Short term upside to gold

You'd have to be a little more positive about gold at these times; principally for 2 reasons:

1. Prospects for ongoing low interest rates

2. Prospects of tensions in Iran, the Straits of Hormuz - as Iran borders the channel through which oil exports flow. This issue is of course escalating because Iran is building a nuclear weapon.

The reality however for gold is that its going to be a short battle, with the US eventually destroying key military capacity, the nuclear facilities, as well as retaining air and sea superiority.

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Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Gold prices set for another rally

Gold prices have bottomed on Friday, and we have seen a rally of $21/oz in Friday (night) trading in the Comex market. The implication is that gold has found support on its long term uptrend, confirming what we always knew was going to happen; that gold was going to rise to new highs. Our interim target is $2,400, however in the medium term we can probably expect a move to $1800/oz.

There are a number of factors giving strength to gold. The prospect of failing monetary policy demanding any effort by the US and other countries to stimulate demand. There is the prospect of escalating tensions in the Middle East. Oil and gold prices alike are likely to be very strong in the next year.

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Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Gold oil ratio signals stronger gold

It is apparent that another important ratio we look at to determine fair value for gold is the gold-oil ratio. Its particularly interesting to look at this ratio because the oil price has collapsed in recent months, falling from $140/barrel to $40/barrel. The result has been a rise in the gold-oil ratio from 7 to 28. In recent weeks the gold-oil ratio has recovered to 21, as oil prices rose.
Its apparent that the first rally in the gold-oil ratio (measured on the right negative axis) was caused by the fall in oil prices. Having recovered to 21, I believe the next rally in the ratio to 28 will be in the midst of rising oil prices and gold prices. I would contend that the rise in oil prices will be caused by inflation and a weak USD. One might also attribute cuts in OPEC oil production as a cause however this is transitory since OPEC is going to lag in production cuts only for as long as such adjustments prove necessary.

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Andrew Sheldon www.sheldonthinks.com

West Texas Intermediate price likely to rally

The West Texas Intermediate crude price shows every sign of having bottomed, so could be considered as offering good buying up to $50, which could be considered a resistance (sell) point in the short-medium term. The slow down in the global economy has placed oil under pressure, and you can expect OPEC to drag the change with respect to any steps to reduce demand. It is for this reason you can expect oil prices to be oversold. OPEC cuts in production will eventually catch up, and you can expect a rebalancing of supply and demand. Don't expect oil prices to fall back to $9/barrel, as we are in very different times. The factors pertinent to today are:
1. Improved policy under Obama
2. Global weakness matched by cuts in OPEN supply
3. Rising inflation
There will likely be consolidation in oil prices in a lower range between $40-50/bbl, and I would expect some good trading opportunities in this range.





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Andrew Sheldon www.sheldonthinks.com

Gold-oil ratio suggests gold prices going to double

Another historic indicator of gold and oil prices is the gold-oil ratio. Basically this ratio measures the amount of gold that one could buy with a barrel of oil, or vice versa.
We can see that the ratio is currently 10, though in the past its been on a trend which would see it valued at 20 at least. This chart is interesting because it poses more questions than it answers. Note that it extends back 170 years, back to the time when they started producing oil. If we accept that the ratio is going to 20 (and that is conservative), then we are looking at oil prices of $30/barrel or gold prices of around $1500/oz. Of course there could be some comprise on both commodities, or the central banks can play with their funny money more, so that in nominal terms both commodities rise. It will not change anything, gold will out-perform energy by a factor of 2:1 for this trend to stay true. I don't see oil prices weakening any further, but I will take a look at oil prices to convince myself.

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Andrew Sheldon www.sheldonthinks.com

