Gold to Oil Price Ratio Says Gold is Cheap

By: Mark_OByrne

Gold was down  $13.90 to $8 69 yesterday  and silver was  down 43  cents to $16.73 . Gold traded flat in Asia and has fallen marginally in early trading in Europe. But with oil prices rising and inflation pressures increasing internationally, gold will be well supported at these levels.

Momentum traders and short term speculative players continue to exert pressure on the gold market but continuing demand for physical bullion from those with a more medium to long term investment horizon, namely individual investors, pension funds, sovereign wealth funds and indeed central banks in Asia, Russia and elsewhere will ultimately lead to higher gold prices in the medium and long term.

See Greenspan says Oil to Continue Rising and G old to Oil Ratio Says Gold is a Strong Buy below

Physical supply and demand of the physical metal will ultimately dictate the price rather than the manipulative short selling and momentum trading of speculative paper traders in the future markets. This is especially the case, w ith supply continuing to be flat at best as seen in the continuing sharp falls in production in South Africa and physical demand remaining robust especially in Asia.

While g eopolitical risk has been ignored in recent weeks, they remain ever-present and it would be prudent not to completely ignore continuing tensions in the Middle East in Lebanon, in Kurdish Iraq and between the U.S. and Iran. There is increasing speculation that the Bush administration may authorise the bombing of an Iranian al-Quds-run camp that is believed to be training Iraqi militants in Iran. Yesterday President Bush said that Iran poses the 'single biggest threat' to the Middle East, calling for measures to be taken against the country. "To me it's the single biggest threat to peace in the Middle East, the Iranian regime," he said.


Today's Data and Influences
A fter yesterday's shock increase in inflation in the UK, markets will again look to government figures and reports in order to assess how real the growing threat of inflation is.

Markets await the April consumer price index (CPI) data which is released later today. Prices paid by U.S. consumers probably rose 0.3 percent last month, led by gains in food and fuel costs that indicate inflation isn't cooling as growth slows. Wall Street's and Alan Greenspan's laughable core CPI inflation which excludes the two most important and indeed essential elements of a consumers purchases - food and energy - should be ignored and it is surprising that it continues to be even reported. A n inflation report that does not include food and energy prices is a bit like a weather report that does not tell you the temperature - completely useless.

The Bank of England's Quarterly inflation report, which is scheduled for release on Wednesday, should provide markets with some policy steer as the focus switches to the June policy meeting.


ECB and Federal Reserve Warn on Inflation
I nflation and stagflation are clearly real and present dangers to the global economy and yet much of Wall Street and the City of London remains in denial. Thankfully there are central bankers of the Volcker school who realise that inflation is not some fleeting flash in the pan but rather a significant macroeconomic risk facing most economies internationally.

European Central Bank Governing Council member Christian Noyer pointed out yesterday how inflationary pressures are leading to a situation that is "unstable and dangerous":

"In short, the world environment has become very inflationary. And yet, in many parts of the world, monetary policies remain somehow permissive. The reason for this paradox can be found in the dilemma faced by many countries which maintain some link between their currencies and the U.S. dollar in order to prevent an unwanted appreciation of their exchange rate. As a consequence many emerging countries are currently led to partially "import" the U.S. monetary policy although their situation and position in the economic cycle are fundamentally different. This situation could be very unstable and dangerous." 

A number of Fed officials all voiced heightened concerns over building inflation pressures. San Francisco Federal Reserve Bank President Janet Yellen said that much of the recent data on inflation has been 'disappointing,' and said consumer inflation excluding food and energy prices is too high for her liking. She said the Fed 'cannot be complacent about inflation,' and said rising food and energy prices 'could lead to higher inflation expectations and an erosion of our credibility.'


Greenspan says Oil to Continue Rising and Gold to Oil Ratio Says Gold is a Buy
Gold and oil are highly correlated over the medium to long term. But oil can often outperform gold in the short term prior to gold catching up when higher oil prices lead to inflation hedging buying of gold.

The long term average gold to oil ratio is 15 to 1 or 15 barrels of oil to one ounce of gold (see chart above). Today, the ratio is near record lows at 6.8 ($865/ $127 = 6.8). Oil is at over $125 per barrel and so if we multiply it by 15 we get a gold price of $1,875. At the higher end of the scale gold has traded at over 30 times a barrel of oil which based on today's oil price would result in a gold price of $3,750.

T hus based on today's oil price of $125, the gold/ oil ratio would suggest that gold is very undervalued at a near historic low of 6.8. The ratio will revert to the mean in the coming weeks and months and will thus see gold reaching its inflation adjusted high of some $2,400 per ounce in the coming years. Gold has experienced a healthy correction and it is a strong buy at these levels.

Incidentally, Alan Greenspan said overnight in Asia that he believed  oil prices would continue to rise over the medium to long term. Greenspan also said the US house prices still have a long way to fall and the US would experience a long recession - more factors likely to lead to prudent safe haven buying of gold.


Silver
Silver is trading at $1 6.70 /1 6.75 per ounce at  090 0 GMT.

PGMs
Platinum is trading at $2063/2073 per ounce ( 090 0 GMT).
Palladium is trading at $434/439 per ounce ( 090 0  GMT). 

By Mark O'Byrne, Executive Director

Gold and Silver Investments Ltd. have been awarded the MoneyMate and Investor Magazine Financial Analyst of 2006.

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