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Gold did not follow oil’s steps
recently – does this mean that the bull market in gold is coming to an
end? Taking into account gold’s latest underperformance, should you
expect gold to plunge, as oil corrects/falls? Not quite.
One of the best ways to view current
events or price patterns is to take a look at the big picture to see whether
or not the situation is indeed extraordinary and should make you alert. Day
to day volatile price swings, short term trades, hundreds of 'important'
headlines in the mainstream press – they all make us perceive markets
emotionally, rather than approach them by means of cold logic. The latter
usually leads us to better investment decisions than the former. This is why
we always focus on the broad view first. If one can look at the big picture
from a different perspective or angle then it’s even better. Keeping
that in mind, we decided to check if something similar has happened in the
past and if so, what was the final outcome. That outcome could give us
indication of what to expect in the near future.
We have prepared two charts with gold and
crude oil in two different scales: logarithmic and linear. Since we are
talking about rather long term trends and relations, we will first present
chart in the logarithmic scale, as it emphasizes growth in percentage terms.
This makes it very useful if prices increase substantially. That has
certainly been the case with both gold and oil in the previous 8 years.
 
First things first – there is a
massive long-term uptrend in both gold and oil, which has not been violated
up to date. Next, gold and oil tend to rise at the same time in the long term. The linear trend line with a positive
slope and the R-square coefficient of 89% suggest that this is relatively
stable type of correlation. Please note that we have highlighted the phrase
'in the long term'. We have done so, because there were short periods, when
oil surged independently from gold, and there were times when profits
achieved on gold were superior to those that could have been achieved on
crude oil. We are not taking any leverage into account here, just the spot
prices.
Generally, one can distinguish two general
trend lines – borders of the rising trend channel. Price of gold
relative to crude oil used to touch both of these trend lines in the past.
These times could have been described as 'critical underperformance'. Should
gold fall substantially below the lower trend
line, we would start to worry about the healthiness of the precious metals
bull market; however this has not materialized yet. According to the trend
lines, gold is undervalued relative to crude oil, but it is still way above
the level of 'critical underperformance'.
This suggests that gold's rather sluggish
performance relative to oil in recent weeks is nothing extraordinary. However
we make our final conclusions, we have a second chart to show you. It was
created using the same data but this time, we used the linear scale.
This time the chart does not give us a
clear picture when it comes to drawing a trend channel, but it tells us more
about the shape of the correlation. As you may see, there have been many
days, where price of gold was trading between $400 and $500 level, while the
price of oil traded between $30 and $70 level. Taking into account these
levels and days they materialized, gold increased by a solid 25%, while oil
increased more than 100%. That is what we previously referred to as the
'critical underperformance'. But what has happened then? Has the gold bull
ended? No, it has not. On the contrary, as the commodities and precious metals
bull market continued, gold has managed to rebound and jumped back above the
trend line. Should that take place with current trend line and the price of
oil of $150, gold would have to go above $1170.
What if that was to take place along with
an increase in the price of oil? That is not out of the question, especially
given escalating international tensions and increased perceived probability
of the war with Iran.
In summary, no
matter how you slice it, gold’s recent price action relative to oil or
lack thereof, is nothing extraordinary. In fact, history shows that there were cases of
more dramatic underperformance, followed by more fair valuation, even leading
to overvaluation – taking into account the trend equation as seen on
the charts above. Therefore, in our view, there is no need
to panic because of the recent performance of gold relative to crude oil.
We use the methodology described in this
essay as well as many other techniques to forecast market’s moves and
discover unique opportunities for profit, while taking into account the big
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Przemyslaw Radomski
Editor, www.sunshineprofits.com
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