Gold and Oil: A Misunderstood Alliance

Sunday, 30 September 2012
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Published in From The CEO

In some investor circles it’s been an article of faith that there’s some magic relationship between gold and oil.  Many have felt if one of these hot commodities starts a ride up in price, we should look to the other for an equivalent bump.  And the reverse has been held to be true also. If one of these commodities slides in price, we should look to the other for an equivalent ride down.

This relationship is most often explained as being represented by a ratio.  And the magic number most often put forth for the ratio is 14.  So when the price of gold is $1,774 per ounce and the price of crude oil is $126.71 per barrel, all is supposed to be right with the world.   Accordingly, as soon as gold reaches $2,000 per ounce, we should look for forward to the world price for crude oil price to reach $142.86 per barrel. 

Positive-Pullback

Given this argument, we’re hard put to tell the horse from the cart.  Does the gold price pull the oil price along with it?  Or does the price of oil drive the price of gold?  And does it also mean that every time it makes sense to invest in gold, we should also feel comfortable investing in oil – and vice versa?

Life isn’t that simple – at least not in the world of money.  While today’s price of gold is, in fact, $1,774, the price of crude oil today is $92.21.  You can forget about the 14 to 1 ratio.  The ratio, based on today’s prices works out to slightly more than 19 to 1.  I wouldn’t look for a correction in that ratio anytime soon.  The gold market and the oil market are being fueled by different forces.

As we’ve pointed out many times in the Investor’s Corner, gold is now being driven by wide-scale quantitative easing.  Our Fed is pumping $45 billion into the economy until some unspecified time in the future.  And Europe, China and Japan have followed suit with their own aggressive programs.    While you could argue that both gold and oil are responding to inflation, the move up in the gold price is principally dollar driven, whereas the move up in oil is a classic supply-and-demand scenario.  One that’s about to end soon.

In a recent article at thebulliondesk.com, financial historian Christopher W. Mayer argues that the bull market in oil is on its last legs.  The largest economies in the world, the U.S., China and Japan are all contracting.  Regardless of this contraction, the price of gold continues to increase because of currency debasement.  But as economies contract, the price of oil will go down as the need for oil decreases.  Mayer also points to new rich new sources of supply in Alberta oil Sands, West Africa, Brazil and Bazhevnov Shale in Russia.

One should not inflexibly invoke a gold/oil ratio to blind oneself to the differences between investing in oil and investing in gold.  Besides, here at the Investor’s Corner, we’ve always recommended investing in the physical metal.  Investing in oil doesn’t lend itself to actual physical possession.  If you keep your eye on the fundamentals driving gold and don’t worry about what oil does, you’ll be invested safely and profitably for years to come.

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Trevor Gerszt

Trevor Gerszt has been passionate about gold since childhood. Growing up in South Africa, the world’s second largest gold producer, Gerszt spent his youth collecting gold coins. Surrounded by a family of experienced coin collectors, he gained valuable insight about the precious metal.

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