Gold+Oil: The New Reality

[Glenn Black]

Gold+Oil_20110223.png

http://stockcharts.com/h-sc/ui

The above chart shows how a new equilibrium level has established itself over the last 3 years between prices for gold bullion and crude oil (WTI: West Texas Intermediate).

The US$ may go up or down as people play on the fringes and speculate. As we can see here, the ratio is getting more and more stable since the major disturbance occurred in March 2008. Also note that there has been a significant shift in the normal ratio, before Mar/08 it was just under 10:1

Now, it is 15.5:1

I wonder why?

There are just a few possibilities. Let's examine them and see if we can discover what's going on.

Gold has certainly moved up in price. Or has it? Could it be that the US$ is what has dropped in value, for gold is sold in US$/troy ounce.

Oil has certainly jumped around in the last 4 years, from $80/bbl, to $147, then quickly back to less than $80 when the Greater Depression hit.

We also have to consider the effect of Peak Cheap Oil. Some people think we hit maximum production in 2008, so it may be more expensive due to supply & demand.

But wait, there's more. Gold has increased greatly since 2001, but they aren't building too many new gold mines. Many of the older ones have re-opened now that the higher price makes it worth while to re-mine the tailings, etc. SO as the market demands more bullion, supply and demand should drive up the price here as well.

Head spinning yet?

What we know for sure is that it takes 50% more gold ounces to buy a barrel of oil today, as compared to Mar/08.

Speculators make maximum returns when they drive prices up or down. Here, we find the opposite; the price ratio is stabilizing and variability is decreasing. This tends to indicate that speculator, evil banksters, dark pools, etc. are not the major driving force here.

I also think that it's safe to conclude that while gold's price is high, it is well justified and a "fair" price when compared to oil. Therefore there is strong support for the current price of gold. If we assume that gold needs to recover its previous price ratio, do we believe it is more probable that the price of oil drops 50%, or that the price of gold goes up by 50%?

Which scenario do you tend to believe?

In 2005, I was working in Saudi Arabia. I saw and heard how the major Saudi fields are pumping more and more sea water and less and less oil as their oil reservoirs run empty.

Around the world, oil processing plants are getting older each year, and need replacing, yet for the most part, it doesn't occur. Check out Exxon's capital depreciation vs. capital spending, as well as their insured replacement values. These should be very indicative. Why are they (and everybody else in the oil industry) holding so much liquid and short term cash and equivalents? Why aren't the oil companies spending billions to build new plants, new capacity, and keep their existing plants in top notch reliability, efficiency, and capacity? I think the answers all point to the same conclusion. The cost to produce the oil isn't going to go down.

Therefore, we can only assume that the price of gold will be going up in price by as much as 50% from Feb. 2011 prices of $1,411

This gives us a target price for gold of $2,116 per troy ounce.

Fasten your seat belts folks. We're in for a ride as the financial titans and other forces convene to make (or prevent) this from occurring. We get to watch the action from front row seats.

[GRG55]

Re: Gold+Oil: The New Reality

The behaviour of various asset classes in recent days has been interesting. In recent years crude oil has been a "risk-on" trade, with prices rising in anticipation of global economic growth & increased demand, and falling rapidly at the onset of any risk to that. Now oil would appear to have flipped to be a "risk off" trade, moving up alongside the traditional havens of gold and the Swissie.

Interestingly the previous risk-off favourite "safe-haven" currency, the US$, headed the other way this week. That seems quite a remarkable change. Perhaps the level of risk concern is not yet sufficiently elevated? Perhaps the US fiscal situation is starting to have influence? Perhaps it requires crises somewhere more important than "those funny little African and Middle East countries" to move people into the US$?

The "next" oil supply shock that EJ warned about would appear to be playing out, at least in people's fearful minds. The fact is there is no current shortage of crude oil. With millions unemployed in the USA and austerity sweeping Europe/UK, which will result in more unemployment, it is very difficult to see how crude oil prices are sustainable in the face of such demand destruction...

