What the Gold-Oil Ratio Is Telling You

Oil and gold stock market

On Monday, BlueScope Steel Ltd [ASX:BSL] fell 21%! In one day, nearly three months’ worth of gains were wiped out.  As the old saying goes, stocks rise by the escalator and go down via the elevator.

After a long run of profit upgrades, which saw the share price rise from just below $3 in 2015 to around $14.50 a few months ago, it looks like the party is over for BlueScope shareholders. It’s been a good time, though.

Whether this marks a turning point for economic growth, I’m not too sure. Steel is one of the building blocks of economic expansion. While BlueScope did say profits will fall in 2018, it’s not due to a slowdown in any particular sector.

Still, this is not a dip that I would buy.

What about gold, though?

As I type, the price is trading around US$1,290 an ounce. The day before it breached the US$1,300 mark, if only briefly.

Let’s have a look at the chart…

Gold price 23-08-17


Source: MarketWatch
[Click to enlarge]

As you can see, the gold price has traded in a broad range for most of 2017. Just this week, it popped out of that range, but couldn’t hold the gains. It ended the day back below US$1,300 an ounce.

What’s pushing gold higher?

For one thing — probably the main thing — the bloke in the White House is freaking everyone out. It’s making big money managers nervous. As The Financial Times reports:

The world’s biggest hedge fund manager is turning more defensive on concerns the political drama in Washington will impair the US government’s ability to function and weigh on already-wobbly financial markets.

The move by Ray Dalio, the founder of Bridgewater, which manages about $150bn, comes in a month that has seen the benchmark S&P 500 dipping 1.7 per cent amid Donald Trump’s nuclear brinkmanship with North Korea and White House infighting over the president’s response to neo-Nazi demonstrations in Charlottesville, Virginia.

Not to mention that one of Trump’s (now former) advisers recently advocated for a trade war with China.

When stocks are already priced for everything to go right, erratic behaviour from the White House is enough to see money managers want to take profits off the table and move some capital into the safely, of, say, gold.

But, as I’ve mentioned before, you really want to see gold break above US$1,300 and hold above that level. Otherwise, there is a risk you’ll see another selloff as the yellow metal continues to trade within the range.

Moment of Truth

The moment of truth for gold will come soon enough. This weekend sees the annual meeting of central bankers at Jackson Hole in Wyoming. Depending on the comments from Federal Reserve chair Janet Yellen and European Central Bank chief Mario Draghi in particular, gold could rally strongly or sell off sharply.

I can confidently say I have no idea which way it will go. While central banks have tried to talk a tough game this year, it is evident that they will only take very tentative steps to tighten monetary policy.

If you see more of the same on the weekend, gold could jump.

What about gold’s old mate, oil?

Gold and oil have always had a symbiotic relationship. Real energy, real money…that sort of thing.

So it’s good to check out the gold-oil ratio from time to time. It tells you whether one is cheap or expensive in relation to the other.

Have a look at the chart below. It shows you a 30-year history of this ratio. The grey shaded areas represent US recessions.

As you can see, each recession occurred during or after a downward spike in the ratio. The lower the ratio, the more expensive oil is relative to the gold price. Economies don’t usually handle high oil prices too well.

Gold-oil ratio 23-08-17


Source: Marcotrends.net
[Click to enlarge]

For example, in the 1990s recession, the gold-oil ratio dropped to 10. In other words, one ounce of gold bought just 10 barrels of oil. Real money wasn’t getting much energy bang for its ounce.

The ratio was even lower in 2008, when oil shot to record highs and no doubt contributed to the pressures on the economy.

Since then, the ratio has moved the other way. That is, gold has been getting more expensive relative to oil. In January 2016, when oil prices hit bottom at around US$27 a barrel, the ratio was at its highest in more than 30 years.

Even with the slight recovery in oil prices since the bottom, the chart suggests that oil is still historically cheap relative to gold.

That’s why I’ve been doing a lot of work on the sector for the past few months. As a contrarian investment idea, oil is intriguing right now. It’s off the radar of most investors, yet it’s more in demand than ever before.

In my view, oil is entering a bull market that will become evident by 2018. And the US shale oil industry isn’t nearly as robust as observers suggest.

Which means oil stocks could be on the cusp of a bull market.

If I’m right about this, the three junior energy stocks I’ve tipped here could potentially hit 10-bagger status.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing.

He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’.

Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors.

Greg Canavan

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