At DailyWealth, we think gold at $570 is still cheap in the long run.

We’re not so sure about oil…

Oil has had a tremendous run, rising 225% in the last four years. Compared to gold’s 120% rise in the same time period, oil has become expensive in terms of how many barrels of oil it takes to takes to buy an ounce of gold.

As you can see from our chart of the gold/oil ratio, the relationship between gold and oil is at an extreme for its entire history. Now, it only takes about eight and three-quarters barrels of oil to buy one ounce of gold, versus a historical median of about 14. (In the nineties, it took 15 – 20 barrels of oil to buy one ounce of gold.)

The most amazing part is, every time in history that this ratio dipped below 10, you would have made money buying gold and shorting oil. Gold’s outperformance in relation to oil once we reach these extremes has always been stunning… either oil crashes or gold soars.

The same happens at the opposite extreme as well... When an ounce of gold “costs” more than 18 barrels of oil to buy, gold then turns into a horrible underperformer.

So what can you do with this knowledge?

The most direct trade is to head for the commodities exchanges and go “short oil, long gold.”

That might work… but it might not, as sometimes it takes a while for the ratio to come back in line. You could get burned in commodities by trying to hang onto this trade.

Another option is to simply buy shares in just one company…

A large gold miner like Newmont (NEM) or Goldcorp (GG) gives the investor an easy way to make a short oil/long gold trade.

Since fuel and energy costs make up such a large portion of a gold miner's extraction costs (around 20%), a year of falling oil prices and rising gold prices would mean much higher profits for these companies.

Owning a mining company like Newmont gives you a way to profit from what could be a big year for gold in 2006. This trade also gives you “wealth insurance,” as gold is a good hedge against war, terrorist attacks, and natural disasters.

So if gold goes up, you make money in gold stocks. If gold is flat, but oil goes down, you make money in gold stocks. And if gold goes down, but oil goes down a lot more, you can still make money in gold stocks.

The way you can lose on this trade is if oil soars and gold falls.

That’s a bet we’re willing to take.

Good investing,

Steve

© 2006 Dr. Steve Sjuggerud
Editorial Archive

Note: Delivered to your inbox every morning, Dr. Sjuggerud and his DailyWealth staff will show you safe alternatives to the risky investments pitched by the mainstream press and the financial community; and bring you the absolute safest ways to make outstanding investments. Sign up now for Dr. Steve Sjuggerud's FREE daily e-letter, DailyWealth... http://www.dailywealth.com/signupX.html

www.dailywealth.com