Sometimes it pays to look at relative value

Spot gold, WTIC, June 2002 to June 2012, monthly with relative value area curve

Spot gold, WTIC, June 2002 to June 2012, monthly with relative value area curve

A lot of times its difficult to determine what’s called fair value in the markets; in other words, what is a fair and accurate price for an asset. I often prefer look at relative value, or comparing the price of two assets, not trying to figure out if one is cheap or expensive in insolation, rather comparing the two.

The chart above shows an interesting relationship between the oil ($WTIC, black line), the price of spot gold ($GOLD, red line) and the oil-gold ratio. In other words, the grey area curve in the background shows how much gold it takes to purchase a barrel of oil. The red circles on the left and right side show how many ounces of gold it took to purchase a barrel of oil in 2002 and 2012 respectively. This is curious, since we know commodities across the board are collapsing, however not all commodities are falling equally as fast. We can see that while all commodities are falling an ounce of gold actually purchases more oil (just to pick one commodity) than it did ten years ago. The lesson: even in The Great Depression not all assets collapsed at the same rate. If we truly are in a deflationary spiral you clearly need to be diversified. Definitely hold cash but also you need assets like gold (or silver) to diversify away from perhaps far riskier assets like shares. I’m still purchasing gold myself as cash flow permits. This is a very dicey market and things aren’t going to look much better in the short term.

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