Oil to Gold Ratio & the Fuel-Food Folly
Sol Palha, May 12th, 2008
Oil to Gold Ratio and the Folly of creating fuel from Food
There are four types of men in this world: 1. The man who knows, and knows that he knows; he is wise, so consult him. 2. The man who knows, but doesn't know that he knows; help him not forget what he knows. 3. The man who knows not, and knows that he knows not; teach him. 4. Finally, there is the man who knows not but pretends that he knows; he is a fool, so avoid him.
Ibn Gabirol
In October 2007 we stated that the oil to gold ratio had moved from favouring oil to favouring gold but we also stated that we thought it was far better to invest in silver as the returns would be far superior.
When the article was published Silver was trading in the 13.30-14.00 ranges. It recently traded as high as 20.80 before pulling back. Thus from low to high Silver gained over 52% in a relatively short span of time. In the same period Oil went on to gain roughly 40%; from a low of 88 to recent high of126%. Clearly Silver proved to be the better trade. Prior to this in Feb 2007 we stated that oil would make for a better investment than Gold and once again this proved to be true.
Now it appears that this ratio is once again pointing in favour of gold and once again we would favour silver over gold as we think on a percentage basis the gains here will be far larger than those of Gold. Note that this does not mean that the Gold and Silver markets are going to take off immediately however it does suggest that investing in silver could produce more gains than investing in crude oil. Adding fuel to this argument is the recent behaviour of the Dow transports; in light of record high oil prices they were able to trade all the way to 5385 before pulling back; a mere 102 points away from the all time high of 5487. It appears that they must be sensing lower oil prices; do not confuse lower with extremely low oil prices as we are talking more along the lines of a correction than a crash. Right now if oil had to pull back to say the 90-99 ranges everyone would breathe a sigh of relief even though a few months ago such prices were considered exorbitantly high.
As it has broken through the zone of support provide by the 7.5 price point level it will most likely test the lower end of the channel formation. If it should trade all the way down to the 6- 6.5 ranges Silver would make for an even better buy. As always do not ever overload into any investment no matter how good it looks; to do so is to go against all known rules of money management and those that do usually end up in the dog house.
Random musings
The Folly of creating fuel from food, power outages and more
The sad part about trying to create fuel from food is that it unfairly drives the prices of all food crops higher; farmers abandon planting regular crops in favour of the ones that are paying the most. In doing so it drives the prices of other food crops higher as less land is now allocated to them than say 2-4 years ago. In this case the culprit is Corn and so now we have a huge swath of farmers planting corn and planting fewer soybeans, cotton, Rice, etc. In addition instead of planting corn for one season and another crop the next to give the land a chance to recover, they constantly keep planting corn. In order to do this they have to use huge amounts of fertilisers; as corn does not utilise fertilisers efficiently a significant portion drains of into rivers and oceans and promoting the growth of algae which sucks the oxygen out of the water and creates massive dead zones where all life ceases to exist.
Imagine some disaster should strike such as massive series of droughts or extra heavy rainfall, and then we will have even less rice, wheat, soybean etc because reserves were low to begin with. We already experienced a huge spike in the price of wheat because the terrible drought in Australia badly affected its wheat production. Now it is stated that a significant portion of Myanmar's rice crop has been destroyed due to the recent cyclone. If such an event had to occur in one of the Major producing rice countries such as Thailand or India the situation could spiral out of control and a significant portion of the worlds poor would suddenly find it almost impossible to feed themselves.
Now with the over planting of corn the situation is going from bad to worse. While some of the higher prices in the agricultural sector is due to the effects of inflation a lot of it has to do with simple demand and supply; demand right now is outstripping supply and as more individuals in Asia move into a position where they can afford to eat better, the demand for these bare necessities is going to keep increasing. However the main culprit is still the bio fuel sector as they are placing higher strain on the price of other products by using huge swaths of corn to produce ethanol. For the first time in decades or maybe ever many nations are imposing export restrictions; they are restricting the export of key food items as they want to make sure they have enough to feed their people. No government can stay in power when the masses are hungry and they know it so they will do whatever it takes to make sure that their people have enough to eat. This in turn is going to have an even larger impact on food prices. We have disaster after disaster waiting to hit. A partial list of disasters just waiting to happen:
1) Food prices spiking to insane levels making the once affordable bare necessities luxuries in most countries and a burden in so called developed nations. Already some families in America have to choose between buying petrol and or eating.
2) A water disaster; huge amounts of water are being used in mining production and or being polluted due to massive industrial expansion or over farming. There is already a critical shortage of clean water on a global basis and mankind's current stupidity is going to make the situation even worse.
3) A global power shortage. Very few nations have prepared themselves to generate a significant amount of power from oil, coal or natural gas, Nuclear energy and as such an ill prepared for huge spikes in demand due to an increase in mining and or massive industrial expansion. One only needs to look at South Africa to see this disaster in action.
As a result of increasing power generation issues we might not witness a strong correction in the base metal sector or precious metal sector simply because supplies are going to start dwindling instead of increasing just when the opposite should be occurring.
The Wall Street Journal recently stated that over 35 countries in Africa are suffering from electricity shortages and the situation looks like its going to get worse. Many of these countries economies depend on mining and should these mines shut down or significantly scale back their operations prices of base metals; precious metals etc are going race upwards even faster. In Port Harcourt, Nigeria, residents enraged at paying for almost non existent electricity chased away the power companies' bill collectors with machetes. The situation is so bad in South Africa that Eskom the main power provider in South Africa asked the government to raise rates by 50% in order to curb demand. South Africa also supplies electricity to Zambia a huge producer of copper and Botswana (diamond producer). Due to recent power outages it has cut supplies to these two nations and these power cuts have affected the mining operations in both these countries. In Jan because of the severe power outages Zambia's largest mining operation had to completely suspend operations. Note to that China is suffering from power issues as is India. It seems the next to feel the pain will be many mining nations in South America which like their peers have failed to plan for the future when it comes to power. The potential for huge spikes is real as mining operations are very power intensive and if there is not enough power then these operations have to be shut down or significantly scale down. Normally this would not be a huge factor but with the stupendous growth that is taking place in Asia these power outages are only going to make things worse as the demand for these base metals is not going to ease anytime soon.
