As commentators have noted, the gold to oil ratio remains near all time lows which could suggest gold is seriously undervalued. With gold at $880 per ounce and oil at $135 per barrel, the gold/oil ratio is now at 6.5. The average for the last 40 years has been around 15. But does this mean gold is too low, or perhaps that the oil price is unsustainable at current levels and has to come down sharply and quickly. It depends on which side of the fence you are sitting as to which viewpoint you take.
One suspects that the reality is actually somewhere between the two. It would see that the price of oil is currently way higher than the supply demand equation would suggest. Some of the rapid increase seen of late mirrors and exceeds that of the late ‘70s oil crisis, while the extremes are even greater in real terms this time as there has been rapidly rising demand in the developing world. Even so there is a strong feeling that today's price levels are not sustainable and, if this is the case, one suspects that the price of oil is set for a major tumble within the next few months - or even weeks.
If this happens, what will happen to the gold price? One suspects that initially the gold price may fall back sharply as well. Investors may have to be prepared for a very bumpy ride. But at some stage recognition will dawn on the market that what drives the gold price is not oil alone - indeed this much should be obvious as on the way up record oil prices have not been followed by record gold prices. The gold price peak was independent of the oil peak and even the fall and rise of the dollar is only having a relatively limited impact on the gold price at the moment.
As far as oil is concerned, though, it does seem that mst of the recent rise has been due to speculation in the markets. With oil apparently not actually in short supply - indeed there is evidence that supply actually comfortably exceeds demand - the oil speculators may be playing a dangerous game. The price has risen to a level which is already contributing to global cost inflation and a significant economic downturn, which in turn is already seriously affecting demand. Add into that the big increases in Saudi production, in existence and planned, and there are all the indications of a potential oil price crash ahead - or at least a rapid return to less damaging levels. But, speculation and sentiment could still cause the price to surprise us and rise further, but all that would seemingly do would be to make the ensuing price crash harder and faster when it does come. There has to be a time when the real speculators will go seriously short on oil and that day may even be with us already.
But that brings us back to gold - and also to silver which will likely continue to move in concert with its fellow precious metal. A bursting of the oil price bubble would almost certainly see gold testing its downside resistance levels too given the lemming tendency of some speculators, boosted too by computer stop losses, but one suspect this gold downturn could be relatively shortlived and should provide a good buying opportunity if it occurs. The only problem here is to pick the bottom. If oil should fall back sharply without the dollar rising significantly, then the gold downside may be limited, but if the dollar does rise sharply (not through US strength, but through weakness elsewhere in the world), and inflation worries lead to the Fed raising interest rates there could also be a very sharp fall in the gold price back to the $700s, before stabilising and climbing up again - eventually testing the $1,000 mark. This could all occur over a relatively short period of time and most analysts still see a strong gold price after the summer is over.