Thursday, August 11, 2011

Crude gold

Back in July 2008 some hedge funds decided to sell oil short and buy gold.

The strategy proved successful.

It was based on an assumption that oil and gold are closely correlated and 1 ounce of gold is equivalent to 10 barrels of oil.

Such relation held true till the beginning of 2008, when first the oil overshoot gold, and later felt down below the previous parity.

In July 2008, one ounce of gold was enough to buy just between 6 and 7 barrels of oil. In January 2009, more than 20.

Later, gold and oil reach a new equilibrium. The new gold-to-oil ratio stood at 13.7 (1100:80) barrels per ounce and 15.8 (1420:90) at the end of 2009 and 2010 respectively.

Most recently the prices diverged significantly again. As for August 10th, one ounce of gold can buy 22 barrels of oil (1796:82).

Gold is most probably entering the final phase of the bubble. It is hard to predict how far it can go during its ultimate exponential ascent. Meanwhile oil is falling in anticipation of economic slow down.

Clearly both assets are on different dynamic trajectories and the gap can extend even further. However, this divergence will most probably end. And the bigger it is, the stronger reversal can occur.

One leg of the strategy is easily implementable using SPDR Gold Trust ETF which very closely tracks gold futures.

For crude oil you can chose either United States Oil Fund ETF or United States 12 Month Oil Fund ETF. For crude oil futures term structure, it is better to chose the later.

Alternatively one can use futures.

Let's see what will happen...

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