I am sounding a "trading alert" in this column. The alert is cheap gold. Dirt-cheap gold.
As any contrarian knows, the biggest, fastest payoff a speculator can earn is when an extreme situation corrects itself.
For instance, betting against tech stocks was unbelievably profitable in 2000. This was one of the greatest extremes in the history of finance. Techs traded for 100+ times earnings (many had zero earnings), so the likes of Cisco (NASDAQ:CSCO), Yahoo (NASDAQ:YHOO), and JDS Uniphase (NASDAQ:JDSU) had tremendous distances to fall.
The same goes with homebuilding and mortgage stocks in 2007. "Extremely" stupid lending practices helped send mortgage giant Countrywide Financial (CFC) from $43 per share to $5 per share in just 12 months. Shorting Countrywide and homebuilding shares was like sitting down at a broken slot machine.
Right now, we have an extreme situation in the commodities market… one you can use to make a lot of money in gold. It all comes down to the gold/oil ratio.
Because gold and oil respond similarly to inflationary pressures, the two tend to trade in a predictable range.
Over the past 25 years, one ounce of gold has bought, on average, 15 barrels of oil. When an ounce of gold can buy 20 barrels of oil, it's expensive and due for a fall. When an ounce of gold can buy less than eight barrels of oil, it's cheap and due for a rise.
Right now, gold buys you just 6.5 barrels of oil – less than half its traditional purchasing power. The tremendous rise in crude oil prices is the cause of this situation. Crude has gained 155% in the last 18 months. Gold has gained "just" 50% in the same time. As you can see from the chart below, this disparity has left the rubber band pulled extremely tight.
There's no guarantee this extreme will work itself out quickly. But this is one trade worth keeping on the radar. If oil stubbornly refuses to correct from its levels above $140, gold could easily pop to $1,000 and beyond in just a few days. In 2005, a similar extreme reading preceded gold's rise from the mid-$400s to the mid-$600s.
If you haven't bought gold as "catastrophe insurance," now is a great time to do so. If more cockroaches crawl out of the mortgage debacle and into mainstream headlines, you'll likely get a $100-$200 per ounce jump in your investment. Whether it's through buying bullion, gold stocks, or an ETF, right now is an extreme opportunity in gold.