Why Gold & Oil Point to Higher Equities?

Both oil and gold are rebounding, but the metal’s three-month rally relative to energy has once again stalled at familiar levels (see chart below). This, according to recent history, has important market implications. The economic and technical rationale is outlined below.

Gold/Oil Ratio Implications for Equities
Declining Gold/Oil ratios have historically proven positive for global risk appetite, as the improvement in oil (usually reflecting increased global demand & economic growth) extends to the point of outperforming gold. The latter then begins to lose its relative luster as global conditions improve and bond yields stabilize/push higher.

Rising Gold/Oil ratios reflect the declining value of oil, resulting from weaker demand/global growth conditions. The weakness of this ratio does not address supply issues, but the historical correlation between G/O ratio with equities has proven robust especially during a decline in the ratio and a rise in equities.

Brent is used for the Gold/Oil ratio instead of US crude due to its wider usage and not constrained by supply overhang issues in the continental US.

Ashraf Laidi Blog

Since April 2009, each time the Gold/Brent ratio neared 17.0, equities stabilized before pushing higher. The latest decline in the G/B ratio off the 17.00 level (now at 16.10) is so far well accompanied by three-day rally in equities, which is likely to find its way towards 1388 and 5720 in the S&P500 and FTSE-100 respectively.

The currency implications of the above dynamics support our ongoing stance of “temporary stability” in EUR/USD, which we expect to remain in a consolidation, supported at $1.2440s and capped at $1.2820s. Today’s euro bounce to $1.2610 is expected to accumulate fresh ground, reaching $1.2670, followed by $1.2720s. More risk-on for now is likely to help Aussie (after RBA’s decision to hold rates) and CAD (on the much needed bounce in oil and improved GDP figures). Our yen-negative stance should be supported by this scenario, with the deepening fracture inside the Japan’s ruling DPJ party further helping yen crosses.

Further accommodation from the European Central bank this Thursday in the way of an interest rate cut and/or an announcement to increase quantitative easing by the Bank of England on the same day are all examples of market-friendly events, propping equities and favouring oil relative to gold. $91 in US crude and $105 in Brent are the preliminary levels in each.

Ashraf Laidi
Chief Global Strategist, 03/07/2012 (4:20pm)

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The Art&Science of Trading Gold
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