Value Microcaps Motherboard

[roguedolphin]

Oil Goes to $100, Where Does Gold Go?

By Tim Wood
02 Sep 2005 at 05:31 PM EDT

http://www.resourceinvestor.com/pebble.asp?relid=12626


NEW YORK (ResourceInvestor.com) --For the first time since President Nixon heeded some rather unwise economic counsel and cut the umbilical link between the American dollar and gold, the monthly average proceeds from selling a barrel of oil have topped 5/32 of an ounce.

Adjusted for inflation, the monthly average gold price breached $60 per barrel for the first time since January 1983. Current prices only need to rise another $17/bbl or so to smash the all-time high since the 1970s oil shocks. The highest monthly average price in 2005 dollars was recorded in February 1981 at $84.64/bbl.




The ratio of the gold price to the oil price has been in a broad downtrend since December 2001 when the monthly average saw an ounce of gold paying for 17.34 barrels of oil. The average for August was just 6.76bbl/oz; an unprecedented low given that until recently 8bbl/oz was widely regarded as the last line of resistance. Indeed, previous slumps in the ratio to below 9bbl/oz have usually been a reliable indicator to buy gold for a sure profit.

Not this time. Since November 2004 only one month has provided temporary relief (May this year) otherwise there has been month after month of losses to gold producers whose margins are being crushed by the diminishing purchasing power of bullion.

August’s ratio marked a 7% fall from the July average. August recorded just 4 days above 7bbl/oz compared with July showing just 1 day below 7bbl/oz. The low for August came on the 30th when the havoc wreaked by Hurricane Katrina along the Gulf Coast became apparent, particularly news that the levees in New Orleans had been breached.

That saw the ratio bottom at 6.17bbl/oz as oil futures were bid up aggressively and after temporary long liquidation in the gold markets followed by rumours of short-covering. Gold on the day was fixed at $430.65 and West Texas Intermediate crude closed at $69.82. Notably it was the lowest gold price in more than a month when gold was fixed at $429/oz on 29 July.


The average ratio for August is an incredible three times lower than the 35-year average of almost 18bbl/oz.

Katrina has now set the stage for a possible near-term realization of Goldman Sach’s much quoted and often disparaged forecast of an oil super-spike to $100 per barrel.

Emergency action by the Feds, International Energy Agency and some European countries to release oil reserves has quelled the oil price surge that went briefly past $70/bbl. However, information emerging from the Gulf of Mexico suggests widespread under-appreciation of how badly oil and gas production and exploration in the region has been affected.

Information on the shut-ins is relatively detailed, but there is an assumption that over time all the capacity will be brought back online. Instead, investors should be concerned about mounting evidence that companies are going to report that some mature fields are not worth recovering. As a result there is likely be a net loss of energy production from the region. At the same time, related infrastructure will not be easily repaired or replaced; many companies will no doubt be rethinking plant location driven by the commands of insurance assessors.

Refineries cannot be easily replaced in new areas unless the various levels are government are willing to suspend the plethora of regulations that make it risky to break ground.

Yet the government is unwittingly about to exacerbate the problem. Several states are considering temporarily withdrawing gasoline taxes to lower retail prices. This would have the opposite effect, causing accelerating demand which cannot be met from local refineries. In all likelihood prices would return to high levels in short order leaving state governments squealing about lost revenue. Were gasoline taxes then reapplied we could expect a tremendous shock to consumer spending and confidence.

Those are negatives that will weigh on the US dollar, as they already have in recent days. On top of that is the disruption to Mississippi freight.

Adjusted to the long-term gold-oil ratio of 17.44 barrels per ounce, gold has an “expected” price of $1,178, whilst oil has an expected price of just $25.46/bbl. The last time gold came anywhere near the $1,000/oz level that was in February 1983 when the inflation adjusted price reached a monthly average of $989/oz.

If we accept that oil’s fundamentals are so superior that we’ve entered a new era, then might adjust the ratio to half the long-term average. At that ratio the expected gold price is $589/oz and oil’s is $50.92.

Looking ahead to a possible $100/bbl spike, the “new era” ratio of 8.72bbl/oz would imply a gold price of $872/oz. At the long-term average, $100/bbl implies a gold price of $1,744/oz.

Of course, with the way things have been going, it is not improbable that the ratio could fall as low as 5bbl/oz.


Rogue