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Bizarre Love Triangle – Stocks, Gold And Oil
Gold and crude oil have been in a slow motion free fall of late, even as U.S. equities rally but ConvergEx's Nick Colas looks at the value of each asset class relative to the other two and assess their historical relationship. For example, you currently need 1.72 ounces of gold at $1178 to “Buy” one S&P 500 index at 2032. That is cheap to the 30-year average of a 1.86x ratio, putting fair value on U.S. stocks 8% higher. Separately, it currently takes 25.1 barrels of crude to buy the S&P 500, versus the 30-year average of 27.8, making stocks look cheap by 11%. Closing out this analytical triangle: you need 14.5 barrels of oil to buy an ounce of gold, but the 30-year average is 16.6. Bottom line using these long-term ranges: U.S. stocks look mildly cheap to oil and gold, but drops in those commodities would erase the difference just as easily as a further rally in stocks. Gold looks cheap relative to oil and should be $170 higher, or oil should trade closer to $71.
Via ConvergEx's Nick Colas,
Would you rather have an ounce of gold or 611 gallons of crude oil? Both cost the same amount as of Friday’s close: $1178. The former has an unrivaled long-term track record of holding value; every ounce of gold ever mined is still worth that not-insignificant $1178. Everyone from gun-toting preppers to the world’s central banks to blingy Rolex-wearing global oligarchs agree it is a good asset to own. On the other hand, the oil – once handed over to your friendly neighborhood refiner – will yield 275 gallons of gasoline plus other hydrocarbon products. That’s enough gas for the average American to drive 6,875 miles, or almost 6 months of daily transportation.
Now, lets throw financial assets into this “Who’d you rather?” style analysis – would you prefer one share of the S&P 500 or an equivalent amount in gold or crude oil? The hard numbers for the non-financial assets are: 1.72 ounces of gold (at that spot price of $1178) or 25.1 barrels of crude (average of Brent and WTI at $81). Aside from revealing any inherent biases you might have related to these options, there are several purposes to such an analysis:
Investors constantly make choices between different asset classes based in part on relative value. Since capital flows freely through the world’s financial and hard asset markets, the price of gold, oil and stocks should maintain some harmony over the long term. Yes, gold haters might say it has no cash flow and peak-oil theorists might posit that crude is structurally underpriced. Markets, however, are more agnostic and often revert to some long-run mean valuation for commodities and financial assets alike.
To determine where gold, oil and stocks might be in some form of long-run equilibrium, you need to assess the price of each through several economic cycles. We pulled the data for the S&P 500, gold prices (courtesy of the Bundesbank) and oil prices (World Bank data, using Brent, West Texas, Dubai and other markets). There are several charts showing the 6 permutations of gold/oil/stocks in ratio form immediately after this note, all going back to 1970. Oil back then, by the way, was less than $2/barrel. Good times…
The recent volatility in gold and oil markets, while U.S. stocks chug higher, first sparked our interest in this topic. Such sharp moves are usually more about sentiment shifts than long-run fundamentals. A multi-cycle analysis usually washes out the vagaries of investment fashions and reveals truer – and more sustainable – valuation parameters.
So what does the record show on the question of relative fair value in the case of gold, oil and silver? Here are our findings:
U.S. stocks look slightly cheap on long run measures versus both gold and oil. Here’s the math:
Over the last 30 years, stocks have traded at an average 27.8 multiple to global crude oil prices based on monthly closing prices for each. With the S&P 500 at 2032 and Brent/WTI at an average price of $81, that is a ratio of 25.1 now. If we were right on the long-run averages, the S&P 500 would sell for 2252, or 11% higher than current levels. Of course, oil could drop further to resolve this imbalance, in which case a per barrel price of $73 would bring it back into balance with the S&P at current levels.
Both assets have, of course, seen their own bubbles in the last 30 years. Crude got to $140/barrel in 2008, and the S&P 500 saw 1500 in 2000 when oil was just $27.50. Outliers abound in this data series. The 10-year average is 17.1 barrels of crude for every S&P 500 unit, and the 20-year average is 32.5, putting a wide range around any volatility-adjusted mean. That’s a long way of saying that markets can remain out of kilter for a long time and you have to use this kind of assessment very carefully.
