Gold versus Industrial Commodities
Gold and Oil
With reference to the following long-term chart*, notice that oil moved back and forth within a wide horizontal trading range between 1980 and the early years of the current decade before finally breaking out to the upside in 2004. Notice, as well, that after it broke above long-term resistance at $40 in 2004 it quickly gained about $15 (37%) and then dropped all the way back to $40 to 'test' its breakout before resuming its upward trend.
Now refer to the following long-term gold chart*. Rather than oscillating within a wide horizontal trading range for a couple of decades, gold trended lower from its 1980 peak to its 2001 trough. However, there's a similarity between gold's price action over the past 6 months and oil's price action during the second half of 2004 in that, as was the case with oil, gold's initial break above long-term resistance defined by its early-1980s high has been followed by a sharp pullback to 'test' the breakout. As part of this testing process gold could drop back to $800 or perhaps even a bit lower, but the point is that this price action is quite normal and, in the grand scheme of things, bullish.
Despite its recent sharp pullback, the above long-term chart creates the appearance that the gold market is very extended and in need of a lengthy consolidation. It certainly wouldn't surprise us if gold spent many months consolidating between $800 and $1000 before embarking on its next upward leg, but while gold may look overbought on the above chart it is not remotely close to being over-VALUED. Relative to oil, for example, gold is presently not far above the 40-year LOW reached in 2005. It is also cheap relative to copper and the Dow Industrials Index.
That gold is presently very low relative to oil and moderately low relative to copper and the US stock market tells us that there is still very little recognition of today's monetary problems. That this is, indeed, the case is also evident from most of the commodity-related commentary we see/hear each week. Considering the price action the quantity of staunch commodity bulls is surprisingly small, but the fully-committed commodity bulls that do exist tend to focus almost exclusively on supply/demand fundamentals. It rarely seems to occur to them that all of these commodities couldn't possibly be rising in price at the same time if there were no problem with the money in which the prices are denominated.
Now we see mainstream analysts coming out with $200/barrel oil-price forecasts, but a $200/barrel oil price would mean a huge increase in energy-related expenditure, which could only be possible if there were an equally huge reduction in expenditure elsewhere OR a huge increase in the supply of money. Any price is possible if you increase the money supply enough. Just ask the average Zimbabwean.
Anyway, our point is that the monetary problems are not YET widely understood, which, in turn, creates gold's upside potential. Gold's REAL upside will stem from more and more people coming to the realisation that the rising prices they see are, first and foremost, a symptom of a monetary problem, as opposed to a consequence of China's economic growth or the other popular non-monetary reasons that are regularly dished out.
Gold and the Industrial Metals
During 2007 the gold/GYX ratio (gold relative to the Industrial Metals Index) reached a short-term peak during the first 5 weeks of the year, pulled back sharply into the early part of May, and then trended higher over the remainder of the year. 2008 seems to be following a similar pattern in that gold/GYX reached a short-term peak during the first 5 weeks of the year and then pulled back sharply into the early part of May. As evidenced by the following chart, it has just reversed upward.
We expect the similarities to continue. In particular, we expect that recession-like conditions within the US, slowing growth elsewhere, and widening yield/credit spreads over the next several months will propel gold upward relative to industrial metals such as copper.
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