Rooting for higher oil prices

The price of oil has sunk even as gold edges higher. That shows fear about the an eventual boost in crude prices might signal a return to health.

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By Paul R. La Monica, editor at large

How effective do you think the Geithner plan to spur lending will be?
  • It's enough to do the job
  • It's a start, but more aid will be needed
  • It won't work

NEW YORK ( -- Gold is getting close to $1000 an ounce again even as oil prices continue to fall.

Plunging oil prices are not really good news. So as heretical as this may sound, it might actually be time to start rooting for oil prices to head higher again.

At first blush, the fact that gold is up and oil is down may seem strange.

After all, gold is often viewed as a classic hedge against inflation, with prices rising along with interest rates. That's not happening now.

The Fed has rates near zero. The yield on the 10-year Treasury is below 3%, a historically low level. And if you look at what's going on with the price of homes, stocks and commodities such as oil, it's clear that more investors are worried about deflation than inflation.

In fact, the ratio of gold to oil prices is now above 25, a 10-year high and a reflection of how far oil prices have fallen in the past few months. What's remarkable about this is that this very same ratio was at an all-time low as recently as July when crude prices spiked above $140 a barrel.

So what's this mean? Unfortunately, it may be a sign that investors still think the global economy is going to remain in this recession for a while. Here's why.

The main reason that the gold/oil ratio was so low in July was not because of cheap gold, but expensive oil. That sparked inflation fears that no longer exist.

Now, with oil trading around 75% below its peak and gold up slightly during the same time frame, some think that the high gold/oil ratio shows two worrisome trends: demand for oil has fallen sharply due to the sharp worldwide economic downturn and investors are seeking safety in gold as a result of said downturn.

"Gold is moving on fear and fear alone. People are not comfortable with their money anywhere else," said David Beahm, vice president of economic research with Blanchard & Company Inc, a New Orleans-based investing firm that specializes in tangible assets like gold and other precious metals.

"Global demand for oil is down and that's usually a signal for gold prices to follow suit. But people want an asset they can hold and know it's still going to be there," Beahm added.

So how out of whack are gold prices compared to oil right now?

Ashraf Laidi, chief market strategist for CMC Markets, a currency and commodities brokerage firm based in London, wrote in a report to clients Thursday that on average, the price of gold has historically been about 15 times higher than oil.

He argues that a pullback in the ratio by about 20% to 25%, or to a range in the upper teens to low 20s, would be an encouraging sign since past declines in the gold/oil ratio "generally coincided with stabilization in the US economy as demand for the fuel reflected improved growth."

But how likely is that to happen? Beahm believes that the ratio will eventually return to more normal levels, largely because of an increase in oil prices. And if that happens, it could be good news if it is truly driven by increased consumption of oil.

However, he thinks that both gold and oil could rise -- for reasons that we should not cheer.

Beahm points out that even though deflation is still clearly a near-term concern, some investors are beginning to fret about the prospects of inflation down the road since the government will be spending a lot on the new bank bailout plan unveiled by Treasury Secretary Tim Geithner this week as well as the economic stimulus bill currently before Congress.

So he envisions a scenario where gold could rise to $1200 and oil could simply catch up and pop back up to $80, which would put the gold/oil ratio at a more normal level of 15, solely due to worries about government spending, not a global recovery.

"Right now, people are looking down the road and realize that the stimulus package along with Geithner's plan means turning the printing presses on. So gold and oil will head higher eventually because of that alone, regardless of demand," he said.

Dan Pickering, co-president of Tudor, Pickering, Holt & Co., a Houston-based investment bank focused on the energy sector, agreed that an increase in oil prices may be an omen of inflation down the road.

But he doubted that a rise in energy prices could take place without an accompanying surge in demand. In other words, if oil finally stops falling anytime soon, that is good news for the economy.

"There is no question that there is an effort to put a huge amount of liquidity into the system and eventually that will be inflationary," Pickering said. "But in the short-term, oil is more tied to an economic recovery than inflation. I'd be worried about the inflation element of oil two to three years down the road, not two to three months."

Update: There have been some interesting developments in stories I've written about in the past week that are worth pointing out.

The Ticketmaster (TKTM)-Live Nation (LYV) merger is now official. And as I predicted, Congress is not happy with it. Expect a tough antitrust review. And check in with Friday for a video edition of The Buzz where you weigh in with your thoughts on the deal.

Sirius XM (SIRI) may be seeking a white knight after all. According to reports, the satellite radio company is seeking an investment from Liberty Media (LINTA), the firm controlled by media mogul John Malone that also has a major stake in DirecTV (DTV, Fortune 500).

Still, as I said Wednesday, I don't think Sirius CEO Mel Karmazin will be too eager to jump into bed with Malone even if it means keeping Sirius from the clutches of DirecTV rival Dish Network (DISH, Fortune 500). So I remain skeptical that Sirius will find a savior.

Finally, several readers pointed out that in Tuesday's column about banks not on the government dole, I neglected to mention other banks that have shunned TARP. The main reason for that is because I was looking only at banks whose stock prices are up in the past six admittedly tiny universe.

Several other publicly traded banks that have avoided taking taxpayer money and who readers believe are deserving of praise are Cullen/Frost Bankers (CFR), UMB Financial (UMBF), Commerce Bancshares (CBSH) and NewAlliance Bancshares (NAL).  To top of page

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