Summary Rising real yields will push both gold and oil down which trumps supply and demand for oil. Fed balance sheet reduction will continue to drive real yields higher. The same balance sheet reduction and Fed inflation focus will cool inflation. Oil faces a further recession and demand risk and gold faces lower inflation risk.

Oil and gold must both move inversely to the real yield (Treasury inflation-protected securities or TIPS are a good indicator) for reasons I explain more fully in this Seeking Alpha post which summarizes the theory behind the valuation approach. The main current determinant of the real yield, which should match real long-term per capita GDP growth, is the degree of excess financial capital made available by the Fed. Chart 1 shows how Fed-created excess capital crushed the real yield and bond yields in general - too much capital cannot earn the same real return.

Chart 1: (Author using St. Louis Fed data) Fed Balance Sheet (Money Creation) vs TIPS Yield


Chart 2 shows a nearly 20-year pricing model for oil. In simple form, the model I use to value oil takes the resulting yield created from the formula: [(expected inflation + expected real long-term per capita productivity growth)/(1 - the expected effective tax rate on tax-deferred investment accounts)] - TIP 5-Year (real) yield. The real yield is subtracted, which if negative, adds to the yield in the formula. Thus, oil is expected to move up with an increasingly negative real yield; and down with a rising real yield and expected inflation. Expected real per-capita GDP growth is just above 1% and can be derived from forecasts on the Conference Board web site.

Chart 2: (Author) Predicted vs Actual USD$ WTC Oil Price

Oil is of course also a global commodity, and a flow rather than a stock, which gold is for example. As a global commodity, it is influenced by supply/demand fluctuations, political...

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