As for gold, you’ve needed 1.86 ounces to buy an S&P 500 unit on average over the last 30 years. The current ratio is 1.72, meaning that the S&P 500 has a long-term fair value of 2191,or 8% higher than current levels using the three-decade average ratio. Or, if gold continues to decline, it would have to settle at $1092/ounce to reach long term equilibrium.
As with oil, there has been significant price volatility in gold over the last 30 years. This time horizon does not cover its run to $850 in 1980, but it does encompass the move from below $300 as recently as 2002 to +$1700 in 2012. The 10-year average for the S&P 500 in gold terms is 1.5x and the 20-year average is 2.35x.
We can also use these ratios to assess gold and oil relative to each other. Two point here:
It currently takes 14.5 barrels of crude to buy an ounce of gold. The 30-year average is 16.6, making gold currently look cheap to oil. To bring the two commodities into long-term balance, gold would have to rise 14% to $1345 or oil would need to decline to $71. Or, of course, some combinations of such moves to bring the ratio back to 16.6 times.
Unlike our prior evaluations of U.S. stocks relative to gold and oil, the ratio of these two commodities has been in structural decline for the last 10 and 20 years. Over the last decade, it is 12.6 barrels of crude for every ounce of oil. In the last two decades, the ratio is 14.3.
One final note before reaching a few conclusions. We’ve focused on the 30-year track records – 1984 to 2014 – because this span encompasses several broadly comparable business cycles. Our charts show the data back to 1970, which predates America’s move away from a gold standard in 1971 and captures the oil shocks of 1973 and 1979 as well as the entire 1970s lost decade for stocks. In case you are curious, here are the averages all the way back to 1970:
S&P 500/Gold: 1.53x (1970-present). The current ratio of 1.72 means U.S. equities are overvalued by that measure and the S&P 500 should trade for 1802. That is 11% lower than current levels.
S&P 500/Crude oil: 25.2x (1970-present). We are at 25.1x, so domestic stocks by this count are pretty much exactly where they should be.
Gold/Crude: 17.0x (1970-present). At current prices the ratio is 14.5, gold is cheap and/or oil is expensive. Equilibrium prices would be: gold at $1377 or oil at $69.
The bottom line here is that the drop in crude and gold paired with a continued rally in U.S. equities isn’t as strange as it seems. Looking at the historical record, something had to give to bring prices back into line. As with any change in market sentiment, there are many explanations but few quantifiable facts to help us understand these shifts. The historical relationships between these three asset classes help to fill the void.
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All outdated .
Some new owners are coming in .
See
https://www.academia.edu/9247204/Be_Your_Own_Owner
or
http://andreswhy.blogspot.com/2014/11/be-your-own-owner.html
It's a Trap!
New Order - Bizarre Love Triangle
https://www.youtube.com/watch?v=7uEBuqkkQRk
I wonder if Ben Bernanke dreams of being in a bizarre love triangle with Janet Yellen and Christine Lagarde,
? Maybe Greenspan does. too.
But oh, now I am really confused..
How might you describe an aging, gun-toting prepper that wears an appropriately camo-wrapped Rolex President?
(oligarchs agree.. it is a good asset to own)
Y'know.. that might be a good, new vertical.. Camo-Wrapped Bling.
not to neglect the fourth corner of the love triangle:
cost of college education
cost of house
cost of admission to a sporting event
median household income
The real wild card (actually, deliberate and not so wild) is state, local taxes and fees.
You could have $2.00 a barrel oil again and it would not make a darn bit of difference if 75% of your income is eaten up in taxes and fees.
I fucking love gold, you can pick this stuff up easily in your nearest stream bed very easily, in fact, it's so plentiful, you don't even need eyes to see it!
https://www.youtube.com/watch?v=Od9D6TECSa0
"U.S. stocks look mildly cheap to oil and gold,..."
Do U.S. stocks look cheap when compared to GDP:
http://www.gurufocus.com/stock-market-valuations.php
Answer: No. Now, considering the impact that monetary policy established by Central Banks is having on asset classes, what is the value of such comparisons between oil, gold and equities? Who knows what something should be worth these days. The day may come when the most valuable assets anyone owns include guns and ammo.
FUBAR.
