Wednesday, August 13, 2008

Gold-Oil Price Linkage

John Tamny at Real Clear Markets examines the interesting relationship between the price of gold and petroleum. What is of interest to me is that the rise in prices in both commodities recently has been tied to a weak dollar. A strengthening dollar will go a long ways towards reducing the price of both commodities.

"Looked at over a longer timeframe, from 1970 to 1981 the price of gold rose 1,219 percent, versus a rise in the price of oil 1,291 percent. This wasn’t coincidental. With gold and oil both priced in dollars, and with gold serving as the best proxy for the latter’s value, a jump in the gold price neatly foretold the oil “shocks” of the 1970s that were merely dollar shocks.

Given the strong price correlations between the two commodities, many economic commentators wrote of the gold/oil relationship in terms of a 15/1 ounce/barrel ratio. As the late Warren Brookes wrote in his 1982 book, The Economy In Mind, “In 1970 an ounce of gold ($35) would buy 15 barrels OPEC oil ($2.30/bbl). In May 1981 an ounce of gold ($480) still bought 15 barrels of Saudi oil ($32/bbl)."

Another item of note is that when that 15/1 ratio gets out of whack, it's a good bet that the prices will eventually return around back to that ratio. The ratio was 7.3/1 yesterday, giving oil plenty of room the drop even further.


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