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Wednesday, December 31, 2008

Gold to Oil Ratio

Lately, this has become a relatively popular chart. Gold is usually priced in US$ per ounce, Light Crude Oil priced in US$ per barrel. The comparison is how many barrels of Oil can 1 ounce of Gold buy.

Firstly, some long term chart over the past 20 years ...

Key observations:

1. Gold is overbought when Gold/Oil ratio is around 22 or higher.
2. Gold is oversold when Gold/Oil ratio is below 10 say.
3. On average - over the past 20 years - the "mean" for Gold/Oil ratio is around 14-16 say.

A closer look over the past 3 years:

Key Observations:

1. When crude hit bottom (below $34) a fortnight ago, Gold/Oil ratio is locally highest, at 24, which suggests that either Gold is overbought, Oil oversold, or a combination of both. Or if Gold is priced normally, then, Oil is extremely oversold. Or if Oil is priced normally, then, Gold is extremely overbought. I lean towards Oil being oversold.

2. It is interesting, that during July this year, the Gold/Oil RSI was oversold, suggesting that either Crude Oil was overbought, or Gold oversold. As it turns out, July this year is when Crude Oil peaked at $147 per barrel.

3. It seems in Dec this year, the Gold/Oil RSI is now the reverse, i.e. overbought. Also appears to have coincided with the lowest Crude Oil price at below $34 on Dec 19.

Other Observations:

1. The Gold/Oil ratio is on a "bull run". As usual, a bull run can always run higher than 24. We now appear to have seen a "local peak" at 24 a fortnight ago. Is this "THE PEAK"?

2. Historically, when measured over years and decades, the Gold/Oil ratio has a tendency to revert to the mean. Personally, I have no doubt that it will revert, it's only a question of when.

3. In the last 6 months, the Gold/Oil ratio has gone very, very quickly from oversold, to overbought. This is the fastest move ever in the last 20 years.

Other Thoughts:

1. If you don't believe that you can time markets, then, around now might not seem to be a bad time to commence entry into Crude Oil if one has a long term horizon measured > 12 months. You won't be able to pick the bottom, but you should be able to scale in your entry over progressively lower prices. The practical problem is of course what vehicle, since crude oil futures are highly leveraged instruments, and you have the rollover / contango problem to overcome.

2. Index funds are interesting, but there are some detailed studies suggesting that the performance doesn't appear to match the actual Continuous futures charts.

3. Oil stock/s with huge oil reserves/inventories are possible prospects, but these require careful study of the stocks concerned. The general feel is that the stock prices have not yet factored in recent low crude oil price.

4. I will not personally consider Options on 1, 2, or 3, as they are more complex forms. And forget physically owning oil in barrels. *grin*

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