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Is Gold Overvalued to Crude Oil?


Does it even matter?

The crude oil market has lost most of its popularity since it's no longer near $150 per barrel (no longer do oil-related topics dominate the main financial websites), but nonetheless, I'm sure that nobody can deny crude oil's importance in today's globalized economy. It's vital for both businesses and individual consumers because fuels are derived from it. Most of us need to drive and purchase goods that also need to be transported to us directly or indirectly.

Because crude oil is so vital to the modern economy, it shouldn't surprise anyone that it influences many markets, and virtually none of them can be completely free from oil's influence. Therefore, this week I'll analyze this particular market, from the precious metals perspective. I'll use the scatter chart in order to focus on the trend and the average shape of the correlation.

As you may see on the above chart, the price of gold/oil has been trading considerable above the dotted trend channel in the past few months because most commodities were reacting the deflation scare that was being hyped by the media about a year ago, and crude oil was no exception.

Gold didn't suffer that much and one of the reasons might have been because it was perceived as a form of money, and during deflationary periods cash is king. I'm not suggesting that we're in one right now -- this is just a brief reminder of what was popularly heralded in the mass media. I'm also not saying that this was done on purpose so the powers that be could get away with printing more and more money, but that's definitely food for thought.

Anyway, crude oil dropped much more than gold and the gold/oil price combination moved far from the trend channel on the chart above. Generally, prices sooner or later tend to reverse to their means, and I don't expect this time to be much different.

However, this time I don't expect gold to form a long consolidation while crude oil soars. To the contrary, I believe that the fundamental and technical factors are in place for a substantial rally in the metals. So, if the relative value of crude oil to gold is to rise, and go back to the previous trendline (which would mean oil at about $130 given today's gold price), I would see this process as oil slowly catching up, in a similar way to what we see today. Consequently, the gold/oil ratio rose significantly, and is now moving lower, which has important implications for precious metla stocks, but I'll leave this part of the analysis to my subscribers.

Another possibility is that metals are going to take off regardless of the situation on the crude oil market. This is probable, but most likely won't take place untill we're in the third stage of the bull market -- keep in mind that this is what happened in the previous bull market, where precious metals outperformed other commodities.

Before summarizing, I'd like to comment on the short-term situation in gold.

The situation didn't change much since the previous week. We're still in a trading range after a significant rally, and I still view the short-term correction after a brief rally as the most probable scenario for the following weeks. The red rectangle marks the probable topping area. It's based on the size of the rally preceding the September consolidation (history tends to repeat itself, particularly during the ABC upswings/downswings), and the Phi (1.618) multiplier used on it.
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No positions in stocks mentioned.
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