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Schork Oil Outlook: Better to Own Oil or Gold?

Wednesday, 17 Aug 2011 | 12:09 PM ET

Gold futures surged to a record close yesterday. Open interest in the contract for December delivery stood at 360,671 contracts as of last night and the market settled at a record $1,785 an ounce.

How high can gold go? We don’t see indicators to suggest it can go higher. Over the last six sessions, the contract on the Comex for December has climbed more than 4%, ever since the Fed stated it will keep short-term interest rates at near zero through mid-2013.

Over the same six sessions the yield curve on U.S. Treasurys has flattened with the spread between two-year and five-year Treasuries narrowing by 8 bps and the spread between two-year and five-year Treasurys narrowing by 2 bps.

Intuitively, a narrowing in the spread between short and long rates implies lower short rates in the future, thereby suggesting prolonged weakness in the economy, hence the Fed’s decision to suppress the front of the yield curve… and the rush to own gold.

As illustrated in today’s issue of The Schork Report, there is a linear relationship between gold and oil prices, with a coefficient of determination of 70% since 1975. This relationship decoupled from linearity in the first half of 2008, i.e. when the oil bubbled ballooned above $110/b. The graph also highlights that the current relationship has broken down this month.

This begs the question, is gold overpriced or is crude oil undervalued? That is to ask, is gold going to correct lower relative to oil or is oil going to catch up to gold?

Bottom line, as far as we are concerned, it’s a coin-flip. That said, as written to clients in today’s issue of The Schork Report, while we are not comfortable shorting gold at this point, we don’t mind owning oil.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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