History says oil is cheap versus stocks and gold

If you’re just analyzing the action in stocks or gold (GLD) or oil (OIL), you’re only seeing a piece of the picture. Pros also look at their relationship to one another to glean broader insights on the markets.

“Long term ratios of different asset classes offer a broad picture of relative value,” said Convergex chief market strategist Nicholas Colas. And understanding the ratios can help investors position ahead of a big move.

For example, look at the ratio of gold versus the S&P 500 (^GSPC). “As much as people might like to think stocks are overvalued and gold is cheap, over the past 30 years, on average it’s taken 1.7 ounces of gold to buy one unit of S&P 500. The ratio is currently 1.8 times. We’re right there,” Colas notes.

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However, looking at oil, the ratio is out of whack. “Historically it’s taken 28 barrels of oil to buy one unit of the S&P 500. Currently it takes 39 barrels of crude.”

Colas said the takeaway can be one of two things. Either oil is properly valued and stocks and gold are too high, or, oil has simply become too cheap.

“It’s entirely possible that oil could be the real barometer,” Colas said, “however, if that’s not the case and gold and stocks are accurately valued then oil should ultimately trade higher,” with the ratio returning to about 28 barrels of crude buying one unit of the S&P.

According to Colas the ratio will normalize around $72-$74 a barrel.

Although this kind of analysis doesn’t inform short term traders, “if you’ve got a five to ten year horizon, the takeaway is that oil is very cheap,” he said. If you believe the global economy isn’t in free-fall, “you might want to start building a position here,” Colas said. “History does repeat itself.” Nice and tidy.

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