[jk]

Re: Gold+Oil: The New Reality

it has been my contention for some time that, between tracking etf's and full supertankers floating at anchor as long term storage, oil is being held increasingly not for use, but as a store of value. of course this is also a role of gold. both are taking on this function of money as the dollar loses this function. the dollar remains a unit of account and a facilitator of transactions. it is ceasing to be seen as a store of value.

[jtabeb]

Re: Gold+Oil: The New Reality

"it is ceasing to be seen as a store of value"


Which is exactly what this Blogger (FOFOA) has theorized would happen, interesting stuff.

http://fofoa.blogspot.com/

[Shakespear]

Re: Gold+Oil: The New Reality

The "next" oil supply shock that EJ warned

This oil shock IMHO looks more like an "orchestrated" one. Too many "coincidences" to these political events which have played out far too easily. Almost like an ocean wave.

The Prelude seems to have been Wikileaks.

[GRG55]

Re: Gold+Oil: The New Reality

This oil shock IMHO looks more like an "orchestrated" one. Too many "coincidences" to these political events which have played out far too easily. Almost like an ocean wave.

The Prelude seems to have been Wikileaks.

An orchestra normally has a conductor. Whom pray tell do you think is on the podium in this instance?

[flintlock]

Re: Gold+Oil: The New Reality

An orchestra normally has a conductor. Whom pray tell do you think is on the podium in this instance?

Yes, I'd like to hear that answer also. The world is not as easily manipulated as many would want to believe. "Sometimes a cigar is just a cigar".

[Shakespear]

Re: Gold+Oil: The New Reality

Now lets take a look. What is there and in the neighborhood that is not found in Mozambique or that hotly contested Greenland? It is not the sand or snow that is of interest. My guess it is Hydrocarbons.

US
http://www.overthinkingit.com/wp-con...roduction1.jpg

UK
http://www.energybulletin.net/image/...8/image002.gif

If you are running out of it you better get control of now or else later you may not be able to afford it. At least not with "Monopoly Money".

Who else is interested in the same? Is it a Bear or maybe a Dragon? A Dragon, China. So Best to get going sooner rather than later to make sure you have "your people" in place. Those clowns close to "retirement" are expandable, and they are being "retired" in a hurry.

The world is not as easily manipulated as many would want to believe. "Sometimes a cigar is just a cigar".

So how did the wheels get blown off of the US economy?

[FRED]

Re: Gold+Oil: The New Reality

We concluded that we cannot diversify out of our Treasury bond position into oil without effectively adding to our gold risk exposure, already over 40% due to price increases since our purchase at $270 in 2001. In other words, investing in gold is effectively the same as investing in oil.

[GRG55]

Re: Gold+Oil: The New Reality

Now lets take a look. What is there and in the neighborhood that is not found in Mozambique or that hotly contested Greenland? It is not the sand or snow that is of interest. My guess it is Hydrocarbons.

US
http://www.overthinkingit.com/wp-con...roduction1.jpg

UK
http://www.energybulletin.net/image/...8/image002.gif

If you are running out of it you better get control of now or else later you may not be able to afford it. At least not with "Monopoly Money".

Who else is interested in the same? Is it a Bear or maybe a Dragon? A Dragon, China. So Best to get going sooner rather than later to make sure you have "your people" in place. Those clowns close to "retirement" are expandable, and they are being "retired" in a hurry.

So how did the wheels get blown off of the US economy?

Yah, I heard that argument about Iraq. Doesn't seem to have panned out, does it? Perhaps you are wrong. Even the dumbest people, including the part of that cohort that lives in D.C., are capable of learning something.

China has a long standing policy of non-interference, because it doesn't want anyone interfering in its internal affairs.

The USA is so far behind the curve on this one that events have overtaken the State Dept and White House's ability to respond to them. Hillary's comment about Mubarak being a family friend, and other things like that, make the USA look foolish [or worse] to everyone here...

