Gold vs. Oil

By Brad Zigler

This week's oil sell-off begs for a little attention to the gold/oil ratio. This week, the ratio rallied in gold's favor from its month-long base.

Gold/Oil Ratio On The Move

The ratio measures gold's purchasing power relative to the price of oil, and it's considered a predictor of gold mining stock margins.

Now at 7.5, the ratio indicates that an ounce of gold can buy 7.5 barrels of oil. That's up "one barrel" from June, breaking to the upside of the ratio's 50-day moving average. The next upside target is 8.4 "barrels."

"Well, that's all fine and good," I hear you say, "but how do I trade that? Do I buy gold? Short oil? Both?"

You can certainly look for gold-buying opportunities. We've pointed to a number of options, including options themselves ("Why Bother With GLD Options?"), to get long gold exposure.

The short oil side's a bit dodgy, though. I'd be very cautious about shorting commodities in a secular bull market.

The market has, however, provided you a seemingly low-risk alternative. Or, more properly, MacroMarkets has. Remember the old MacroShares Up and Down Oil trusts ("Accounting For MacroShares Premia/Discounts")? Well, they're baaaaaack!

The new versions are the MacroShares $100 Oil Up (UOY) and the MacroShares $100 Oil Down (DOY). These securities are interests in a trust, consisting of repurchase agreements and Treasury obligations, that shifts assets from the Up side to the Down side, and vice versa, with the ebb and flow of oil prices. If oil goes up, Treasuries are moved from the Down trust to the Up trust. If oil goes down, the asset flow goes the other way.

The mechanics are the same as the previous MacroShares trust, though the reference price is now $100 a barrel, rather than $60. That means that the upside termination trigger is set at $185 a barrel. The trip wire on the downside is laid at $15.

Folks wanting to make hay from oil's current swoon will find no double-short oil ETFs or ETNs available (though ProShares has one in registration at the SEC now; see "Plenty To Choose From In New Filings"). The MacroShares DOY, however, behaves like one.

How's that? NYMEX spot oil futures have fallen 8.3% since the July 1 launch of the trusts; DOY's market price, however, has gained a whopping 48.9% since then.

So how's that make it act like a double-short oil portfolio? While the price action makes DOY look more like a "six'er," the outsized gain arises from the daily volatility of the DOY security. Its annualized standard deviation is 110%. NYMEX futures' is 47%. About double.

There's another thing to know about DOY. It inherited the premium/discount problem from its predecessor. Right now, the spread between DOY's market price and its NAV hovers around the $5-a-share level, complementing the $5-or-so discount seen in UOY's market price.

MacroShares Oil Premium/Discount

If you're interested in trading the gold/oil ratio, then, a long DOY position could be paired against the DB Gold Double Long ETN (DGP) for a volatility match. For more detail on DGP's volatility, see our March article.

Good luck.

Comments

[BrucePile:]

Gold could be starting a big catch up move to match oil's recent big move from about $80 to $130+. The things that usually follow oil (silver, gold, nat gas, and sugar) all look like they are preparing for take-off. However, I am growing a little leery of nat gas because it's simply too levered to the U.S. economy. The other three things are not.

2008 Jul 18 05:37 PM

[bearfund:]

The MacroShares products simply do not track the price of oil well at all. If you want to be short oil, you've got a couple options: use the futures market, or buy a car. It's pretty much the same damn thing.

2008 Jul 19 01:34 AM

[fireball:]

if you look at gold as real money it is saying oils real value is rising against me. whether real, faked, hook or crook gold is acting as money should if oil is becoming less abundant.

2008 Jul 19 10:05 AM

[Managing Ed...:]

bearfund -

You're right, of course, about MacroShares' price variance from oil. That's, in fact, the point of the piece: turning an investment lemon into lemonade. We're USING, instead of simply DECRYING, this characteristic.

DOY's tracking error is a boon for the short-minded trader in this case because it creates, unintended though it may be, a leveraged return.

The premium and discount reflected in UOY and DOY prices are the costs of the embedded options discussed in "Accounting for MacroShares Premia/Discounts" (www.hardassetsinvestor...).

2008 Jul 19 10:44 AM

[traderjohn2:]

The ratio of GLD to USO is now in about the middle of its three year range, as seen here:
stockcharts.com/h-sc/u...

2008 Jul 19 01:55 PM

[ussmls7:]

Google this & weep, Energy Non-Crisis"by Lindsay Williams! Thats all I have on crap as truth! Gold is Money,as with Silver, no ETF's for me,I like it simple & legal!

2008 Jul 19 10:00 PM

[jcbs:]

Don't read too much into the gold:oil ratio, since Peak Oil is kicking in now and therefore this ratio is a busted flush. It might never go above 10 again...

2008 Jul 21 06:02 AM