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Discussing the Gold to Oil Ratio
The other night when I was on with Kudlow and CO. Larry brought the Gold/Oil ratio up. I was still quite jet lagged form my trip to Dubai, so I had no sharp reply but I have some very strong feelings about it, especially with oil at $128! Watch the video and then read Charlie Nedoss and my explanation below the video.
To watch the Kudlow & Co Video Click on the Gold to Oil Ratio link.
Gold to Oil Ratio Video Click Here
Simply put it’s the amount of Crude that can be bought in terms of gold. In other words if you divide the prevailing price of gold into the current price of oil. (GOR).
Currently using June futures price this spread is running at historical lows- 6.89.
The relationship is important because oil is the world’s most important commodity, as all developing and undeveloped nations need it to function. (ie. transportation, manufacturing…)
Gold has always been the ultimate currency or form of money for hundred of years.
Therefore, I feel this relation is valid and one that should be monitored as we are comparing a widely followed commodity and a measure of currencies that is global.
The 38 year average of this spread is roughly 17.5 barrels of oil can be bought per ounce of gold. Again since gold is globally priced it eliminates currency disparities.
Both of these commodities have rallied in tandem. But in February the spread started soften and most recently is trading at historically low levels.
It must be noted that both of these commodities are dollar denominated so the effects of the dollar fluctuations should have the same impact on both. If you look at the chart below you will see that recent dollar strength has had a negative effect on the price of gold but crude oil has continued its ascend to new contract highs. Thus the GOR has been taken to abnormally low levels. (Blue=Gold Red=Crude Oil)
For this spread to revert back to the mean either crude oil has break relative to gold or gold has to rally relative to crude oil.
With increasing global demand and the U.S. not at the point of rationing demand by price then it appears the path of least resistance is for gold to rally to bring the spread back in line.
With this being an election year and the U.S. consumer being strapped with the highest debt load ever it is doubtful that rates will be raised going into November. (On a side note I believe rates need to move higher not lower to cure our economic ills but lets leave that for another discussion).
In summary, I believe the Gold – Oil ratio is undervalued and that Gold must rally relative to Crude in order to for this spread to come back to a more normal relationship. I feel this will be driven by continued dollar weakness and strong global demand for Crude Oil.