[coolhand]

Re: Gold+Oil: The New Reality

Yes, I'd like to hear that answer also. The world is not as easily manipulated as many would want to believe. "Sometimes a cigar is just a cigar".

No conductor here that is making the music harmonious - but the conductor is Mr. Ben Bernanke. The game is very simple IMO: If we do nothing, emerging markets will grow enough in the next 1-2 years to start cutting into our oil supplies, & make life miserable here as we have taken on all this debt assuming our cheap oil supplies would grow forever...just like the Soviet Union in reverse - if our oil supplies shrink, given our debt levels, the US will collapse, with a high degree of likelihood.

So instead, we are taking the fight to the emerging markets: Rather than allow the emerging markets to cut into our oil supply, we print gobs of money, burn 40% of our corn crop in our fuel tanks, & starve the emerging markets into serial revolutions, which then cuts their oil usage relative to what it would otherwise be, & as we're seeing in Libya, reduces mouths to feed on a large scale. They are the only nations that are really growing anyway from a reproductive/demographic standpoint.

I don't like "the music" as a human, but if I strip away my human empathy, it's a brilliant geopolitical strategy for the US to pursue, given that we didn't start doing smart things with our energy dependence like we should've, back in the Carter or Reagan Administrations.

It's Machiavellian really. I doubt Ben Bernanke realizes this per se, but maybe he does. I have no doubts that somewhere in the US intelligence community, someone is aware of this sad but true fact: If we hyperinflate the dollar, food costs will take care of the peak oil shortage by wiping out a lot of incremental demand in places that aren't the USA or our closest allies.

[Glenn Black]

Re: Gold+Oil: The New Reality

We concluded that we cannot diversify out of our Treasury bond position into oil without effectively adding to our gold risk exposure, already over 40% due to price increases since our purchase at $270 in 2001. In other words, investing in gold is effectively the same as investing in oil.

On closer inspection of this data, I would like to suggest an alternative interpretation, as follows:

The oil embargo in '73 was a separate incident that came and went, staying only in our minds and our nightmares. The goldil ratio recovered. The crisis ended in 1985.

Thereafter there is a slightly different ratio between goldil, then inflation starts to act as hot money pours into the stock market and housing, continuing until 2008.

I think the linearization of these two events is a un-necessary simplification that can cause significant errors of interpolation (ie. between the data points 1973 - 2008), causation (ie. beyond correlation, common factors, and direct or inverse relationships), and extrapolation (ie. looking to the future beyond the last data point)

[Glenn Black]

Re: Gold+Oil: The New Reality

No conductor here that is making the music harmonious - but the conductor is Mr. Ben Bernanke. The game is very simple IMO: If we do nothing, emerging markets will grow enough in the next 1-2 years to start cutting into our oil supplies, & make life miserable here as we have taken on all this debt assuming our cheap oil supplies would grow forever...just like the Soviet Union in reverse - if our oil supplies shrink, given our debt levels, the US will collapse, with a high degree of likelihood.

So instead, we are taking the fight to the emerging markets: Rather than allow the emerging markets to cut into our oil supply, we print gobs of money, burn 40% of our corn crop in our fuel tanks, & starve the emerging markets into serial revolutions, which then cuts their oil usage relative to what it would otherwise be, & as we're seeing in Libya, reduces mouths to feed on a large scale. They are the only nations that are really growing anyway from a reproductive/demographic standpoint.

I don't like "the music" as a human, but if I strip away my human empathy, it's a brilliant geopolitical strategy for the US to pursue, given that we didn't start doing smart things with our energy dependence like we should've, back in the Carter or Reagan Administrations.

It's Machiavellian really. I doubt Ben Bernanke realizes this per se, but maybe he does. I have no doubts that somewhere in the US intelligence community, someone is aware of this sad but true fact: If we hyperinflate the dollar, food costs will take care of the peak oil shortage by wiping out a lot of incremental demand in places that aren't the USA or our closest allies.

