Monday, 26 May 2008

Gold:Oil ratio to fall at Peak Oil? 2008-05-26

Monday 26th May 2008, 3:26 p.m. Gold:Oil ratio to fall at Peak Oil?

On the questions section on here: Mp3, one of the callers (Justin) made a very astute question asking if Peak Oil was the possible cause of the fall in the gold:oil ratio to 7 from its long term average of 15 and its medium term recent average of 10. Jim answered the question saying that Peak Oil is likely to be part of it and the undervaluing of gold is another major part of it. He used it as a prodictor for a big upmove in gold in the near future but gave no real fundamental or market justification for this, for instance related to supply and demand.

I think Justin hit the nail on the head. He even went to mention that the only other time in trading history that gold:oil was at 7 was 33 trading days, all in 2005. Of course, he said this to imply the connection to Peak Oil, because it seems to be established that the peak in conventional oil production occurred in May 2005. That's surely too much of a coincidence to be ignored. I have already mentioned this possibility in a previous blog entry (Oil to $1000 per barrel?) but Justin the caller asked the question in a particularly clear way. Unfortunately, Jim didn't give quite enough attention to answering this question, in my view. I think it was an important concept. However, he does such a great show with so many ideas in it and it is always worth a listen!

I see no reason why the ratio should not reset to a lower level for quite a time, for instance to 7:1. I actually mentioned that if oil reached $1000 a barrel, gold would be $5000 if the ratio was only 5:1!

Take the example of the gold:silver ratio. This has historically been 15 or 16:1 as set by Sir Isaac Newton in the 1700s and the free market over millennia. The ratio returned to this in the panic buying in 1980 with gold at $850 and silver at $50 but has spent decades since 1980 much higher, even as high as 75:1. Right now, it is 926.50/18.26 = 50.7. This ratio has been away from the historic average for more than 20 years!

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