HardAssetsInvestor

Written by Brad Zigler  |

December 14, 2009

What's The Gold/Oil Ratio Telling Us?

Details

Can the relationship between gold and oil, two traditional bellwethers of inflation, give us any clues about our future economic prospects?

• What drives the gold/oil ratio?
• The influence of retail vs. institutional investors
• Are we heading back to normal?

 

Just as sailors and aviators rely upon thermometers, barometers and other gauges to plot their courses, investors use indicators of their own to map the economic landscape, among them the gold/oil ratio.

When taken separately, oil and gold can tip you to certain goings-on in the economy: Oil tends to become more expensive when gross domestic product is on the rise, and gold turns bullish when the greenback falters.

But what about gold's relationship to oil? Can the interplay between the two commodities—expressed in the gold/oil ratio—tell us anything about our current economic prospects?

 

The Gold/Oil Ratio Defined

To get to an answer, we first have to better define the question. First of all, just what is the gold/oil ratio?

Expressed mathematically as the per-ounce price of gold divided by the cost of a barrel of crude oil, the ratio tells you how many barrels of oil can be bought with an ounce of gold.

Even though oil and gold are thought to be bellwethers of inflation, their price movements aren't in lockstep. Since the 2001 launch of the current bull cycle, the correlation between U.S. benchmark West Texas Intermediate (WTI) crude oil and the London morning gold fix is only 23 percent. In fact, it's the lack of a tight correlation that makes the gold/oil ratio meaningful.

 

Gold Vs. Oil

 

The ratio can vary widely over time; since 2001, one ounce of gold could have bought between 6 and 24 barrels of oil. In midyear 2008, as oil prices surged, gold scraped a historic low at a 6x multiple (a 6-to-1 ratio). A half year later, the ratio had rocketed to the 24x level after massive deleveraging sent oil prices down $100 a barrel.

Over the longer term—say, the past four decades—the average multiple has been 15x. Keep that figure in mind. We'll come back to it later.

 

Disparate Messages

With a little bit of hindsight, we may be able to parse a rationale for such dramatic shifts in the ratio, which in turn may help us determine if the ratio is in any way useful as an economic indicator. Given the fact that the gold/oil ratio just crossed above its 200-day moving average for the first time since mid-2008, this is a very timely consideration. Gold is rapidly becoming more "expensive," while oil is, relatively speaking, cheapening.

 

Gold/Oil Ratio