12/27/08

Relative Value - on which side of the equation?

Gold and Oil have a long-term relationship. It is marked by volatility, but it lives within a range. Gold's per-ounce price runs from a 10 to 30 mulitple of Oil's per-barrell price.

This chart from IncredibleCharts.com shows the thirty-plus year history of the gold-to-oil ratio.

As this chart ends in 2005, the next chart uses the ETF's for each commodity.

Since the gold ETF, GLD, has a 1:10 ratio to the per-ounce price, that makes the relevant range of 10:30 reduced to 1:3.

That's exactly what the range has traveled in a New-York-minute. While almost all commodities have fallen like a stone, gold has held up.

Commodities have been giving an indication of deflation during the financial crisis unwinding of massive leverage. Common sense tells a different story, seeing the Fed and US Government ready to move trillions in place to prevent a financial collapse. Caught in-between is the once weak dollar which rallied in the face of the unwinding. Now as the dollar is weakening again, that leaves the question whether gold will resume its role as a hedge to the dollar and inflation.

Regardless, the gold-to-oil ratio is historically high. Will oil or gold be the stronger relative mover to shrink the ratio. Not knowing the answer, I think buying GLL, the ultrashort gold ETF, and long USO is the best combination.

No comments: