Gold's Net Longs & the Gold/Oil Ratio

by Ashraf Laidi
Feb 12, 2009 1:20 | 6 Comments

The latest run-up in gold's secular bull market has reaches 7-month highs of $947/oz, triggered by an initial decline in the US dollar following a disappointing Tuesday market reception of the US Financial Stability Plan. Remarkably, however, gold shifted to the next gear despite a rebound in the US currency or the decline in oil prices, underscoring the metals improving allure as a yield replacement during interest rate-eroding policies in the industrialized world.

The high profile divergence between gold and oil is a stark reminder that inflation is not the only pre-condition for a surge in the metal. The gold-oil ratio reached a 10-year high of 25 as the global recession erodes demand for energy commodities and investors abandon monetary assets in favour of the safe haven metal. Before assessing the market implications of the surge in the gold-oil ratio, lets recall the September 18 piece warning that the recovery in the ratio from its July record low augured negatively for U.S growth in particular and the world economy in general. The rationale was based on the notion that multi-year lows in the G.O. ratio reflected soaring energy prices, which were instrumental in bringing the world economy to a standstill. The rebound in the G.O. ratio ensued as financial markets unwound gold longs and central banks reverted to interest rate cuts.

Gold's Net Longs & the Gold/Oil Ratio - Gold Oil Feb 11 (Chart 1)

Now that global central banks are flirting with zero interest rates and the world economy in contraction mode, the ratio faces no prospects of a pullback any time soon. Only a decline of at least 20-25% in the G.O. ratio would signal the markets pricing of a recovery (pace of oil rebound outpaces that of gold). The above chart serves as a helpful historical guide indicating pullbacks in the G.O. ratio (white graph) generally coincided with stabilization in the US economy, while rebounds in the ratio preceded a broadening slowdown. Particularly positive for gold is that a pullback in the G.O. ratio may not necessarily occur at the expense of the metal, but rather, a recovery in oil relative to gold. This was seen in 2002 and 2004, when the decline in the ratio emerged mainly on a faster increase in oil than in gold, and not on a decline in oil. Thus, any economic recovery strong enough to support energy demand is likely to boost gold on industrial demand for metals and investor interest in gold funds.

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The speculative element
to golds surge is reflected in the 138% increase attained by speculative net longs in gold futures to a 9-month high of 155,306 contracts (see above chart). Speculative longs as a percentage of total open interest reached 52%, the highest since July, suggesting further upside remains ahead. Interestingly, the record high in golds net speculative longs was reached in December 2007, three months before the metal hit its all time highs. The 3-month lag between golds net longs and multi-year highs also took place in 2006. Thus, even if speculative net longs regain record territory above 200K contracts, prices may have at least 2-3 months of upward momentum. The prospects for $1,200-1,300 gold by end of Q3 remain underpinned by a set of cogent fundamental variables involving currencies, interest rates and the global economy. Meanwhile, even as the divergence between gold and oil begins to fade, any oil-friendly dynamics are seen positive for gold's luster.

For more detailed analysis on the market and economic implications of the gold-oil ratio, go to Chapter 6 of my book Currency Trading & Intermarket Analysis.

Comments (Showing latest 6 of 6) View All Comments
Ashraf Laidi
London, UK
Posts: 0
5 years ago
Mar 19, 2009 16:58
Hi Goldbug, welcome to the site. if u bought gold that low, its ncie to take some off the table. Get a password/email and go to the HotChart section where I had an analysis on Gold. I told people 885 will hold for target at 1050. once global economy shows signs of recovery, we'd 1100 and 1350.

Ashraf
goldbug
Ottawa,
Posted Anonymously
5 years ago
Mar 19, 2009 15:20
Ahraf, my wife and I viewed your visit to CNN today, and were impressed with your knowledge to say the least.

My question is, when to sell our gold bullion holdings. We have found out that since buying in the mid 80s at around 656 USD, we are happy to have this asset in today's markets, when our paper assets have let us down.

We are over 65, and must use our bullion now to live on for the next two decades or so until we are in the box.

You mentioned something about a two month timeframe will lead to the increase of the Au commodity, which will likely only be enhanced with time as inflation sets in.

What value will likely be attained a) in 2 to 3 months and b) in 2 to 3 years?

The big jump of todays US valuation of 956.90 USD was almost entirely offset by the increase in the Canadian dollar, marginally up, so this is another factor in the equation.

Thanks so much
Ashraf Laidi
London, UK
Posts: 0
6 years ago
Feb 17, 2009 17:22
Hi Ced, as I indicated in an ealrier Intraday Market Thought, fears that downgraded Eastern European banks will hurt Eurozone banks are knocking down EUR. Overall risk aversion is helping USD (despite rallying gold). Looks like Asia will test $1.2470. I dont see $1.22 until later in the quarter. I still favoir NOK vs USd in long term, while USDCAD may continue to have legs into $1.28

Ashraf
Ced
London, UK
Posts: 12
6 years ago
Feb 17, 2009 16:12
Hi Ashraf,

How do you explain (un)expected US$ strength and how far it can go (e.g. in EURUSD)?

Thanks
Ced
Ashraf Laidi
London, UK
Posts: 0
6 years ago
Feb 13, 2009 14:44
Hooshang, As I said in my article, the rally is gold is not a result of inflationary fears but due to plumetting yields in monetary assets. The inflation that you may be talking about is that of liquidity injections.But commodity price inflation is muted. As for oil, Id say 45-50 target by end of year but Im no expert in forecasting oil.

Ashraf
Hooshang
toronto, Canada
Posted Anonymously
6 years ago
Feb 12, 2009 14:30
Ashraf, where do you see oil, in 6-12 months, keeping in mind a possible truce between Iran and U.S. could take out the political factor from price of oil? Gold is going up out of fear of inflation in the future, how does inflation affect the price of oil in future dollars? Thanks.