West Texas Crude Oil price outlook

Well we have been told for a long time that there is no oil shortage; that its speculative trading that is driving oil prices higher. The flipside is that given the current weakness on the (economic) demand side, there is very little to hold oil prices up except the promise of a resurging oil price. Crude prices have for a long time been a very volatile commodity. So where are prices going?
I point will be reached when traders say - it must be time to buy again. Some wind has been taken out of the market, but oil is still the most important commodity on the earth. So when might we expect oil prices to bottom. Well its still a little time off. Certainly we are not returning to the bad old days of the 1990s when commodities were under-appreciated. Oil will trade in a new, higher range. We will not see oil prices return to $9/barrel when there are large emerging markets like China and India around, and a large number of SUVs with a useful life of 15 years.
Oil prices are going back to around $US77.50s, though I would argue traders could take it as low as $70/barrel in volatile intra-day trading. I do however think there will be some resistance on the downside around $97-100/barrel. There are 2 reasons for this:
1. A weaker oil price is likely to give equity markets encouragement
2. People's standard of living expectations will adjust, resulting in an improvement in consumer confidence. Not everyone went out and bought a 2nd house, and speculated on US property. But some people did, and some people did buy at the top, fearing they were going to miss out.
3. Lower oil prices will give consumers more money to go out and spend
Nevertheless I don't see the market fully recovering for a while yet, but I do think the next 6 months will yield some stock bargains, particularly with property foreclosures and commodities. I think the nickel market will be the first to recover, followed by gold. The other metals will likely take a bit more convincing.
So the target price is $US77 level for a bottom in oil prices. This is a strong support having been resistance, though I have some suspicion that oil might fall to $70/barrel in the short term, so there is some reason to be cautious trading that position in order to get the best entry.
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Andrew Sheldon www.sheldonthinks.com

The outlook for oil - $140/barrel and beyond

People might be interested in my thoughts on oil. Some time ago I forecast that oil would go to $140-150/barrel. Well, now that we are there I am thinking abour what is install now for markets. There are some compelling facts about oil:
1. OPEC member states control more than 50% of supply
2. Russia is actually the largest producer, but it consumes more than Saudi Arabia so it exports less
3. Iraq has the largest 2nd largest oil reserves after Saudi Arabia
4. There is considerable controversy over whether Arab oil reserves are really as large as stated since OPEC discloses very little.
5. Among the fastest growing users of oils are countries like China and India which actually subsidise supplies. I understand that China recently reduces subsidies causing oil prices to rise 10%(?), but this is still far from market pricing
6. Some prospective oil provinces are locked up, preventing oil exploration, eg. Alaska

When I made my forecast of oil I was using a very simple financial model to determine its price outlook. At this point, I want to perform some more detailed analysis. I will offer some advice about where I think the world is going:
1. China and India will be forced to reduce their subsidies, though the slow pace at which they do it will push oil prices higher. The cost to the country is likely to be the compelling reason for lowering them.

2. The United States and other countries will increase their tax on petroleum. The rationale will be 'resource security' and 'environmental', but more than that it will be a compelling taxation scheme. The US government will need a new tax to replace the 'hole' left by Bush as the economy slows. He has adopted 2 tax cuts to stimulate the economy. There is no fat left on the carcass, so rather than raise income taxes again, I think Obama will adopt higher fuel taxes. We must remember that fuel in the USA is relatively cheap. I expect this will stimulate more use of trains, sale of SUVs, but importantly it will be a discretionary tax to some extent, and the gun-totting SUV user is more likely to be a Republican anyway :)

It goes without saying that oil prices are going a lot higher and that the government will want a piece of the price action. There is no question that the price incentives are already there for oil exploration, so I think the US and other governments will take the opportunity to carve a share out of the oil pie. The proceeds will in many countries be used for nuclear, solar, wind, geothermal (hot rocks), fuel cells, battery (load shaving) power schemes, energy saving subsidies /initiatives, and electric train-based transport systems.

More on my oil price forecast later.
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Andrew Sheldon www.sheldonthinks.com

The gold-oil ratio still high

Looking at the Gold-Oil ratio you might wonder if we are close to the stop. Far from it. The gold-oil ratio has not moved much over the last 6 months. This is because the oil and gold price have been moving up together.
Looking back in time, in fact, the fall of the gold-oil ratio occurs mostly because the rise in 'cost of living' inflation raises interest rates to an extent where economic activity is curtailed. Of course that hurts oil, and not gold since there is comparatively less industrial demand for gold whilst paper money is being debased. I suspect gold & oil prices will continue to rise until oil prices start crimping economic activity, then I suspect the oil prices & gold-oil ratio will fall, but gold prices will remain strong.

