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Lior Cohen's  Instablog

Lior Cohen
  • on Gold & Precious Metals
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Hi I'm Lior, an MA graduate in Economics. I have worked for several years in a variety of economic related positions, and in 2010 I started my own blog – Trading NRG, which is a news and analysis blog about gold, silver, natural gas and oil.
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Gold & Silver Monthly Outlook
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Trading NRG
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  • Tackling the oil to gold ratio paradigm – fact or fiction? A short analysis
    By: Lior
     
     
    There are many "crystal balls" that are sold on line that suppose to help us understand how to trade and invest in commodities, and even help predict commodities' prices such as crude oil prices
     
    One of these "crystal balls" is a ratio commonly used – the oil to gold ratio. A quick search on Google came up with nearly 4 million results of this term. One of the first results stated that there is normally a positive linear correlation between crude oil prices and gold prices. I have decided to check out this paradigm and see what kind of relationship there is between these two major commodities – gold and crude oil, and is it sensible to use this crude oil to gold ratio as a predicting tool.     
     
    To that end I have checked two basic facts: the trend of both of these commodities and the level of correlation between the two.
     
    In the following graph you can see the trend of both of these commodities' price series – gold spot prices in USD / oz. and WTI crude oil spot prices USD / barrel, for the years 1998-2010 (monthly basis prices). In order to make these series comparable I have normalized the figures to 100=1/1998 (i.e. January 1998 was set to be 100).
     
     
    The graph appears to show some relationship between the two commodities' prices. Nonetheless, since we all know that charts could be sometimes misleading I have also checked the correlation between the two series.
     
    In the table below I have checked the level of correlation between the monthly percent changes (from month to month) of crude oil prices and gold prices. While for the entire period there seems to be a weak positive correlation, when breaking the time series to couple of years, a different picture reveals. In the table you can notice that in some periods there is a positive correlation (such in 2000-2001), while in other there is a negative correlation (such in 2009-2010). Also notice that the strength of the connection also varies between the periods, such is the case in 2006-2007 with a whopping +0.57 correlation.
     
    *Monthly average prices; Source: EIA website and World Gold Council website.
     
     
    What does it all mean?
     
    For one thing, the correlation between the two commodities is not predictable and varies, that is the only prediction you can make based on this exercise. Furthermore, since correlation doesn’t mean causation, I think that in this case it's very much true with these two commodities. And finally, there are additional variables, much more important, that affect these two commodities' prices (i.e. interfering variables) in the same (or opposite) direction, such as the previous Quantitative Easing program from March 2009 of the Federal Reserve which apparently had a positive affect on both of these commodities' prices.

      



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: gold prices
    Dec 19 12:32 PM | Link | Comment!
  • Ecstasy for the Gold – Examining if there is a bubble in the Gold Market
     By: Lior Cohen;

    Website: www.tradingnrg.com

    As the gold price continues to roar up the ladder and on its way to pass the 1,400 USD/t. oz. mark, one might think if this price is justifiable for this precious metal. Could it be possible that there is an economic bubble in the Gold market?

    I think it's well known that many investors and traders fell back on Gold because it is considered a safe heaven when the level of uncertainty as the markets rises. What is the uncertainty? We all know them, it includes such as: the U.S. economy's peril condition after the 2008 bank crisis; Europe's decline with Greece and Ireland nearing bankruptcy, and with other countries on the target such as Portugal. Therefore many consider commodities for investment, and in particular Gold, which has proven to be with stable demand for many years.  

     

    In order to have a bubble in a certain market, the current prices of an asset shouldn't be detached from its real price, i.e. the demand/supply price. If the asset is priced more then its worth then we have a bubble ready to explode.

     

    In order to check this claim in the Gold market, I have gathered data about the total world demand and supply in tons between 2004 and 2010 (Q4 2010 was an estimation) and compared it to the average yearly gold price.

     

    If there is no bubble it should mean that the rise in the Gold price should be inline with the rise of demand or the lack of the supply to maintain the demand.  

     

    So let's get started…

     

    In the table below there is the gold price in yearly average for 2004-2010 (2010 is up to October), and it is compared with total world Demand for Gold, total world Supply and the supply surplus or deficit (supply minus demand). The last figure shows that if the demand isn't provided then there is merit for the price to rise because of lack of Gold.

     

     

     

    The table shows that in the past couple of years there is no shortage of Gold and if any, a surplus; furthermore, the demand is lower in 2010 then it was in 2008.

     

    The table below presents the year to year change of the demand, supply and gold price (percent change).

     

     

     

    In the following graph you can see a time series of the price of gold chart and total demand vs. total supply for the years 2004-2010 (yearly scale).

     

    A price of gold chart (USD/t. oz.) & Demand vs. Supply (tons) 2004-2010

     

     

     The graph shows that while the gold price rises very sharply the demand and supply didn't rise in the last couple of years.

     

    Could it be a matter of inflation? I.e. the prices of most commodities rose and therefore the relative price of gold didn't change much. Perhaps, however I don't know of any high inflation that we have recently suffered from in the Western world (e.g. Crude oil prices and natural gas prices aren't higher then they were a few years back).

     

    So what is the bottom line?

     

    I think we should consider that Gold is at a very high price and could be separated from its "real worth". If it's true, then it means that Gold is overpriced and its market is a bubble ready to pop any time…

     

    When, if any, this bubble will burst? Good question… I can't give a good estimate because it's a tough question…however, I could speculate that it could happen when investors will try to move their funds to somewhere more attractive. Therefore the answer relies on the question when will investors gain again trust in U.S or Europe's' financial markets to invest in them; nonetheless, this bubble burst could take a long time (even years), because there are no apparent good alternatives as I have pointed out at the beginning, and as long as the trust in the major markets isn't restored, it will be hard to persuade anyone to move from Gold. 



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: GOLD
    Dec 16 7:04 PM | Link | Comment!
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