I used this insight and logic to warn investors about an imminent downturn in gold prices earlier this month. I got a lot of “feedback” from disappointed gold bugs. But it didn’t take long for them to eat their words as the price of an ounce of gold fell by nearly 10% in the last month.

But as I said earlier in the week, the slide is over. Of course, unlike the nation’s leaders, I’m willing to follow my words with action.

Here is what I sent to TFN Strategic Trader members first thing this morning:

“It is time to make the move. With the dollar increasing in value, America’s fiscal future looking stronger than its European brethren and record inflows proving safety has taken a backseat to asset appreciation, the price of gold has fallen by nearly 10% over the past month.

“Just yesterday, I read my first article in nearly a year that discusses the downside of the shiny, precious metal. Now that gold is trading for $1,100 an ounce, the sentiment has turned.

“Where were these articles a month ago when I warned of a turnaround? Now that the crowd has caught on, it’s time to change our outlook.

“As option investors, that means it is time to by. All you contrarian investors are going to love this week’s play. It gives you a chance to maximize the gains from gold’s upcoming turnaround.

“With gold shedding a significant portion of its value over the last four weeks, the speculation surrounding the metal has diminished greatly. That means once we get back down to base levels – the charts show its somewhere between the $1,050 and $1,100 per ounce range – we are set for even more upside.

“Rising inflation, interest rates and economic activity will boost demand well into the new year.

“Here is how I want you to take advantage of the situation. It is simple. Buy…”

You didn’t think I would give it away did you? To get in on the action and learn what I recommended, click here.

***We have come to the end of the year. In some ways I will be glad to see it go and in others, 2009 will be missed.

As a financial pundit, there will never be another year like 2009. Between pyramid-scheme scandals, unfathomable amounts of government intervention, a market nosedive and a roaring comeback, we never had a shortage of topics to cover.

As an investor, the action was bittersweet. Nobody likes extreme volatility like we saw in the first half of the year. Sure, there was profit opportunity, but not if it means losing your hair and risking your house.

For buy-and-hold investors, the year will end with gains of about 20% from the major indices. A nice victory, but still well short of where we were two years ago.

For in-and-out traders, the sky was the limit in 2009. Over at TFN Strategic Trader, we wrapped up a significant number of triple-digit winners.

But instead of looking backwards, it’s important to look towards the future and see what is just across the horizon. For 2010, it will be all about currencies, commodities and small caps. With so many of the nation’s smallest companies restrained by lending restrictions and top lines that refuse to grow, the next twelve months will be pivotal for the smallest of publicly traded companies.

For investors with the determination and skill to uncover the companies likely to be successful during that time, expect strong rewards. You can bet we will cover this sector in great detail as the year kicks off.

Until then, enjoy the last few hours of 2009 and have fun celebrating the arrival of the New Year.

Right now the gold-to-oil ratio is trading around 7. That means a single ounce of gold is roughly worth seven barrels of light sweet crude. With oil trading near $130 a barrel, this is an extreme low point for the ratio.

The previous drop in mid-2005, when an ounce of gold was briefly worth 6.5 barrels of oil, was the lowest the ratio has been in decades.

Oil Too Expensive, or Gold Too Cheap?

So what does it mean when the gold-to-oil ratio moves toward an extreme like this? In historical terms, it suggests that something is out of whack. Either oil has gotten too expensive, or gold has gotten too cheap.

The last time we saw an extreme in the other direction was late 1998, when the gold-to-oil ratio rose above 26. That was a case of oil being way too cheap… and of course, crude oil bottomed out for all time just a few months after that.

Given the way oil is trading now — the recent rocket ride to $130 a barrel, etc. — some think that oil has gotten too expensive, too fast. Their view would be that the price of oil has to come down, perhaps by a lot, and that the gold-to-oil ratio is reflecting this.

Your humble editor disagrees with this view for a number of reasons.

For starters, there’s a lot of hot air about how oil could be a bubble and speculators are driving oil prices… but there is little proof of this charge, and a lot more evidence pointing in the other direction.

Germany’s Folly

Angry German politicians have gone so far as to call for a worldwide ban on oil trading. They think that $130 oil is all the evil speculators’ fault, and that all the traders should have their hands tied.

This is about the dumbest thing I’ve ever heard, and a good example of how politicians can be dangerous. One of the key functions of markets is price discovery; through self-interested buying and selling, the markets act as a useful forecasting tool. (One of the best forecasting tools we have at any rate.)

Without a functioning market mechanism to determine the price of a valued good, the market breaks down. You either have lots of one-off transactions taking place in the dark, or else you have some government committee setting the price by fiat. I hear Soviet Russia tried that. It didn’t work out too well.

The activity of traders and speculators also provides much-needed liquidity to markets. When, say, an airline like Southwest buys heating oil futures contracts to lower its exposure to jet fuel costs, more often than not there are traders on the other side of the transaction. Without someone to take the other side of a trade, end-users of oil and gas products have no way to hedge their business risk.