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Andrew Sheldon www.sheldonthinks.com

Petroleum Market Outlook

The world is currently experiencing an energy shortage. There are several reasons for the shortage:

1. Excessive intensity of consumption by the US
2. Strong growth by the US, China & India in particular, as well as other emerging markets
3. Shortfall of refining capacity

Upstream Sector – Exploration
Contrary to investor perceptions, there is no shortage of oil. For the last 30 years oil reserves have remained between 30-40years of annual consumption, or 1 trillion barrels in absolute terms. The bulk of these reserves lie in the Middle East – Saudi Arabia, Iraq, Kuwait, UAE, etc. For this reason, the OPEC countries are likely to increase their share of production capacity. In addition, there are still a lot of areas which are still eventually virgin exploration targets. These areas include:

1. Deep water areas of existing & new basins
2. Russia – particularly the Siberian peninsula
3. West Africa
4. India and the Bay of Bengal (delta)

Downstream Sector – Refining
The reason for high oil prices is not lack of oil, but largely poor planning to ensure adequate refining capacity to get that oil to the market. There are several reasons for this:

1. Planning & government licensing, eg. Land availability, government permitting greatly slows down the development of new refineries.
2. Capital intensive: Refineries are expensive so industry participants are reluctant to build new capacity
3. Diversification of energy products: Governments are demanding that producers improve the environmental rating of their fuels, which results in a broader variety of products. This greater variety complicates the product mix and reduces the flexibility of producers and consumers to purchase from other suppliers, creating bottlenecks. This results in a risk premium being added to product prices.
4. Poor returns on investment in the 1990s mean corporations were reluctant to build new capacity. Part of the problem was that corporations were more concerned with complying with meeting environmental compliance measures.

Other Factors
A number of non-market factors also have contributed to the market shortage for oil products:

1. Poor strategic planning & cooperation between governments and the private sector
2. Excessive reliance on oil for transport by many western countries. Sweden and Japan are 2 countries that have adopted transport systems to reduce oil reliance. The USA, Britain and Australia have overly relied on cars, choosing to underfund rail despite declining domestic oil production.
3. Excessive growth in the US and China in particular is creating a pressure no global refining infrastructure. These demands are the result of monetary stimulus.
4. Subsidised oil products: A number of countries have subsidised their oil product markets so the market signals are not being communicated to the market. These countries include India, Indonesia and China – whom are among the largest oil consumers.

Energy Market Outlook
The outlook for the energy markets is down for a number of reasons:

1. Softer demand: The strong global growth recorded in 2004 was cooled off in 2005, and is likely to fall further in 2006.
2. Market pricing: Those countries which are subsidising oil products are likely to remove this support because of a deteriorating in their public finances, as well as pressure from the USA and EU.
3. Substitution: There is likely to be some degree of substitution for other forms of energy which will free up capacity.
4. Inflation: Higher oil prices will feed through to general price levels, eventually causing higher interest rates, which will reduce demand.
5. Investment: Higher oil prices will spark investment in new oil capacity, but that will take time to come on-stream. When it does, there is often over-capacity, particularly as shortages usually arise during periods of excess demand.
6. Alternatives: Higher oil prices will encourage development and investment in alternative sources of energy, as well as products that utilise these types of energy. Examples include industrial batteries for energy demand (peak load) management, cars and computers powered by fuel cells.

Its already evident that higher oil prices have forced other energy sources higher. Eg. Uranium prices have risen from $US12/lb to $US28/lb, and coal prices have doubled, so additional capacity will grow in these areas as well. Because much of the global trade has grown due to US consumer largesse, its safe to say that a large over-supply will arise.

The positive aspect of higher oil prices is that you can make money out of it, whether by investing in:

1. Petroleum Refiners & other energy processors, producers, explorers equities
2. Petroleum & other energy product futures
3. Alternative energy exposures, eg. fuel cells, battery suppliers, etc
4. Railway locomotive manufacturers

In Australia my favourites are:

1. Capathian Resources (CPN): It is developing small oil fields in the Czech Republic. Because these are small, land-based fields they are cheap to develop, but under-valued, since close to infrastructure.
2. ZBB Battery Systems (ZBB): They have developed a zinc bromide-based battery to compete with the old, less efficient lead-acid batteries. Higher energy prices should prompt greater use of batteries in those markets still dependent on oil for local power generating capacity. This tends to be markets like China and India which are growing very quickly, but also countries like Venezuela and Saudi Arabia that use their abundant oil to fuel power generation, and thus are paying a significant opportunity cost. The batteries allow companies to buy power at off-peak rates and use it at peak periods, saving during those periods.