-- Posted Thursday, 2 March 2006 | Digg This Article
Question of the Week:
Greg, what is the best allocation between Gold and Oil stocks for the coming year?
Answer:
Wow, ask me an easy one!
Lets begin with identifying what we DO know or at least what we think we know.
We believe we are in a Secular Commodity Bull Market.
We are uncertain as to its length but if history is any guide we think 15 to 20 years - a generation.
The bull market began around 2000 which means we are 5 years in.
Bull markets evolve in 3 phases.
The first phase is normally characterised by LARGE Percentage gains as prices rise off a low base and very low public participation.
We have probably completed the first phase of this commodity bull market.
The second phase is the long grinding phase. We are probably at the beginning of this phase now. Belief is built up and the public accept we are in a bull market. This is the longest phase with EXCELLENT Price appreciation.
The third phase is FIREWORKS. A speculative frenzy ensues. Price moves are QUICK and FIERCE! Prices go higher than anyone ever thought possible.
People start saying this time is different...and the bull market ends right there!
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Taking all of the above into consideration we can say that a BALANCED commodity portfolio should have exposure to all MAJOR hard asset classes. That would be Energy, Metals and Agricultural type commodities (which is a topic by itself).
However, these asset classes don’t perform at exactly the same time. In fact we can and did go through long periods of out-performance of one asset class over another.
That said, why don’t we take a look at the monthly performance of Oil Stocks versus Gold Stocks:
Figure 1 - Gold Stocks vs. Oil Stocks
- From 2001 to the end of 2003 Gold stocks outperformed Oil Socks.
- From 2004 to roughly the middle of 2005 Oil Stocks have outperformed.
- Now Gold stocks seem to have retaken the mantle of out performer!
The question is what should we expect from the future?
The answer: A continuation of out performance of Gold stocks against Oil stocks.
The reason:
- The Trend is your friend! If you had held Gold Stocks since 2001 you would have come out ahead. The period of out performance by Oil looks to be a mere correction now that Gold has reclaimed the mantle.
- More importantly, there has been a monthly MACD crossover (red circle). This is significant because it shows acceleration in the strength of Gold stocks against Oil Stocks.
So what’s holding Oil Stocks back?
To answer that we need to look at a monthly chart of the Oil stock index- the XOI.
Figure 2 - Oil Index Monthly
In a previous article entitled 'HUI Targets' I explained in detail my methodology for forecasting price movements - I call it the Exponential Fib.
My methodology uses the Golden Fibonnaici number of 0.618 and the Percentage move from the prior wave to forecast the target of the current wave.
Based on the move from 209 (1992) to 550ish (1999/2000), the current move is forecasted to end at around 1100 [550*(((550-209)/209*0.618)+1)]. Which is where we are now.
Incidentally a Top is characterised by the emotions of over-exuberance and all out Bullishness – is that what we see here?
Figure 3 - Oil Index Weekly
The weekly Oil index chart is showing some serious divergence on the RSI and MACD (green circles).
In answer to the question what’s holding Oil stocks back, I think they are seriously over-bought, tired and in need of a good correction.
I’ve been proven WRONG more times than I care to remember but I’d say we are seeing a TOP in the Oil Stocks.
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Is that a hand going up?
Your question Sir: Where do I think we’ll correct to?
Tough crowd!
Ok, my guess a 50% Fib retracement to around 750. But as I’ve said before,"...corrections are nearly IMPOSSIBLE to forecast."
Note: This does not mean the Energy Bull market is over! Its just time for a rest.
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Here’s a Worry!
Based on what we’ve seen Oil Stocks have had an AWESOME run since ’03.
But so has the entire Stock Market!
Figure 4 - Monthly Oil Index (red) versus DJIA (blue)
Oil stocks have been tracking and leading the broader stock market higher for the last 3 years.
And if we’re correct in thinking that Oil stocks are making a top then the stock market may be heading for problems of its own.
And guess what?
Gold stocks perform best when the broader stock market is dropping:
Figure 5 - Monthly HUI (red) versus DJIA (blue)
Asset Allocation:
The Commodity sector is in a secular Bull market.
Every portfolio must contain exposure to Energy and Metals particular Precious Metals.
It seems likely that Gold Stocks will outperform Oil Stocks for the foreseeable future in which case its best to be over-weight Gold Stocks.
What ratio?
That’s entirely up to your risk profile. But I’d say no less than 70/30 in favour of Gold Stocks.
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SIDEBAR:
What economic conditions would cause Gold to Out Perform Oil?
My guess is an economic slowdown that slackens the demand constraints on Oil. Causing the Fed to juice money supply in an effort to kick-start the economy. In turn causing Gold prices to rise on monetary inflation FEARS.
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Happy Trading!
Greg
p.s. Many readers are asking me if I prefer Silver to Gold - I will discuss my views in my next article.
More commentary and stock picks follow for subscribers....
Greg Silberman CA(SA), CFA (Retired)
goldandoil@yahoo.com
I am an newsletter writer specializing in Junior Mining and Energy Stocks.
Please visit my website for more free articles and analysis
Click here: http://goldandoil.blogspot.com/
This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.
-- Posted Thursday, 2 March 2006 | Digg This Article
