Oil Due for A Correction
By: Martin | Posted: 21st May 2008
Oil keeps hitting record highs, but whenever we see this type of hype, we can expect to see a much needed correction. When we see items become front page news, it is time to look for a serious correction. For example, nobody in the general investment market had a clue that wheat and grains were making dramatic gains. But as we started seeing reports in the last month on how expensive wheat was becoming, we saw a major turn in the price of wheat – it fell 45%.
The same story goes for rice. It started to rise dramatically, made it to the front page news, and then dropped almost 20%.
For oil we are in what is typically called the “shoulder season” and even though we typically see the high for oil in March, it is not unusual to see the price of oil peak in May. As with rice and wheat, the price of oil has risen too far, too fast – it is time for a correction.
Gold has been in a correction mode since mid March. But now we are seeing gold start to make a move, partially being driven by the spike in the price of oil. We are now looking for gold to make a move here, but be aware that should oil correct as we expect it will soon, then gold and silver will also likely retract with the price of oil, for a short period.
We like to look at the chart of the gold/oil ratio. This ratio has declined dramatically recently, and today an ounce of gold only buys just over 7 barrels of oil. On the chart, this ratio looks to be turning, meaning that it would make sense to lighten exposure to the oil sector and increase exposure to the gold and precious metals sector.
We cannot tell you that this ratio is going to turn tomorrow or the next week, but our analysis shows that we should see a rise in precious metals and a decline in oil stocks. This means that oil could continue to rise in the near term and gold could drop in the near term, but for our money we are accumulating more gold and silver stocks at this point in time. We are seeing some gold and silver stocks starting to rise, and this may be an indicator that the gold shares are looking to lead the way up.
With the stock markets, we have been looking for that point where the damage from the sub prime and credit crunch has been fully discounted. We have been hearing for over six months now that the worst is over and the market has fully discounted the worst from the sub prime and credit problems. Recently we have been reporting that the main issue today is the lending freeze that has been in effect. At this point we would be willing to suggest that the Fed has been reasonably successful in averting a credit freeze in the lending markets. But what we are still very uncomfortable with is that credit is still being extended by banks in the real estate market.
So while we see credit expanding in the real estate sector, it is how this is coming about that worries us. The banks are selling securities, mostly selling bonds to the Fed, which is creating much of the new liquidity. But what is troubling here is that we see a decline in deposits being held by US commercial banks, which is counter to the basics of banking 101. Typically you would see a rise in deposits, increasing the bank’s money supply – not so in this situation.
But what is even more troubling from our point of view is that these US banks are increasing their liquidity by borrowing from foreign banks. So here we have US banks selling securities, not based on deposit growth and they are borrowing from foreign institutions to expand this credit.
The next problem that we see is that this credit is being offered is being offered at a much higher price. So while the credit freeze seems to have been averted, at least temporarily, the price is much higher. So while we seem to have made our way past the Bear Stearns scenario, it looks like there is another shoe still to drop.
Today, we seem to be in a respite period where the markets have moved up and the commodities have pulled back some. We have been closely watching the dollar, anticipating a fairly strong rise soon. But as we can see on the following chart, the dollar rally that we have anticipated appears to have stalled – at least at this point.
At this point, we are seeing that investors are more interested in buying up the dipping gold price than they are at scooping of the cheap US dollar. We think that the reason is that the market does not like the way that the credit freeze has bee averted – it is not fundamentally sound. Stay tuned!
Changes to the TREND letter Templates
Overall, Gold & Silver stocks are now a “Buy.” But save some capital in case gold is pulled down with an oil correction.
About the Author
Martin Straith is the Chief Editor of the TREND letter, a very successful investmetn newsletter. www.thetrendletter.com
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Tags: point in time, short period, hype, front page news, grains, spike, price of oil, gold and silver, would make sense, ounce of gold, record highs, investment market, mid march