My primary goal in starting this blog is to gather important information on the markets to inform and to potentially profit. For the past couple of months I’ve been playing catch up with the market: trying to figure out what information has been properly priced in and which hasn’t. For example, the large financial firms have experienced most of the price action they are going to get. Disclaimer: I have never traded either gold or oil or followed their price actions for any substantial period of time.
With that said, if you agree that:
- With every Fed cut, the dollar devalues and that for the foreseeable future we will get more. I’m thinking 1% Fed Funds rate by the end of summer as treasury yields go down below 2%.
- Oil is only traded in dollars. So every foreign country with a currency that has appreciated against the dollar has seen oil prices rise slower than that in the US.
- Using correlation trading, an ounce of gold has historically bought you 17 barrels of oil. At current valuation gold would buy you 10 barrels. Check out this article on the gold oil swap.
So?
Not all OPEC nations use the US dollar everyday. In times of a strong dollar, OPEC loved converting their dollars to other currencies, but today the weak dollar is cutting into profits where ever there is a currency exchange component to business. Although the coming US recession sounds like a good excuse to cut production for OPEC, I don’t believe it. Inventories have been increasing, not decreasing. Here’s an embarrassing story that must have caught people by surprise. Here is an excerpt from the Bloomberg story:
“There comes a point where fundamentals can no longer be ignored,” said Michael Fitzpatrick, vice president for energy risk management at MF Global Ltd. in New York. “You can’t justify $100 oil when inventories are up six weeks, demand is weak and the economy is slowing.”
Cutting supply is just a way to up the dollar price of oil in order to maintain the same level of profitability in a global world. To the rest of the world a decreasing dollar and stagnant oil prices means cheaper oil. The devaluing dollar makes oil more attractive to foreigners, increasing international demand. Half of all demand for oil is coming from outside the US. Here is another interesting take in video form from Bloomberg. Ronald Smith admits that oil consumption does not slow down during economic downturns.
Here is a chart of Gold vs Oil:
No real relation is apparent, but we know that the average gold to oil ratio is 17 and that any move below 6-9 has been followed by a move to 15 within 2 years.
Here is a chart of the Dollar vs Gold:
I think what we are seeing here is a move like that in the late 1970s where increasing oil prices drove up the value of gold. Note the transition between relatively strong dollar to weak dollar beginning 1976.
It’s interesting to note that oil began its rally days after the January Fed cut.
Here is a trade idea. Listen to the trader explain why he thinks gold is going up. I don’t buy it. At the end of the day, oil is rising due to the devaluing dollar. As the dollar weakens expect oil to go up. Then, expect gold to follow. In my opinion, the recent success of both is the smart money betting on further dollar deterioration. There have been many rumblings recently of $1,500 gold. Remember, tips are for waiters: go make up your own mind.
Finally, following this reasoning you can see that deflation measured by the CPI will not occur during this coming economic downturn. Unless, of course, we have a commodities implosion. But that’s a whole other post topic…
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April 22nd, 2008 at 11:15 pm
[...] recently wrote on the topic of oil and gold. I argued we should be seeing a bull market for both mainly due to the weak dollar. This goes [...]