Gold Crosses the Rhine
By Dan Denning
When Allied soldiers charged the beaches of Normandy on
June 6, 1944, victory seemed very uncertain and, at best,
very distant. Nine months later, the Allies crossed the
Rhine into Germany. Gold's recent charge through $500 an
ounce will lead to a similarly decisive and shocking
victory in the monetary realm.
Last summer, I suggested that the crude oil/gold was
establishing an important low. So far, so good. With gold's
move to $533 an ounce, the ratio has jumped sharply since
summertime. So let's revisit this ratio and consider what
it might imply for oil, gold, and gold stocks.
In late August I observed:
"The age of peak oil has arrived, but its investment and
economic consequences are just beginning to filter down to
the consumer level. Individual standards of living will be
affected as permanently higher energy costs make their way
into your daily life...Oil's move up to $65 and above
signals a bottom in the crude oil/gold ratio.
"That means two things: First, it takes fewer barrels of
oil than ever to buy an ounce of gold. So far, this has
been evidence of oil strength, and not of gold weakness.
Gold futures are in the $450 range as we go to press. The
ratio, then, can't be explained away as gold weakness. The
second thing the ratio indicates is coming gold strength.
This will happen even as oil prices climb higher.
"Obviously, that means gold prices have to climb faster
than oil prices. In the inflationary scenario I describe
below, you'll see just how that happens. If you don't yet
have a position in physical gold or gold stocks, now is the
time to take one.
"Since then, spot gold prices have moved up another 20%.
And oil, despite coming off all-time highs is trading
around $60 a barrel. And if, as I suspect, the gold bull
market will accelerate over the coming months, merger and
acquisition activity in the gold sector will also
accelerate, just like it has in the oil sector.
The oil/ratio bottomed last summer at 6.17, meaning it took
6.17 barrels of oil to buy an ounce of gold. Today—with oil
at $59.94 and gold at $538—the ratio is at 8.9 and
climbing. The good news is, the ratio could double from
here and still have plenty of room to grow.
If the ratio continues to rise, to say, twelve, while the
oil price remains around $60, you'd get a gold price of
$720 an ounce ($60 x 12). But twelve is just an arbitrary
number. The all-time high for the ratio occurred back in
1988, at 33. If the ratio soared that high again, while the
oil price stayed near $60, you'd have gold at around $1,980
per ounce, which sounds about right to me. I don't expect
that to happen tomorrow, however.
Gold will visit $2,000 an ounce sometime over the next few
years, but not while oil languishes at $60 a barrel. Most
likely, both commodities will rally together to some
extent.
The ratio skyrocketed in 1988 because the world was awash
in cheap oil, while gold rallied. In other words, the
ratio was high not because gold was "back" but because oil
was historically cheap.
Today, the situation is entirely different. The age of
cheap oil is over. And it is ending at exactly the same
time that gold is emerging from its two-decade long
slumber. In other words, we're headed to a place where the
oil/gold ratio doesn't make a new high, but where gold and
oil both make new highs in absolute and inflation-adjusted
terms. We're headed to a place where gold hits $2,000 an
ounce and oil hits $100 a barrel, in the process sending
the oil/gold ratio to around 20.
"Nonsense!" you say. "The top is in!"
Maybe, but gold's recent spurt above $500 closely resembles
oil's "breakout" above $40 in the middle of last year. At
that time, most investors believed oil to be putting in a
major top. OPEC, Wall Street and the major oil companies
all considered $30 to be the "normal" price of oil. Few
imagined a world where $60 would become the new "normal"
price of oil. Likewise, most investors seem to consider
gold's latest rally a "fake-out breakout," rather than the
beginnings of an enduring gold rally.
Gold, from both a technical and psychological perspective,
has been engaged in a war of attrition against public
opinion and the belief in the dollar.
The move about $500 is like the Normandy invasion. And
above $525, the July, 1944 break of German lines in
Operation Cobra. This advance turned the war from a
creeping reenactment of World War I into a war of movement
again, the way it had begun with the German blitzkrieg of
France.
Only this time it was American and British tanks moving
east, not German tanks moving west. Of course, it's worth
nothing that the Allied drive to the Rhine stalled in the
Ardennes forest in December of 1944. In fact, on December
16th, 1944, the 101st Airborne Division was surrounded at
Bastogne during a surprise German winter offensive. (The
battle at Bastogne is described well in the mini-series
"Band of Brothers," which makes a nice Christmas gift).
Eventually, of course, the Allies broke out at Bastogne and
on March 7th of 1945, crossed the Ludendorf railway bridge
at Remagen, across the Rhine and into Germany. Of the 22
road bridges and 25 rail bridges across the Rhine, the
bridge at Remagen, taken by the 9th Armored Division, was
the only bridge the Germans had not destroyed, although
they tried to demolish it twice.
"This bridge is worth its weight in gold," Eisenhower, is
claimed to have said.
Simply stated, gold has crossed the Rhine...and now begins
its inevitable conquest of paper currencies and its
inexorable advance toward monetary hegemony. The move gold
is making now argues for bigger and stronger gains ahead in
2006.
And both moves in oil and gold make perfect fundamental AND
geopolitical sense.
Oil is moving on increased global demand. Even $44 billion
of new investment planned in Kuwait--which would boost
current production from 2.5 million bpd to four million--is
not going to bring enough supply on line to meet the
growing demand of India and China.
And this assumes the Kuwaitis (or the Saudis, or the
Iraqis) can actually produce what they target. And, even if
they can, for how long? Oil wells don't deplete as fast as
natural gas wells. But when you have to start pumping
seawater in to a well to boost production, you're simply
hastening the rate at which you exhaust all the cheap, high
quality petroleum from the ground.
Also, note that the Kuwaitis are not boosting money spent
on exploration, but production. Perhaps they are hoping to
get top dollar for the 100 million barrels of oil they
claim to have in the ground. Geopolitically, oil is at the
center of many national grand strategies. It's going to
stay there for awhile. And the price will go higher.
Gold is rising because of the fundamental mismanagement of
the dollar by Alan Greenspan. And to be fair, in the club
of central bankers who destroy the purchasing power of
their currency, Alan Greenspan has a lot of company. Their
respective tactics and strategies might differ, but the
result is the same: decreased confidence in paper money and
an increased appetite for gold.
In the meantime, you probably won't see Congress hauling
the gold miners in front of the TV lights to ask abou t huge
mining profits. But that doesn't mean the insiders at the
gold majors haven't already done what their colleagues in
the oil industry did: make a list of acquisition targets.
Gold production CAN be increased, but you've got to find
the gold first. That means you have to explore for it. And
with higher gold prices on the horizon, the incentive for
finding it is definitely there. Gold majors, looking to add
new assets to the balance sheet, are going to be in an
acquiring mood.
Fortunately, I think there's a simple way for investors to
profit from this Christmas shopping by the gold majors -
without having to speculate in junior exploration stocks.
I've recommended how in the Jan issue of Strategic
Investment, which I hope to have in your hands by the end
of the week.
