File the Divorce Papers – Gold Breaks Away From Oil

By John Lee, CFA

Nov/16/2006

Since mid-October gold has risen 10% breaking through both its 50 and 200 daily moving averages.

All the while, oil has fallen to $60 a barrel and copper has come down 13% to breach its 200 DMA; barely staying above $3 a pound.

These events signal a major change to the current commodities cycle.

We commented in our Sept 19th update:

“The CRB is now 10% below its 200 DMA, a feat that has never happened since the bull started in 2002. This is a significant event and must not be taken lightly. At this juncture, we interpret the shift in trends as follows:

1. CRB, oil, and base metals have peaked for at least the next 12 months.
2. The precious metals have one more run left that will begin later this year and last into fall of next year.
3. Agricultural commodities typically shine last and will take the leadership role in the CRB from here on.”

http://goldmau.com/gold_simmers.html

In the past, we have also commented that gold must separate from oil and copper. This is happening now.

Oil peaked at almost $80 a barrel in July and since then it has been in decline. Psychologically and fundamentally, over the last few months oil investors have been hit with bearish news. First Amaranth lost billions of dollars in the energy market which dampened the mood. The Chinese government then indicated its intent to reduce domestic subsidies on gasoline which will raise Chinese consumer gas prices and dampen demand. The final nail in the coffin for energy traders and speculators may well have been the recently proposed tax changes to the oil and gas income trust sector in Canada.

On a historical scale the 36-year average ratio between gold and oil is 17.5 barrels of oil per gold ounce. On that basis, today gold is very cheap in terms of oil. We believe gold has seen its days trading below 10 over oil (see chart below). Our 12 month target for the gold to oil ratio is 14, which translates to an $840 gold price at $60 oil.

The same can be said with the copper/gold ratio. Since early October gold has been rallying while copper has been in decline. The gold over copper chart has recently broken above its 200 DMA. At our target ratio of 3 and with copper at $2.5 in the next 12 months, we come up with a gold price of $750/oz.

Why has gold been lagging and only beginning to catch up? We can only speculate but we believe primarily

1. Traders and speculators can relate oil and base metals better than gold.
2. Asian governments have been subsidizing oil and base metal, boosting consumption.
3. Oil and base metals are for consumption, with limited supply, while gold has vast supply.
4. After 2 decades of believing inflation was dead, the crowd is in the mode of inflationary disbelief and therefore most have not yet hedged their portfolio with gold to protect against inflation.

Oil and copper have established their peaks. This also means that the CRB has likely peaked for at least the next 12 months. At this time we favor precious metals and grains over energy (including uranium) and base metals.

John Lee, CFA