Gold to Oil Ratio Picture

I found the image above at kitcocasey.com and it clearly illustrates the earlier gold to oil ratio that I wrote about. In the image, notice how when the red line representing oil, crosses the yellow line representing gold the ratio is approximately 10:1. If oil prices remain strong, gold will have a long way to rebound to match the historical ratio.

I suspect that the USD index may rebound to 75 levels causing a downward trend for physical gold and doubly so for gold stocks.

A True China Bear

With all the talk of a bear market in China, it pays to look at China in comparison to Hong Kong its nearest cousin. I would consider a true bear market as one that drops 80% or more. In 1973, the Hang Seng Index dropped from 1100 to 153 in under a year. Today the Hang Seng Index is over 25,000. China may be a similar long-term opportunity as Hong Kong in 1973. In 30 years, a Shanghai Composite Index at 150,000 points or higher seems plausible if we look at the history of emerging economies that continued growing into a developed economy. In the U.S. the Dow grew thousands of percent as the economy grew between 1930 and 1960.

Since reaching an all time high in October, 2007, The Shanghai Composite Index has dropped nearly 40%. At the moment the best way to invest in China is through Morgan Stanley’s China A Share Fund [[CAF]]. The fund is down from a high of $72.30 to $45.41, a drop of 37.19%. Last month, CAF dropped over 50% to a one year low of $33.51. If the fund were to drop to $20, it would represent a drop of 72%, close to a true bear market and I would enter heavily at that price as a long-term investment opportunity.

*Disclaimer: The author does not hold a position in any of the stocks mentioned.

Extreme Gold Disparities

We now have a large number of disparities facing gold investors. Here are a few oddities I’ve noticed and I saved the biggest for last:

- We are now facing the $120 level for oil, yet gold is currently at $890.
- Rice, a staple food for half of the global population, has doubled in price over the past three months, yet gold is falling.
- Currently gold continues to drop when U.S. markets are open, yet overnight gold typically ends up in Asian markets.
- Mid-large cap U.S. gold equities, such as Yamana Gold [[AUY]], Barrick Mining [[ABX]] and Newmont Mining [[NEM]] have roughly dropped 20-25% in the past two months. In Asian markets, many mid-large cap gold equities have dropped 50% or more.
-Many gold equities are trading at prices when physical gold was in the $700-$750 range.

The brilliant minds of the gold investment world have reported about the perfect economic storm brewing for gold and gold equities. To a large extent they were correct as we witnessed a dramatic surge in physical prices from the fourth quarter of 2007 to the first quarter of 2008. All the financial turmoil, rate cuts and rise in inflation should have propelled gold equity investments as a safe hedge against a falling market. What we witnessed with gold equities was an entirely different story leading to a large disparity.

There seems to be a weaker connection between the rising physical price of gold and gold equities, than the falling price of physical gold. When the physical price of gold drops, as we have seen in the past two months, the price of gold equities drops doubly. We are now rapidly approaching heavily oversold territory for gold equity investments. Once financial markets stabilize and capital begins to flow back into equity markets, gold equities have tremendous room to play catch-up. This is contrary to what many people are reading from analysts and the media.

Looking back at gold equities rise in 2005 and 2006, we can see that rising prices had little to do with financial turmoil in global markets. Pandemics, terrorism and natural disasters seemed to push gold equity investments higher than a possible financial collapse. This is why it will be prudent to watch capital markets stabilize before shifting a large share of your gold investments in favor of equities.

*Disclaimer: The author hold no positions in any of the stocks mentioned.

Alibaba Versus Baidu

Two of China’s Internet behemoths are oddly trading in opposite directions. Baidu [[BIDU]] has risen dramatically since its IPO. Baidu’s recent 52-week trading range was between $98.45 and $429.19, a positive difference of 336%. Alibaba (1688.hk), listed on the Hang Seng Index, held its IPO on November 6th, 2007. Alibaba has dropped from $41.80 to $12, a negative difference of 71%. The stock is currently trading approximately 10% below it’s IPO price of $13.50.

If we look at Baidu’s stock price shortly after it’s IPO, we can infer that Alibaba’s stock may be due for additional drops as the market digests the first few quarters of earnings. Baidu fell from a closing price of $122.54 on August 5th, 2005, to its lowest close of $45.15 on February 7th, 2006. The stock dropped 63% before going on to gain nearly 895% since February 7th, 2006.

Alibaba faces a weaker international trade environment that is causing investor uneasiness over future earnings. Ultimately the stocks performance will be linked to the companies earnings. If Alibaba can grow at the same pace as Baidu or at the early days of eBay [[EBAY]], investors should be in store for a large jump up in the price of the stock.

