Breakout

Commodity Chaos: How to Play Gold & Oil Now

Jeff Macke
Breakout

It's been a bumpy, generally negative, ride for commodities in 2011. This has been particularly true for crude oil and gold, both getting whipsawed by investor sentiment and wild shifts in mood regarding the global economy. Black gold is traditionally a proxy for global growth whereas gold is a place investors turn in times of economic strife.

With both gold and crude well off their highs, the question facing investors is whether buyers are getting a value or catching a falling knife.

WTI Crude peaked at about $114 in late April, before dropping to just over $75 earlier this month. Along the way black gold recorded its worst quarter in 3 years. What happened? Not shockingly, evidence points first to slowing growth, not just in the U.S. but China and emerging nations as well. Remember at the beginning of the year the pace of the economic recovery was in question. By summertime, the debate deepened into whether or not a global recession was unfolding. The price of crude oil behaved accordingly.

The "big elephant in the room" is the European nightmare, according to Ed Meir, senior commodity analyst at MF Global. Meir is in the camp that a European recession will take the world down with it. He says crude prices have been reduced to moving "lockstep" with EU debt crisis developments.

Of course, economic chaos is supposed to play into the hands of gold bugs who regard the barbaric metal as a safe harbor in crazy times. It's a thesis that has held strong when you look at the price of gold year-to-date, which has risen 16%. Latecomers to the gold party haven't been as lucky, at least since August. As equity prices crumbled in August gold ripped to $1,900 before dropping to current levels above $1,600 an ounce.

Meir has good news and bad news for the gold bugs. The bad news is he doesn't see solid support until the $1,500 area. He says the widely rumored forced selling in hedge funds facing redemptions, most notably those run by John Paulson, along with money coming out of the Gold ETF (GLD), Meir says gold is going to have a hard time making headway until the flood of supply dries up.

Now the good news; in the long run Meir still sees gold as cheap. And he believes almost any developments in Europe are bullish for the yellow metal. "A European resolution could drive gold higher," he says, citing the likely currency debasement which accompany a bailout.

"As long as we have this avalanche coming our way out of Europe and here in the States, the general theory is paper currencies are not going to hold up well in terms of purchasing power and people will be moving into things they understand, like gold," Meir says.

Add it up and you've got two basic choices: If you think global growth is going to kick into high gear, then buy some crude in size. If you're in the camp that there's no way out of the global economic nightmare which doesn't involve money printing and some degree of chaos, start loading up on gold if and when it hits $1,550, and go in whole hog at $1,500.

If there's a third option I'm all ears. Lay out your thesis in the comment section below.

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