A lot of contrarian investors say gold is a bargain right now — “a one-way bet.” J. Christoph Amberger is not so sure. History shows gold prices trend in line with oil. This means if oil hits $50 a barrel, gold could drop back below $500 an ounce.

J. Christoph says the best way to play this move — and protect yourself against volatility — is through put options on the SPDR Gold Trust ETF (NYSE:GLD).

This from Today’s Financial News:

Increasing prices for crude oil result in increasing inflation… making their way into increased transportation, heating and utility costs until they’re eventually reflected in virtually every finished product, including food and commodities in general. Increased inflation in the dollar typically results in higher gold prices.

So — presuming the methods of calculating risk and reward are applicable in bull and bear markets — how would a goldbug calculate the price of gold right now?

In 2005, Nick Barisheff, co-founder and President of Bullion Management Services Inc. (established to create and manage The Millennium BullionFund, Canada’s first and only RRSP eligible open-end Mutual Fund Trust that holds physical Gold, Silver and Platinum bullion) wrote:

“Over the last 50 years or so, gold and oil have generally moved together in terms of price, with a positive price correlation of over 80 percent. During this time, the price of oil in gold ounces has averaged about 15 barrels per ounce. However, with recent soaring oil prices, the relationship has strayed far from this average.

While oil prices recently set an all-time high of $56 per barrel [remember, that was in 2005!], gold prices have not kept pace and the oil:gold ratio fell to an all-time low of 7.5:1. At US$56 per barrel oil, the gold price should be in excess of US$840 per ounce. Some experts are suggesting that, in two or three years, US$100 per barrel oil is very possible. At that price gold should be US$1500 per ounce.”

Let’s apply just the two ratios: At 15:1, a price of $70 per barrel of oil should give us a price per ounce of $1,050 per ounce. At 7.5:1, we’d have half of that… a mere $525 per ounce.

If recent historic ratios hold up, gold may be in a hurry to lose another 25%… just to catch up with oil’s current levels around $70. But as I pointed out in yesterday’s TFN eNews, the outlook for oil is not at all bullish: Supply is expanding… demand is stagnating… global economic expansion is expected to stagnate if not turn recessive. Worst of all, the speculative buying frenzy that exploded oil prices into the $140s has stopped… and is now converting into selling pressure.

Oil has lost over 50% — or $70 dollars per barrel — in four months. Could it lose another $20? In my opinion, it could happen just as easily as Lehman Brothers going out of business: A thing like this was inconceivable two months ago…

But times have changed.

What could that mean for gold?

Let’s do the math: Oil at $50, applying the 7.5:1 ratio, leaves us with $375 per ounce of gold. A bit more than half of today’s post-plunge value.

Gold investors undoubtedly will argue that the gold-to-oil ratio is no longer valid. Maybe even that it has never been valid. That gold is money and Asian countries “traditionally” like gold. Mints are running out of bullion due to demand. That the money supply, calculated in 1980 dollars, projects prices of $1,500, $2,000, $4,000 an ounce.

Sure thing. But let’s ask ourselves for a second: Is gold at $500 a likely scenario?

After all, since 1975, gold has spent far more time trading below $500 than above… the longer you chose your time frame, the more gold’s recent spike looks like a short-term aberration:

I agree that’s not much of an argument (although it is not different from projecting the value of the Dow Jones Industrial Average based on historic P/Es…)

Quite honestly, I don’t think any scenario could be dismissed as unlikely these days. Yes, there is still large-scale buying going on, especially by followers of undaunted “contrarian”, hard money advisories. But the “last opportunity to buy below $1,000″ may be extended indefinitely when poor performance, increasing redemption pressure, and tax loss selling come to a head in December.

The most prudent way to play volatility in the gold and commodities right now is by hedging your bets with appropriate options strategies. For gold, the most appropriate vehicle would be a set of options on the SPDR Gold Trust ETF (NYSE:GLD)… and in my opinion, it should be weighted to a considerable downside.

Source: Shocking Forecast: Oil-to-gold ratio now puts gold’s downside at $500… even $375 an ounce!