is that gold and silver would move briefly higher and then correct the post-$1000-breakout rally.

Disclosure: I own gold and silver

Comments

[Tom Szabo:]

An alternate theory gaining a bit of credibility compared to "first a slight correction, then to da moon!" is that commodities, oil and gold will trade in a wide consolidation pattern during the next few years. There is no fundamental reason why oil couldn't be trading at $50 today just like there is no fundamental reason that it is trading at $80. Similarly, I think the idea that gold cannot trade for an extended period in a price range of perhaps $700-$1100, but instead must inevitably trade much higher in the short run, is a sign of groupthink. I have a large exposure to precious metals in the form of physical holdings and stocks so I would love for gold to explode in price but at the same time I believe it's important not to drink the market's Kool Aid.

Oct 25 06:07 PM

[sjgold:]

uhhhhh NO!


On Oct 25 06:07 PM Tom Szabo wrote:

> An alternate theory gaining a bit of credibility compared to "first
> a slight correction, then to da moon!" is that commodities, oil and
> gold will trade in a wide consolidation pattern during the next few
> years. There is no fundamental reason why oil couldn't be trading
> at $50 today just like there is no fundamental reason that it is
> trading at $80. Similarly, I think the idea that gold cannot trade
> for an extended period in a price range of perhaps $700-$1100, but
> instead must inevitably trade much higher in the short run, is a
> sign of groupthink. I have a large exposure to precious metals in
> the form of physical holdings and stocks so I would love for gold
> to explode in price but at the same time I believe it's important
> not to drink the market's Kool Aid.

Oct 25 06:10 PM

[Laurence Hunt:]

I consider Mr. Radomski one of the best technicians in gold.

I read every word he writes. Great to see this article.

My argument against a retest of the $1000 level is (1) the maturity of the rise against the $1000 level (this now dates back to March 2008) and (2) the amount of gaming going on in the market, particularly the current squeeze on the Comex gold commercial shorts (our new best friends).

I'm thinking $1100 before $1000.

Oct 25 09:39 PM

[David Sullivan:]

Israel bombs Iran, oil goes to 150. Iran explodes bomb, oil goes to 150.

Oct 25 10:24 PM

[Bruce Pile:]

Many of the commodity ratios like gold/oil and oil/nat gas have entered a much different world the last two years or so. I don't think their decades old correlation is going to be the same anymore. Oil/gas has forever been changed by peak oil. If you look at the oil vs gas production curves at goodstockinvesting.blo... you can see why this is so. This chart also shows why nat gas, along with coal, has to be the bridge to our non-fossil future.

As for gold/oil, we have entered into a new monetary situation that has forever changed gold's role.

Oct 25 11:36 PM

[anarchist:]

Dollar kicks-ass gold goes to $900. Market collapses gold goes to $900.


On Oct 25 10:24 PM David Sullivan wrote:

> Israel bombs Iran, oil goes to 150. Iran explodes bomb, oil goes
> to 150.

Oct 27 01:51 PM

[MaxWeber:]

Oil is devalued and stagnating.

Oct 27 04:15 PM