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As I toured around
the world to talk about the merits of gold during the last several years, the
same question was posed to me over and over again
"John, oil is
$80, $100, $150 a barrel, why hasn't gold lived up to its reputation as a
hedge against inflation?"
Oil's triumph over
gold from 2001 - mid 2008
While gold investors
faired well as gold went from $250/oz in 2001 to $1,000/oz in early 2008, oil
investors reaped stupendous profits as oil price topped $145/barrel in July
2008, up from $22/barrel in 2002.
Ten year charts of
gold and oil
 
People have
attributed oil's superior rise, and the relative underperformance of gold to
1. Peak oil theory
2. Emerging market needing oil, not gold
3. Oil is consumed and gone, while there are lots of gold
4. Jewelry market favoring platinum, not gold anymore
5. Central banks having lots of gold to sell
And my answers have
always been
• Oil
production has been rising yearly from 60million barrels a day in 1980 to now
over 80 million barrels a day
• Gold is about preservation of global wealth, which is ever
increasing.
• Gold is money, which is to be saved, not consumed
• Jewelry demand represents a tiny fraction of gold's trading or
gold's total volume, most of it in bullion form.
• True, but central banks today have also inordinately large
amount of US dollars (over $8 trillion), yet to be diversified.
So why was gold
lagging until recently? My single most plausible answer was
"People are
buying the growth story. Speculators like oil, not gold at the moment."
Financial
deleveraging and gold's resurgence in 2008
The fortunes of gold
and oil have reversed 180 since July, when we witnessed the most speculator
fall in oil's history in the last 100 years. Oil price plunged over $110, or
75% from $147 to $37 a barrel. You can't possibly explain away such dramatic
correction by fundamentals. So what if super tankers are storing oil and
world oil inventory now can sustain 59 days instead of 54 days of global
consumption. Would you see the price of milk go down 75% because people are
cutting back consumption?
In my view, the
freefall of oil price has more to do with the collapse of Lehman Brothers, US banking, and US hedge fund industries. Many of those outfits are leveraged up to 30 times,
bankrupt, and had to close out entire line of positions (including oil) in a
hurry at any cost.
We can also see the
rapid and all-out deleveraging through the reversal of yen carry trade. The
yen has gone up 24% since August not because Japan all of a sudden became a
star investment destination.
12month yen chart
Where is gold headed?
Adjusted for
inflation/CPI/money supply growth, various analysts have pegged a fair gold
price of between $700/oz and $1,200/oz. Gold authority James Turk will show
you how gold has exchanged more or less the same units of oil through
hundreds of years.
20 year chart of gold
to oil ratio
The lower and upper
horizontal bands in the chart above show an oz of gold has exchanged between
22 and 10 barrels of oil since 1989. The ratio dipped to as low as 7 and
right now it trades at 20. One shouldn't buck against the trend and I expect
the ratio to exceed 20 to reach perhaps 30 or more.
You can play with two
of the three variables (oil, gold, and ratio) and come up with the third. For
example, at ratio of 30 and oil price of $50/barrel, the formula produces a
gold price of $1,500/oz. I honestly have no idea what future lies, except
• Oil is
oversold and cheap
• Gold is not expensive by historic means
• The gold-to-oil ratio will keep rising until it comes down.
Fundamentally gold is
attractive as investment of last resort. It's no good to leave money at the
banks earning zero interest, or buy real estate that is faltering, or invest
in equity market during recession.
While gold's blow-off
phase is yet to come, I like to offer a word of caution. Given how quickly
things can change, it might soon be a good idea to hedge gold position by
longing oil.
Enjoy the ride and
happy holidays from all of us at Mau Capital.
John Lee, CFA
Goldmau.com
John Lee is a portfolio manager
at Mau Capital Management. He is a CFA charter holder and has degrees in
Economics and Engineering from Rice University. He previously studied under
Mr. James Turk, a renowned authority on the gold market, and is specialized
in investing in junior gold and resource companies. Mr. Lee's articles are
frequently cited at major resource websites and a esteemed speaker at several
major resource conferences.
Please visit www.GoldMau for
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