|
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 fared well as gold went from $250/oz in 2001 to $1,000/oz in
early 2008, oil investors reaped stupendous profits as oil prices 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:
- Peak oil theory.
- Emerging market
needing oil, not gold.
- Oil is consumed
and gone, while there are lots of gold.
- Jewelry market
favoring platinum, not gold anymore.
- Central banks
having lots of gold to sell.
And my answers have
always been:
- Oil production
has been rising yearly from 60 million 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 degrees since July, when we
witnessed the most speculator fall in oil's history in the last 100 years. The
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 industry. Many of those outfits were
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.
12 month
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
positions by going long 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
instant market alerts and stock updates.
| 
