Monday, December 5, 2011

Political / Energy Crisis to Drive Gold Higher?

In February this year I looked at the possibility that we might have a replay of events seen during the last bull market in Gold/Silver, a set of events which could play a part in driving the 3rd phase of the current Gold bull market. 

I briefly compared the 1979 Iranian Revolution vs the uprising we are seeing today in the middle east, pointing out an energy crisis could result from these disruptions (as occurred in 1979). In the last post I specified Libya as the potential catalyst for the energy crisis, but with Gaddafi dead and tensions building around Iran there is the potential we could see Iran drive the crisis once again. So history could repeat instead of just rhyme.

Over the weekend a Foreign Ministry spokesman suggested that disruptions to Iranian oil supply could spike the price to $250 a barrel (over double current prices):
Iran warned the West on Sunday any move to block its oil exports would more than double crude prices with devastating consequences on a fragile global economy.

"As soon as such an issue is raised seriously the oil price would soar to above $250 a barrel," Foreign Ministry spokesman Ramin Mehmanparast said in a newspaper interview. Reuters
During the last bull market Gold peaked at a ratio of 20.77 to oil. This snippet from a previous post looking at the ratios:
If we were to see Oil at $200, where might we expect Gold and Silver to be relative to the price of Oil given similar ratios to the peak in January 1980?

The price of Silver at a ratio of 1.2 to Oil with Oil at $200 =  $240
The price of Gold at a ratio of 20.77 to Oil with Oil at $200 =  $4154

Of course Silver's peak in January 1980 was also partially the result of the Hunt Brothers attempt to corner the market, perhaps a fairer ratio to use would be that seen later in October 1980 which was a Silver/Oil ratio of .56, which would translate to a Silver price of $112 with the same ratio and Oil at $200.

Of course it's just speculation that Gold/Silver will reach exactly the same ratios as seen in 1980 or that Oil will reach $200 in the near future, however the Middle East unrest seems far from over and I think an energy crisis developing and the prices mentioned above being reached are a definite possibility. Bullion Baron
If we got the suggested $250 per barrel for oil and the Gold/Oil ratio headed back to 20.77 then we'd be looking at a spot price over US$5000. Even if Gold remained around the average ratio (against WTI) we've seen over the past 40 years (see chart below, from a previous post of mine), then we'd still be looking at a spot price of almost US$4000.

Can you just imagine the performance of the local Gold price if we were to see the AUD crumble against the USD as this energy crisis played out (see my post from mid November for more on this)? Although if we were to see a rocketing oil price I can't help but assume that western economies would have to return to QE to support their economies (which may result in a more stable or rising AUD).

An oil price of $250 is certainly not out of the question in the short term. In fact it was only in Chris Martenson's video that I posted the other day where he suggests that a doubling/tripling of oil over the next few years is likely without even considering a major supply disruption.

In 1979 the price of oil more than doubled in the last 9 months of the year, peaked in mid 1980 and then remained near those highs for 18 months following.

A user on Silver Stackers pointed out a new ETF on the ASX (launched 2 weeks ago) which which provides Australian traders/investors with direct exposure to the WTI price of oil (hedged A$, much like QAU provides access to US priced Gold). You can read more about the product here.

While I do think Oil and Gold are ultimately heading higher, short term influences can impact heavily on either of their prices. The situation in Europe continues to cast a shadow of doubt over short term price action. If we see the Eurozone break apart rather than try to borrow and print their way out then we could be in for a storm which absolutely decimates asset prices including Gold/Oil. However, recent central bank co-ordination and efforts would suggest they do not want to go down this devastating route.

One of the themes presented at the recent Sydney Gold Symposium (sorry, can't recall who it was) was that timing is critical to play this rolling crisis profitably if you are trading short term and they were dead right. You could buy the right long term assets, but lose your shirt short term if you aren't able to ride out the volatility. Personally this is why I prefer to have most of my exposure to the metals unleveraged and am ready to ride out any short term noise... because in my opinion Gold is heading higher in the medium term, much higher.


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