According to this Forbes article, the core group of investors in Alibaba’s IPO include, “AIG Global Investment, Taiwanese billionaire Terry Gou’s Hon Hai Precision, Peter Woo of Hong Kong’s Wharf (Holdings), the Kwok family of Hong Kong’s largest real estate developer Sun Hung Kai Properties, Malaysian Chinese media and hotel magnet Kuok Hock Nien, Cisco Systems [[CSCO]] and China’s largest bank, Industrial and Commercial Bank of China.”

Investors should take note that the group above is locked-in to holding Alibaba stock at $13.50 for a period of 2-years since they received a pre-IPO allocation. In the mid-term, Alibaba may be setup to reflect Baidu’s positive performance. I wouldn’t rule out a future Alibaba ADR listing if the company continues its rapid growth and the stock receives favorable interest.

Historical Gold to Oil Ratio and How to Monitor the Next Wave of Gold Equity Investments

In September, 2006 I wrote the article, Gold’s downward spiral.

Taken from the article:

Gold appears to be headed down along with the price of crude oil. Historically there has been a correlation between the price of crude oil and gold. Most gold fans and economic historians peg the ratio between the price of gold to oil at 10:1. The price of crude oil is currently $65.71 per barrel. Using the 10:1 ratio would mean that gold should be priced at $657.10 per ounce. Gold is currently trading at $590.40. Gold has not been following the historical ratio as geo-political pressures and concerns over terrorism have contributed to a risk premium in the price of crude. If the historical ratio between oil and gold is to return, either gold has to rise or crude has to drop. I am more inclined to believe that gold will rise. Physical demand for gold tends to be strong going into the fall.

During September, 2006 gold was priced around $590 and oil at $65. The gold to oil ratio was roughly 9:1.

Currently Gold is priced around $920 and oil at $117. The current gold to oil ratio is roughly 7.9:1.

For the historical ratio of gold to oil to remain true, either gold would have to rise close to $1200 levels or oil would have to drop toward $90. There are a number of factors supporting rising gold prices in the short-term. Principally, due to the weakness in the financial sector, the Federal Reserve must continue to lower interest rates to make access to capital easier. The lowering of interest rates is the medicine needed by financials to engage in income producing activities, such as investment in alternative higher yielding currencies, or direct investment in foreign economies. Financial institutions will continue to borrow USD to shore up capital and in order to recover non-performing assets.

If interest rates on the dollar approach 1% levels, the currency will begin to gain strong favor as a carry trade currency similar to the yen. Lower interest rates will inevitably lead to inflation and eventually hyperinflation as we are seeing with rising oil prices. In the short-term, gold will continue to be a strong hedge against inflation and a falling dollar due to low interest rates. In the medium to long-term, I believe we will emerge with a stronger economy and a stronger dollar. This will put downward pressure on gold. For the moment, I expect that we are in the final bullish phase of this cycle and will see continued and escalating daily volatility in gold prices.

I would continue to monitor shares of miners such as Yamana Gold [[AUY]], Gold Corp. [[GG]], and Barrick [[ABX]]. I also see a large opportunity in junior miners and exploration companies such as Northgate Minerals [[NXG]] and US Gold [[UXG]]. Shares of smaller gold companies have barely moved in the past half year in light of rising gold prices. Eventually these companies will begin to rise as capital returns to the market and overall economic conditions improve. Earnings should improve for gold miners as prices remain high for gold. I would pay special attention to companies that begin to hedge their sales in the future. For the past few years, gold miners have de-hedged their sales since they were locked into selling gold at low prices. Gold prices may reach over $1500 by some analysts and authors estimates. We should begin to pay special attention to miners that lock in high sales prices by selling their gold forward. Traded companies that hedge themselves against falling gold prices, will present a big opportunity going forward.

Negative Real Interest Rates

(Click the picture above for a larger view)

The chart above should be a major concern for any serious investor. The data in the chart is supplied by the Federal Reserve Bank of St Louis. The current negative interest rates are calculated by subtracting the 5-year treasury note interest rate from current inflation. Depending on your view of current inflation, we are either in slightly negative territory or approaching double digit negative territory for real interest rates.

Raw Greed Hacked

My blog was sadly hacked by a Turkish hacker. Please click the image above. The hacker broke my upgrade to Raw Greed and replaced the front page. I’ve replaced the missing posts and most of the functionality of the blog. Some of the pages still haven’t been updated with the newer versions.