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Would The End of Lockdowns Cause a Mean Reversion to The Historic Ratios?

Peter Hemple uses the asset price historic ratios as an indicator of what to expect in 2021

It is fair to say that 2020 was a year that none of us will ever forget. While we keep our fingers crossed that 2021 will not be so disruptive to our social lives, our work lives and of course the economy, in this article we will once again take our annual step back and look at what has happened to the five major asset prices (the FTSE 100, gold, Brent crude oil, UK property and London property) over the past 12 months and what the historic ratios indicate might happen this year.

After a long, multi-year run of successfully predicting which direction these asset prices will move, 2020 was, perhaps unsurprisingly, the first year that they did not prove to be a reliable indicator.
If you have not read any of my annual articles on historic ratios before, the formula is relatively simple. I take the price of each asset at the end of every year for the previous 20-year period. This gives me an average price over the past two decades, which allows me to then calculate the average ratio between two assets, like gold compared to oil, or UK property prices compared to the FTSE 100 etc.

Once all of the ratios have been calculated I then take the most recent end of year price to give a solid indicator of what each asset price should be, when compared against the other four assets. This allows me to make an estimate for the coming year, with regards to which asset prices should rise and which should fall. So how did my estimates pan-out in 2020?

Oil moved in the wrong direction
At the start of 2020, the price of a barrel of Brent crude oil was around $66 and the ratios suggested that it should be almost $83. However, nothing can send the price of oil crashing quite like the complete shutdown of most major economies, the grounding of thousands of airplanes and more than a billion cars not being used every day to commute to work.

At the start of 2021, the price of a barrel of Brent crude oil was around $52 but that only tells half the story, as it actually crashed all the way down to less than $19 per barrel in April 2020 and if anyone was tracking the ‘live’ historic ratios at that time, they would have seen what an incredible buying opportunity oil was at that price. Had they bought oil at $19 per barrel, they would have made a 200% unleveraged return in just nine months (the price exceeded $57 in January 2021). The famous Warren Buffet quote of ‘buy when others are fearful’ has never been so poignant.

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