"assess their historical relationship"
The problem with comparing the prices to our recent history, is that we're in uncharted territory. The Debt to GDP ratio is getting more and more out of hand, and all the more so if you look at unfunded liabilities in the US. So what to make of that? Gold is more, and more and more, an insurance policy against irresponsible drunken sailor spending by the USG corporation, enabled by the FED's money printing and massive increase of its balance sheet, as well as so many other corporations buying back their stock with 'cheap debt.' All of it is financial manipulations (ultimately crimes against the nation) not unlike the packaging of subprime mortgages into AAA safe securities. How did that work out? How is that working out?
So while we may pine away for the days of the 1950s, and reversions to averages from days of yore - when we weren't in such massive debt excess and uncharted territory - we are - and those historical averages will apply less and less, as we deepen into this debt morass. Also, just look at the diminishing return on debt, vs. say the 50s, and 60s - we are in negative territory now, unlike then. So many reasons why those historical averages should be way worse now relative to the SPX.
http://economicedge.blogspot.com/2010/03/most-important-chart-of-century...
Agreed.
These ratio relationships fail to take into account asset correlations and the interchangable nature between more liquid asset classes than a 400k brick of gold.I could cook up a similar chart to show that natural gas is cheap, or it's cheap on silver basis. But without projecting and forcasting how the supply picture has changed, Nick is leading people down a blind alley.
Nick does have the right point, either gold & oil are telling the story on true demand or forward expectations are correct. The lead will likely be if BABA's aggregate demand 'single day' binge can be reiterated by the US retailers as they pull Cybermonday and Black Friday ahead by a full 2 days. If we see little move in inventory or foot traffic then this whole "consumers will spend because gas is cheap" that Larry Kudlow and the celeberties have been binging on (and bidding up every momo large cap) will prove false. In which case, I look forward to seeing a fresh set of Retail sell side analysts looking for jobs in 1H15. The disconnect between KBR & the homebuilders with Lowes, HD & Armstrong is also starting to prick my eyebrows.
Shout out to Stockman, impressed at how well he picked up his A-game this week in trying to go a bit deeper in this themantic calls. Others should follow, even if that requires something (and educating) deeper than your standard ratio / pannel regressions.
if one of them is cheap then, oil must take a hit...cuz gold is like kryptonite to the fiat USD
My metric is the silver to Ford Aircraft Carrier ratio.
Well, at least gold's finally broken that 3+ year correlation with the yen - either that, or the yen's setting up for a turn-around. I think either's a pretty plausible scenario, since the guys running the trade have probably decided they made enough money, and it's entirely possible that Kuroda's success is FINALLY just around the corner. Not to mention gold's looking solid technically - almost back to its 'pointing straight down' 10dma!
It was once said that "gold and oil can never flow in the same direction". If the current price of oil doesn't change soon we will no doubt run out of gold.
C deO
wink wink
China was not a factor in gold buying until end of 2002. Now Chinese real estate is now worth $200 trillion and the Chinese people will buy lots of gold much to Yellen's chagrin:
In December 2002, the Chinese Government allowed the Chinese people to once again buy gold for the first time since 1949, when the Communist Party came to power.
Some believe that the 'price' of gold and oil has been manipulated by supplying a bit of gold along with currency so that the Saudis would keep the cash price low but they would still get some gold. After they went through all the currency they spend they want something to keep for the long term...that would be gold.
In view of this these same folks belive that analyses such as these are irrelevant.
I think that the price of gold is based on flash-trading and speculators. At the current time, gold spikes up and flash traders get in and win by selling off for their up to 1% daily gain. Speculators are currently making too much with stocks to want to buy gold. Since gold is traded by ETF it spikes all over the place depending on where the speculation money is flowing.
Ad naseum - the price of paper gold...
Does the price of physical gold not closely track paper gold?
Let's quit making such deductions about price by looking in the rearview mirror. And let's not forget that these are measured in a fiat paper currency whose supply is infinitely expandable.
Logically, analysis should refer to SUPPLY and DEMAND.
SUPPLY and DEMAND... ? THAT is SOO out of fashion. Price too high? Let's (paeper) short this bitch... Price too low? Let's go paper long and strong... That's how they roll. For now, at least.
Bla bla bla
Its all rigged.
Ill keep my PM Thank You
If only my girl didnt loose them over the side of the sail boat while we were out having a bizzare triangle.
