The Developing Oil and Gold Price Divergence

You’ve surely noticed he recent huge drop in the price of crude oil (currently at around $62.50 per barrel, down more than 21% from its July peak of $78.40 per barrel.) Simultaneously, we have seen smaller, yet significant drops in the prices of gold and silver. (See the 30 Day gold and silver charts at Kitco.) Gold has dropped about 11%. The declines in the prices of the precious metals can be attributed to gut level trades made by the big institutional investors. Decades of experience has taught them that when oil moves significantly, then gold and silver will move in harmony. But if they had “done the math” based on the old commodities market fundamentals, they would have pushed gold down even farther. Clearly, things have changed. It is important to note that if these pull-backs were in full harmony with the oil market, then gold would be another 10% lower–as low as $520 per ounce. Why hasn’t this happened? I believe that a market fundamental has changed: the price of gold and the price of oil are no longer firmly linked. I expect this divergence to continue to expand in coming years, to the point that the price of the precious metals will begin to move on its own–almost entirely unlinked from oil. Call it what you like, but a divergence is developing.

I also predict that the markets will get even more exciting in coming months, with larger swings in prices. The oil glut is expected to continue for at least the next six months. However, at the same time, the price of gold and silver should get back on their bull market tracks, leaving the commodities market pundits scratching their heads. We live in a dangerous world, where any maniac can brew up a chemical or biological weapon, and there is a lot of fissile material floating around outside of accountable circles. Meanwhile, nearly all of the world’s currencies are entirely de-linked from reality–or at least from convertibility to gold or silver upon demand. Governments are printing paper currency and fiddling with interest rates with reckless abandon. These and other macro factors almost assure a strong precious metals bull market for at least another three years, and perhaps a full decade.

I will repeat something I’ve stated several times in SurvivalBlog in the past year: If you feel the need to diversify out of dollar-denominated investments into precious metals, then buy on the dips. And in case you haven’t noticed, this past week was a big dip. Take advantage of it. When silver is eventually at $50 or $60 an ounce (perhaps just two years from now), you will be glad that you did!

Lastly, don’t fall in love with any particular investment. As the “dot.bomb” of the bubble and the more recent end of the housing bubble have illustrated, no investment goes up forever. Keep a small core “survival” holding of silver coins for barter, but make plans to divest the majority of your gold and silver holdings as the market cycle ramps up near its peak. Do not try to time the absolute peak. Some folks tried to do just that in the last big run-up of the precious metals (circa 1980), and most got badly burned. It is often better to sell six months to early than a week too late. I’m no wizard, but based on the intrinsic value of the U.S. dollar, the peak in the current bull market cycle will likely be at around $60 per ounce silver and $3,000 per ounce gold. Don’t be greedy. Start to sell your metal holdings gradually when you think that the market has reached 70% of its potential top, and then immediately reinvest the proceeds in another tangible. In this case, I think the best choice would be productive farm land. I will go out on a limb and predict that real estate market will be nearing its bottom just as the metals market will be nearing its top. That might be as soon as 2008. Swapping gold into land at that point will be a monumental “win-win” trade.