Make Money on Gold in ’06… Even If It Goes Down
By Dr. Steve Sjuggerud
January 5, 2006
At DailyWealth, we think gold at $530 is still cheap in the long run.
We’re not so sure about oil…
Oil has had a tremendous run, rising 215% in the last four years. Compared to gold’s 90% rise in the same time period, oil has become expensive in terms of how many barrels of oil it takes to takes to buy an ounce of gold.
As you can see from our chart of the gold/oil ratio, the relationship between gold and oil is at an extreme for its entire history. Now, it only takes about 8 barrels of oil to buy one ounce of gold, versus a historical median of about 14. (In the nineties, it took 15 – 20 barrels of oil to buy one ounce of gold.)
The most amazing part is, every time in history that this ratio dipped below 10, you would have made money buying gold and shorting oil. Gold’s outperformance in relation to oil once we reach these extremes has always been stunning… either oil crashes or gold soars.
The same happens at the opposite extreme as well... When an ounce of gold “costs” more than 18 barrels of oil to buy, gold then turns into a horrible underperformer.
So what can you do with this knowledge?
The most direct trade is to head for the commodities exchanges and go “short oil, long gold.”
That might work… but it might not, as sometimes it takes a while for the ratio to come back in line. You could get burned in commodities by trying to hang onto this trade.
Another option is to simply buy shares in just one company…
A large gold miner like Newmont (NEM) or Goldcorp (GG) gives the investor an easy way to make a short oil/long gold trade.
Since fuel and energy costs make up such a large portion of a gold miner's extraction costs (around 20%), a year of falling oil prices and rising gold prices would mean much higher profits for these companies.
Owning a mining company like Newmont gives you a way to profit from what could be a big year for gold in 2006. This trade also gives you “wealth insurance,” as gold is a good hedge against war, terrorist attacks, and natural disasters.
So if gold goes up, you make money in gold stocks. If gold is flat, but oil goes down, you make money in gold stocks. And if gold goes down, but oil goes down a lot more, you can still make money in gold stocks.
The way you can lose on this trade is if oil soars and gold falls.
That’s a bet we’re willing to take.
Good investing,
Steve
Editor's note: Steve Sjuggerud is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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