I doubt that OPEC will continue to bust their but every day to keep the US supplied, especially when the US$ is becoming more trouble than its worth.

As a mind experiment, picture yourself in the following scenario:

You're driving along on a divided highway at the maximum posted speed, enjoying the radio, the scenery, and the sunny day. All is good. There is a concrete barrier between you and the multi-lane traffic going the opposite direction, but you are a foot inside the yellow line marking the edge of your lane, and there is 8 ft. wide shoulder before you get to the barrier. You are well aware that your car's beautiful paint and sheet metal is no match for hard concrete.

Now let's pump up the stress level. You suddenly have an emergency in the car. Let's say your Dad is in the back seat and has a sudden heart attack. You need to get him to the city hospital ASAP, and its 100 km away. You must be your own ambulance. You step on it, and are now doing 30 mph faster than the posted speed. Fortunately traffic is light to non-existent. Up ahead, you see there is a construction zone, lanes beside you are closed, and the shoulder beside you will soon disappear. You dare not slow down, or your father will surely die. Now you are at an extremely high speed, and the concrete construction barrier beside you is mere inches from your outside rear view mirror. You dare not blink for it might cause you to hit the cement barrier beside you. You cannot look at the traffic signs, for losing focus on steering. Somebody tells you that the sign said the construction zone end in another 65 miles. You start to pray and sweat.

The above scenario approximates what it is like to run an industry flat out, full speed for 24 hrs/day, 7 days per week, for decades. It is extreme stress, and the slightest mistake or indecision can spell huge consequences. In the above case, it is only one person who in squeezed. Fortunately, in major industries, there are others to spell you off so you can go home, sleep, eat, and play with your kids. However, trust that there is always somebody in the driver's seat praying and sweating.

This is what the Saudi oil industry and others have been doing for decades.

Add to that stress, the added benefit that your customers don't like you, call you terrorists, and say your entire life (which surrounds Islam) is a huge problem, and you can only buy half of what you used to buy with the customer's worthless paper money. How willing are you to climb back into the stressful driver's seat?

I would suggest that as this scenario slowly unravels, OPEC will get a breather as the world's demand for oil will drop as the economy gets worse & worse. OPEC and China, as did Iraq and others try in the past to buy & sell oil in other currencies than US$, will force the movement away from US$ denominated trade more and more. The US knows the consequence if this is allowed to occur, and they will fight it by all available means, as well as some "unavailable" means. In the end, it will only delay.

A wounded animal is extremely dangerous, even more dangerous than before it was wounded. Everyone stays well clear of the teeth and the claws as they watch the blood spurting out of the wounds. It won't be much longer.

[flintlock]

Re: Gold+Oil: The New Reality

In other words, investing in gold is effectively the same as investing in oil.

Ha, that's funny. I kind of came to the same conclusion on my own. I'm roughly 33% gold and 41% oil. I was a little late to gold but some good luck with oil has helped me catch up a bit. Didn't start out so heavily weighted in either, but then that's what gains will do for ya.

[flintlock]

Re: Gold+Oil: The New Reality

So how did the wheels get blown off of the US economy?

I'm just talking about oil prices here. I don't think anyone orchestrated the BP Gulf Oil spill or the revolutions in the Middle East and North Africa. At least not in some Machiavellian way. The timing has just been bad is all. I certainly do think someone blew up the world economy. Which I guess you could say indirectly led to the revolutions. But they didn't necessarily plan it all that way. Rather it's unintended consequences. Don't give selfish bastards more credit than they deserve. There just common criminals. Not geniuses. We are just collateral damage to them.

I was watching a show about Ford Motor Company the other night. Huge growth of sales in India. Who could have shaped that? That is where you problems with oil prices will come from. From massive demand in countries that didn't used to use so much oil. China as well of course. The way I see it, the world doesn't even have to be in a boom economy. Just modest growth in those nations with the sheer numbers of people and you will see oil demand stay very high.