Is there a relationship between how much gold is worth and the price of oil?
Some say there is and that it is linear…i.e. when the price of oil increases, so does the price of gold. One justification is that rising oil prices place upward pressure on inflation thereby stimulating how much gold is worth since a part of gold’s appeal is as a hedge against inflation.
Let’s start by looking at the historical price of oil over the last 40 odd years.
The Yom Kippur conflict of 1973 and subsequent Arab oil embargo resulted in a jump in the oil price from under $5 a barrel to over $10 which ever since then has been the floor in this market.
Just as markets were getting used to this doubling in price, 1979, the year after the Iranian Revolution saw another surge which pushed the price to $40 a barrel causing shockwaves around the world.
It was not until a substantial increase in production by Saudi Arabia during the mid-eighties that prices eased back to $10 a barrel and subsequently traded in the $10 to $30 range until the millenium after which the oil price has been constantly rising and even reaching over $100.
Now if there exists a relationship between the price of gold and the price of oil, then one would expect to see similar movements in the gold price during this period.
In the simplistic case where an increase in the price of oil leads to a similar increase in the price of gold, a graph mapping the ratio between the two should result in a line of approximately constant value.
Gold-Oil Ratio = Price of Gold (per oz.) / Price of Crude Oil (per barrel)
This gold/ oil graph results in a ratio that varies between a value of 10 and 30. This means that at times the price of gold is worth 30 times that of oil and at others, it is worth only 10 times as much.
This is hardly a straight line indicating that a strong relationship does not exist between the two. However, clearly some kind of elastic band is keeping the two together ensuring that they do not stray outside of these values for too long.
This gold/oil ratio is more useful to economists to identify at a high level when gold is generally over-bought or over-sold. For example, it the indicator hits 30, you know that gold is overvalued and a price correction may be on the cards. (On the other hand, oil may be undervalued and a price surge may be imminent…don’t you just love the free hand of the markets.)
So in conclusion, this brief analysis shows that oil and gold are tied to each other to some extent. This should not come as a surprise as they are both commodities that are of great importance to the global economy.
After all, oil is the ‘black gold’.
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