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.
