There has been a divergence between the performance of Crude Oil versus both Gold and Natural Gas that looks to have created a couple of opportunities, the recent correction in Oil prices being the trigger.
Gold and Oil prices have long been correlated over the longer term, likely due to the defensive nature of gold against rising energy prices and a slowing economy/weak dollar. Oil and Natural Gas are correlated by both being in the energy sector, however there are significant supply/demand and usage differences between the two - the market often ignores this fact, though.
The following chart shows the percentage change in Oil (using the (OIL) ETF) versus the performance of Gold (using the (GLD) ETF).
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Oil versus Gold, Price % Performance since 3/21/08
What I see here is that the correlation of the two commodities was very close from the beginning of 2007 through around March 21st 2008. At that point, a big price divergence, reaching an apex during the week ending July 11th. This divergence has begun to narrow itself since then, indicating the compression of performance has begun, but looks to have a ways to go. The play here would be Short Oil/Long Gold in an even Dollar amount hedge - this is banking on the historical correlation continuing to narrow itself out over time. Whether Oil prices fall faster than Gold, or Gold rises up to meet Oil's gain, the trade will profit. This hedge can be put on in a variety of ways: through playing the actual futures, by trading the ETFs, and through using options strategies on the ETFs or individual stocks. The Oil versus Natural Gas price performance chart also shows an interesting divergence. Examine the following chart, which uses the ETF (UNG) for Natural Gas:
OIL versus UNG, Price % Performance since 4/20/07 This are the kind of convergent/divergent hedges you should consider putting on as trades in your portfolio to limit both sector and price risk. Hedge funds have long been trading hedges like this in areas such as volatility, interest rates, and price performance. Disclosure: Long Gold/Short Oil recommended to clients
The UNG ETF was incepted on 4/20/07, since that time there has been a strong divergence since Oil and Natural Gas prices. While this performance gap has been fairly wide since inception, it looks to have reached a peak recently with the high in oil prices. In addition, from a fundamental basis, I see Natural Gas as a better play in the long run. Putting on a hedge to bank on a convergence of these two commodities would be to go Short Oil/Long Natural Gas. This may take some time to play out, but I foresee it having a very good risk/reward ratio, as the divergence is unlikely to expand any further in my view. This trade can also be done through Options Futures, ETFs, Individual Stocks, and even Mutual Funds.
