The impressive (and anticipated) drop in oil came a week late and a dollar short. We were enjoying the prospect of taking 100 points plus $320 in premium out of our crude oil ratio spread. Instead, oil soared above our selected strikes and placed us short upon expiration. Unable to sustain the position, we were forced to cover before the correction. Once again, the axiom is proven, "Timing is everything!"

While it may have gone unnoticed, gold and crude oil appear to have reconciled since 2001 after a series of separations. Look at a weekly continuation chart for crude, gold, and the U.S. Dollar index. See how the patterns are a near perfect correlation over the last two years. Is gold emerging as a monetary measure, once again?

In prior reports, I emphasized that oil's price rise was associated with the dollar's deterioration because the world oil is still priced in dollars. It stands to reason that a commodity priced in dollars will, by definition, respond to changes in the dollar's relative value. The intriguing aspect of the 3-way relationship is the uncanny similarity between crude and gold beginning in 2002. As though a switch was suddenly thrown, oil appears to mirror gold in the post 9/11 era of global uncertainty.

In contrast, see how the Dollar Index was rising along with crude prior to 2002. This means oil was becoming fundamentally more valuable as both dollar parity and price complimented each other. At that time, gold was disassociated as it appropriately declined in response to a rising Dollar Index.

I am surprised gold advocates have not picked up on this development. The implications of a gold/oil correlation are significant when considering how the dollar has gyrated as much as 33% to the upside and 58% to the downside of the Euro. The market is suggesting the gold has become the standard against which the world's most valuable consumable is more precisely measured.

This brings us back to the logic that was debated during the last great gold rush--Actually, it was more of a silver rush with a golden kicker. The precious metals' "Go-Go" years from 1978 through 1980's first quarter resulted from the Hunt brothers' attempt to reintroduce silver as a monetary standard. As oilmen, the Hunts were closely involved with OPEC members. As the inflation of the 1970's took its toll upon the dollar's purchasing power, OPEC balked at the dollar/oil pricing mechanism. There was no Eurocurrency at that time and the yen had not established itself as a serious dollar contender. Having left the gold standard just four years earlier, the world was still feeling separation anxiety. The Hunts recognized the dollar's vulnerability and proposed using silver as a means for exchanging oil. At the very least, a basket of floating currencies was preferable to a sagging greenback.

Realizing the danger posed by a successful transition back to metallic-based monetary valuation, the U.S. authorities quickly intervened on several fronts that included restricting the Hunts' trading while impressing upon OPEC members that they needed to maintain a "friendly" relationship with the United States. As quickly as silver reached all-time record prices, it declined to interim lows. Some believe metals markets have never recovered.

When I wrote "The New Precious Metals Market" in the mid 1990's, I was attempting to justify trading silver and gold as commodities that had the special properties of monetary linkage. The book was released in 1998 and collected dust as the financial community continued ignoring silver and gold in favor of roaring stocks and bonds, not to mention real estate. Suddenly, there was a pop in sales when Berkshire Hathaway's Warren Buffet announced his interest in silver. As silver climbed above $7, investors pulled bags of silver coins and bullion out of the closet with the hope that they could finally achieve a return or, at least a breakeven on their inventories.

Boastfully, I must say that the book alerted readers that just such an event could and would take place. Drawing on the Hunt experience, it was clear that silver could regain public participation on the heels of a single renowned investor. But, the book warned that the party would likely be brief.

Although gold and silver were out of favor when I chose to write a "new" book on precious metals, I was concerned that the floating monetary system could encounter a confidence crisis. This was, or would be the type of development that could return the world to a metallic standard of monetary valuation.

I am the first to admit that I did not see a confidence crisis on the horizon. In fact, President Clinton was doing a very good job of instilling confidence in the system. Under his administration, the United States experienced an unprecedented period of high employment, high productivity, and low inflation. This seemingly contradictory economic phenomenon raised questions about fundamental economic theory that has gone unanswered to this day. Is there an absolute relationship between employment and inflation? Apparently not. However, the length of time we enjoyed the aberration was too brief to draw any long-term conclusion.

When gold broke out above $290 on its way to $300, sales of my book perked up. The royalties were sufficient for me to afford a New York City lunch for two without dessert and not including the tip. At $325 for gold and a commensurate move in silver, the dust was blown off the shelves and, to my amazement, The New Precious Metals Market had sold its way out of print. Needless to say, the Second Edition is in the works as I write and I have been forced to take a fresh new look at the postulating done in the First Edition. Are gold and silver just commodities as so many economists insist? Can we see monetary linkage so soon after gold was abandoned?

As seen by our prior options positions in the Euro, bonds, and notes, trading range conditions can yield nice profits when selling premium. The metals have been a bit tricky since the volatility has pushed both the calls and puts.

Adding insult to the approach is our ratio spread in October crude oil 50 and 51 calls and 45/44 puts. At the time, the 50/51 looked like it had the greater potential to yield $1 before expiration. Now, the 44 puts are in the money! We collected 70% from the calls and 40% from the puts. So far, we remain to the positive side with $2.10 collected and 75% in the money. Since anything can happen, prudence dictates taking the calls off the table.

Fundamentally, crude failed to positively respond to news that northern Iraqi pipelines were attacked yesterday. The consensus among oil traders is that damage was minimal. As U.S. and Iraqi forces gain momentum against the insurgents, threats of further sabotage are assumed diminished. I can't say I agree, but I called attention to the amount of crude in transit based upon August shipping schedules. I believe OPEC has significantly increased production and has sold forward.

The promise of "flat-out" pumping was made in late June. Assuming a six to eight week lag, this production should be inventory in September. The refiners know what to expect and are adjusting positions. There is a strong possibility speculators will get caught in the middle if huge quantities of crude start hitting U.S. ports.

August 30, 2004

Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey
201-784-1235

Presented by:
CONSENSUS, Inc.
P.O. Box 520526
Independence MO 64052-0526
816-373-3700
Fax: 816-373-3701
editor@consensus-inc.com
www.consensus-inc.com