The US is not a growing economy or a high inflation economy like going off gold standard will do. You just cant compare the US economy to any US economy of the past.
Track small business growth. How many new Mcdonalds or burger kings? How many new walmarts? how many new growing retail businesses? None, they are all dieing. So why would you pick time periods where growing retail businesses were common?
Agenda has an agenda.
I 'ates it when some blighter throws logic at the illogical.
Where was this guy back in May before the $usd made it's parabolic 10+ % run-up and hammered PM's and oil into the dirt?
Gold is still gold. Oil is still oil. But the S&P today, is not the same as the S&P from 1970. Many companies have been dropped, while others have been added. In addition, the average is weighted and free floating. It is comparing apples to mood rings.
Nowadays gold is used to plate tungsten bars.
/sarc
OIL and Stocks are over priced! They have to come down!
Nothing ever "has to" come down immediately. It might go up a lot longer than you anticipate. It's all a roll of the dice. Best you can do is run your quantitative analysis, do your qualitative research, get good information and then make an educated guess.
You're backing a horse at the end of the day. It might be the biggest, strongest and most well prepared animal on the track, but if it stumbles out the gate you're still going to lose. Thus, uncertainty is a bitch.
'Thus, uncertainty is a bitch.'
Heisenberg had a lot to say about that
http://en.wikipedia.org/wiki/Uncertainty_principle
(probably no cats were harmed in the creation of this comment)
Hey Tyler..
If somebody cares to run the same data series in comparison to bonds, I would be extremely curious to see the results.
My guess is, all three look cheap compared to them. Could be wrong, but actually I see all of these rising comparative to that market. The only question is the magnitude of each rise relative to one another.
(PS: also might be currency risk in certain geographic markets.)
Here is a novel concept ...
How about getting the "so called" banks out of the markets and finding out what happens?
What would happen if there is no buyer and seller of last resort that is setting price?
Once the Fed started up QE2, any Historical relationships become Hysterical!
How about stocks relative to GDP and gold relative to M2?
"...Over the last decade, it is 12.6 barrels of crude for every ounce of oil..."
Colorado called. They wanted to know is that a 32 gram or a 28 gram ounce?
Hmm, all comparisons to a time when fiat money reigned supreme.
If the ratio of S&P to gold since the 70s was 1.53, stocks are only fueled by money printing, and gold is priced below the production cost, that means...the ratio can go << 1. This period of global fiat currency was too unique to make such comparisons of valuation.
Looking at the historical charts, the Dow was only at 1,000 in 1980 before all this globalization nonsense.
You could be listening to too much Beethoven. ;)
The price of 1 oz of gold has been between 15 and 16 barrels of Brent Crude for years (even at Browns Bottom) so gold is looking cheap at just over 14.
The recent falls in oil price seem to be outpacing any slowdown in demand.
Is the price of oil falling due to the oil companies cutting back on new extraction expenditure ?
If that is the case then perhaps the new foreseeable price of ~$75 makes any current capital investment have negative return (although as capacity drps, the price should rise causing an oil investment rush)
Or is there something new on the horizon that will make oil look like steam ?
(H/T to Limacon's link at the top)
Our very similar analysis..We also analyzed bonds:crude, copper:crude, palladium:crude
http://goldenopportunitytrading.blogspot.co.uk/2014/09/i-have-found-oil-...
However, you cannot compare tangible assets to assets made of air.
http://www.newmont.com/our-investors/stock-data/operating-statistics
Dont see $1200 as cost here, way less and they have shareholders who can sue if they lie.
another head fake for gold - was up almost 20, then gave 10 back. more punishment tomorrow.
Why is Brent Crude ~$80 per barrel ?
Has demand dropped 25% ?
5% global drop YOY I can believe
10% global drop is plausible
15%, no, that's bollocks
25% wtf
The question is 'what were they spending that 25% on before the price dropped', some was on coke and hookers (obviously), the rest was on future infrastructure.
The second question is 'why would a business suddenly stop investing in future infrastucture' ?
Methane Clathrates spring to mind.
Bollocks!, all comparisons to the past are meaningless, we have never had QE of the scale that has been used in the past 7 years approx, you end up comparing apples with oranges trying to compare ratios of assets from now with the past.
We are in uncharted waters, watch out for pirates.