In a very real sense, speculators are paid to take on risks that hedgers don’t want. Risk transference is a vital market mechanism. The German politicians don’t get this. Or maybe they do get it, but they just don’t care.

Trying to restrict trading would be a fool’s errand anyway. There is more than enough competition among global exchanges to keep the trading going, even if some goofball government tries to ban trading on a local basis. That’s a very good thing.

Et Tu, George?

Hedge fund legend George Soros is blaming the speculators, too, calling the oil price a bubble. Without putting too fine a point on it, this is a major piece of hypocrisy.

Why? Because the existence of men like Soros show exactly why big markets are hard to manipulate.

If the price of oil were truly in a bubble, some big hedge fund player with guts and foresight could come along and make a killing by shorting the daylights out of it… thus driving the price of oil back down to non-bubble levels in the process.

This is exactly what Soros himself did in 1992. That was the year he earned the nickname “The Man Who Broke the Bank of England,” for the huge score he made shorting the British pound.

Both gold and oil are hedges against inflation… but which one is the best?

The divergence between the prices of gold and oil has been the subject of much speculation over the last few months. The FT waded into the argument this morning with two opposing views on the front page of Companies & Markets.

The first came from Ian Harnett at Absolute Strategy Research. He noted that an intriguing feature of the current oil price spike was that it brought the price of WTI to a 40-year high when compared with the price of gold.

“Only briefly – back in the late summer of 2005 – has an ounce of gold purchased fewer barrels of oil. We expect such a situation is unlikely to last for long… so it may be time to be long gold and short black gold,” he said.

Then there was the view from Julian Jessop of Capital Economics. He argues that the ratio between the two commodities was not stable over time and he reckons that gold has its limitations as an inflation hedge.

He thought gold’s recent slide was down to the fact that the dollar is set to undergo a slight recovery and the rise in the oil price was down to expectations of emerging market growth. The fledgling economies need more oil than gold. Based on this argument, he reckons that the gold price will not get moving until there is evidence of significant inflation in the US.

So where do I stand?

Well, I lean more toward the view from Julian Jessop. My argument is that the gold price fall was driven by the realisation that the US Fed was running out of rate-cut ammunition. They can’t cut rates much below 2%.

However, I am also sure that inflationary pressures are building in all economies, driven by food-price inflation and rising raw material costs. I think significant inflation is here already, so Jessop’s trigger that will get the gold price moving again is actually with us now. When markets will wake up to this fact I simply do not know… but I believe they will.

I also reckon that supply and demand dynamics in the oil industry will keep the oil price above $100 for the rest of this year… but I cannot ignore the speculative element of recent gains.

The view that gold will not start moving again until US inflation ratchets up is commonly held in the market – this has made investors seeking a hedge favour oil. Recent US inflation data has been tame, but regular readers know that I do not believe inflation figures released by governments… they are all damned lies.

US consumer prices rose a smaller-than-expected 0.2% in April and everyone breathed a sign of relief. I reckon this was a mistake.

Governments manipulate figures. They change the way unemployment is calculated to flatter the figures and they massage inflation data to meet their own ends. I therefore don’t believe the US inflation data – and anyone who buys food or gas in the US (that’s, almost everyone) could see that these figures are essentially a lie.

Fortunately, shadowstats.com calculates CPI the old-fashioned way. It uses the methodology applied before 1990, when Bill Clinton started playing with the way these figures are worked out.

Pre-1990 methods indicate a US annual CPI rate of just below 12%.

This is much more believable. I think the same is the case in the UK too… just think about how much your electricity bills, petrol costs and food bills have gone up. That’s not even considering soaring council tax bills and Gordon’s underhand stealth taxes.

The reality is that we are in a very serious inflationary environment. We are also seeing accelerating oil demand from emerging economies.

Investors seeking a hedge against inflation can choose between gold or oil. Over the last few months, oil has won out and investors seeking a hedge have put money in oil futures as a momentum trade. Harnett’s argument was that this was about to be reversed and you should sell oil and buy gold.

I disagree…

You should buy oil AND buy gold…

Demand will support the oil price and inflation will eventually get the gold price moving.

There may be time in the coming months and years when the market favours gold as a hedge and when it favours oil. By owning both, you can let debates such as the one seen in the FT today play out, safe in the knowledge you are hedged against the ebb and flow of these views.

Long-term, however, the price of oil is heading higher and the price of gold is as well, so the which-is-a-better-hedge debate is irrelevant to those with a long-term view.

These commodity-price rises will be caused by rampaging inflation, by the demise of the dollar as oil is priced in other currencies and by soaring demand from Asia.

You need to own both gold and oil. Then you can ignore these debates about which is the better hedge.

Remember: We are investors not traders… the long term outlook for both commodity classes is extremely bullish.

The only problem you should be facing… is deciding which oil and gold stocks to buy. With the prices for both certain to rise… and give a great hedge… what does it matter which stocks you buy?

Such thinking is nonsense… there are a multitude of wrong moves to be made in these markets. Discover what all the right moves are now…

Regards

Garry White
Editor
Smart Commodities UK

Source: Gold or Oil, No One Agrees on the Best Hedge