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Attention Gold Bulls: Oil Is Leading the Way

Stocks in this article: GLD USO UNG

The direct relationship with energy and commodity prices comes from almost every product having a large energy cost component. The easiest relationship example is at the fuel pump with gas and diesel. The cost of oil has a very high correlation to the price of gas we put in our vehicles.

As the price of diesel falls, the cost of shipping, trucking and rail also falls. Lower transportation costs of products we buy, regardless if through mail order or off the shelf, result in lower sticker prices. Lower sales prices are by definition, deflationary. The same holds true for production costs of almost everything.

Plastics come to mind quickly; however, don't forget that fertilizer, medicine, tires, roofing, shampoo, dentures, artificial turf, soft contact lenses, lipstick, DVDs, toothpaste, pillows and even the monitor you're using to read this article is made with petroleum. All of it is dropping in price as oil moves lower. Inflation is not leaving today or tomorrow; inflation took an early flight out yesterday and is nowhere to be found.

How can we be sure inflation won't decide to come back next week? No one can know for sure; however, we can look at facts to draw a logical conclusion.

In the hoopla of Facebook's xanadu IPO, you may have missed a significant change between Alaska and North Dakota this week. North Dakota pushed Alaska's ranking down to become the No. 2 oil-producing state. What makes this statistic particularly interesting is that North Dakota is only at the beginning of its potential production capacity.

The more capacity and transportation become available, the less oil will cost. The best is yet to come though, because as domestic sources increase in proportion of total needs, the less supply-risk premium is added. Taking on the risk of a problem in North Dakota is a whole lot cheaper than taking on the risk of a Middle East problem.

Natural Gas

Oil has greater competition than ever before in North America. Take a look at natural gas prices through the US Natural Gas ETF (UNG). Last year around this time, UNG traded for more than double the current price. Natural gas prices are so low that trucks consuming natural gas instead of diesel are increasingly common. The low natural gas prices are lowering E&P, effectively putting the market on notice that prices are expected to remain relatively low indefinitely.

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