Thursday, July 02, 2009

Black Gold Rally Done?

A weakening dollar will keep commodity bugs aflutter but what can it mean for commodity prices; gold and oil in particular? The chart below shows my June 22nd annotations for the EURUSD which are still in play. If the dollar was to weaken another 10% what impact will this have?

Looking at the historical relationship between oil and gold prices any spike into the upper 20s (ie when gold trades at 25-30 times the price of oil) has been a good opportunity to buy oil. This has shown itself well on the recent spike.

Prior to 2000, spike lows in the ratio in the 6-10 range have not been a good time to own either gold or oil.

But the questions the aforementioned chart asks are

[1] Is now the time to sell the oil given the relationship has dropped to the 1997 spike low at 13.50 when oil prices peaked?
[2] Will a further deterioration in the dollar potentially see this ratio fall back to sub-10s (although a weak dollar will boost both oil and gold prices, but would oil benefit more)?
[3] What of the elephant in the room from 2001-2008 when the ratio effectively traded in a tight range of 6.00-15.00 as both oil and gold made tremendous gains - oil in particular?

Whatever the short term implications of a weakening dollar the long term picture for oil may not be so hot. Yes, we live in a very weak economic environment but with considerable inflation pressures down the road. However, it is rare for any asset to emerge from a strong trending period to kick straight into another. Oil is likely to spend the next decade trading in a range probably between $30 and $80 a barrel.

As a finite commodity it has a built-in appreciation level so it has excellent potential for future price growth. It is an ideal asset to have in a retirement account (either as a related stock or ETF) where timing short term appreciation is not the goal.

As a trading instrument any drop into the $30s is a buy irrepsective of economic conditions. Anything pushing $80+ is a good reason to take some profits with a psychological break and hold of $100 probably enough to see it challenge 2008 highs.

Gold is a trickier beast. Given the relationship to oil has never cleared more than 28 times its value one could assume gold has the potential to trade up to $2,240/oz if oil traded at $80. However, weak periods for oil over the past 20 years have not been strong periods for gold. Gold Bugs will probable argue differently but it seems unlikely for gold to get past $1,000 this time around.

Dr. Declan Fallon, Senior Market Technician, the free stock alerts, stock charts, watchlist, multi-currency portfolio manager and strategy builder website. Forex data available too.