The Gold to Oil Ratio Does Matter 24 comments
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Seasonally, oil (USO) is extremely weak from October through December. In 2008 oil started October at about $100 and ended December around $40 or around a monstrous 60% decline. Oil is strongest seasonally from July through September with the strongest individual months being January and August. Oil’s 200dma sits right around $100, appears to have hit around its bottom and the 200dma is exerting a gravitational like effect pulling oil prices up.
By contrast gold’s 200dma is at about $860 per ounce. Gold (GLD) has recently passed through its strongest seasonal period from September to December. It maintains the uptrend from January to March, is asleep the rest of the year except for a strong rally in May. While seasonality is helpful, it does not etch the future in bullion and this year has been different.
The recent financial turmoil has caused tremendous technical damage to gold almost as if it was done intentionally to stunt its bull market during all of the financial carnage. GATA asserts that when the news is really bad gold goes down. Well, the last half of 2008, when gold should have performed well seasonally, it swooned from over $1,000 per ounce to the $680’s while Lehman Brothers (LEHMQ.PK) evaporated, Fannie (FNM) and Freddie (FRE) were nationalized and bailouts were served every night on the news. Such suppression has only wound the spring that much tighter.
It is important to keep in mind that both of these commodities are still in strong secular bull markets. The FRN$ is in a strong secular bear market as is the DOW and real estate. The Gold/Oil ratio is now about 23 barrels of oil per ounce of gold. The 200dma is about 9.5 and the historic average is around 15.
The extremes happened in 1974, 1986 and 1988 as the ratio approached 30 and 1977, 2001, 2008 at about 8 and 2006 at around 6. For these relative prices to return to more normal ratios something is going to give. Oil is either going to go up, gold is going to go down or to move into some sneaky calculus the rate of oil’s rise will be faster than gold’s. The silver (SLV) to oil ratio is not nearly as extreme as gold to oil but silver will most likely follow gold, either up or down, at a faster rate of change.
This is where geo-politics arrives. Are the oil producers willing to take so little value in exchange for their precious black gold? With Peak Oil (mp3) asserting itself the oil producers should hold the bargaining power. The latest IEA numbers indicate an extremely serious steeper than expected 9.1% decline rate. Yes, the Canadian Oil Trusts will rise in value as a safe, secure and stable source of oil. But perhaps the oil exporters should sit on their oil and let the importers roil and writhe in pain as E. M. Forster’s 1909 essay The Machine Stops is played out. After all, a barrel in the future will be worth more than a barrel today. Obviously, the collapse will not be televised.
At all times and in all circumstances gold remains money. It is the most powerful currency in the world. Oil is the world’s primary energy source which is why the gold to oil ratio is important. Gold is the most effective tool humans have to perform mental calculations of value. By analogy it is the tool used to determine how many calories an apple provides and how many calories it takes to collect and process the apple so it can be eaten.
Producing gold is essentially converting energy into bullion. How many calories go into producing a one ounce gold coin? In some cases to produce a single ounce hundreds of tons of rock are moved. Ultimately, money is about energy. To make it personal, how much value should you put on that nice steak dinner, bottle of water from Fiji or 3,000 mile Ceaser salad? Well, think through the supply chain and how much energy the good or service represents.
The world has a very serious problem. Because it has used a fiat currency with no definition or basis in reality for nearly 100 years and because oil production was constantly increasing during that time the effects of unwise capital investment were masked. Energy Return On Energy Invested (EROEI) calculations were not even performed. A fiat currency attempts to sustain the unsustainable while a commodity-based currency employs the strict laws of reality to ensure the unsustainable is not encouraged.
In other words, no one knew or calculated either how many calories the apple supplied or how many calories it took to procure and process the apple. The entire infrastructure of the entire world was built using mental calculations of value based on a derivative illusion. As natural and economic law assert reality and gold begins circulating as currency in ordinary daily transactions the distortions will be removed and the gross misallocations of capital will be revealed. I wonder what such a world will look like? Will The Machine Stop?
Disclosures: Long physical gold and no position in GLD, SLV or USO.
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This article has 24 comments:
stays strong and assets trend sideways or weaker, then gold and metals
have to fight the tides to move higher, correct?
If oil prices remain low, then the signal I get is the world economies are also
weak. Gold has other factors but I stick to the theory of low oil = flat gold
or strong dollar = flat gold.Opinions welcome.
I am less trilled about gold as that currency though, for the reason that it has no utilitarian uses.
Makes me wish I was a goldbug,starting 3 yrs ago...would have done a lot better than I did chasing equities...
(Actually, gold has a few, minor mundane uses: in electronics and (increasingly) in medicine.)
"I am less trilled about gold as that currency though, for the reason that it has no utilitarian uses."
That's precisely WHY gold needs be "that currency"; it has the fewest "distractions" in the form of other, i.e. utilitarian uses.
I am in the pawn shop business and deal mostly in gold.
Trace: why does the gold to oil ratio matter?
The only way any ratio has significance is if it is fixed or reverts to it if it becomes temporarily skewed. This particular ratio has been all over the map. IMO
low oil = flat gold
De-leveraging = flat gold
I believe the de-levering is what is primarily causing flat gold prices. I know GATA assumes a position of government intervention. I assume they do induce some degree of control, however i do not believe it's as strong and widespread as they say. It is China's interest to also maintain gold prices as low as possible, obtain the 4000 tons at a minimum price.
However we also forget, the world is now 3 billion more individuals larger for gold.
The only question i have is with deflation rampaging thru the world, would this not also tend to maintain gold at a stable price in the short run (3 to 4 years)?
Gold:oil ratio is certainly more significant than the gold:silver ratio because each is representative of something critical that's hard to come by..gold being the ONLY real substitute for paper money..and oil being very sensitive to the value of its currency peg (largely US$) and a diminishing critical resource.
Gold is telling us very clearly that in spite of the deflationist nonsense credit creation on a huge scale is lurking ahead, in virtually all paper currencies. That means catch up for oil...at the prices today for all grades of oil there is little incentive to maximize current production..and NONE to develop future production. Producers will cut internal subsidies and budgets and bide their time....because as the great philosopher Mick Jagger once said.."time is on my side."
On Dec 30 02:17 PM bricki wrote:
> A commodity based currency is a good idea. The Sumerians based theirs
> on a fixed weight of barley, the shekel.
>
> I am less trilled about gold as that currency though, for the reason
> that it has no utilitarian uses.
>
>
>
Interestingly, back in 1964, a gallon of gas was around a quarter (of a US dollar).
If you have a 1964 quarter, you can still buy roughly a gallon of gas with it. That's because quarters previous to 1965 are 90% silver.
On Dec 30 04:51 PM aitvaras wrote:
> Trace: why does the gold to oil ratio matter?
I assume you read the NCDEX article I quoted so for others. "India is already a large gold importer at about 600-800 tons or approximately 25% of worldwide production. India also imports about 3,000-4,000 tons of silver per year with demand mainly among the poor rural farmers."
Many people bringing in their golden trinkets to get cash and pay their debts or buy gas?
On Dec 30 04:40 PM fatcat wrote:
> Trace,thanks for your reply...I was referring to N.American demand,but
> my understanding is that Indian demand is down as well,due to price,but
> since I don't conduct business in India,I could be wrong.
>
> I am in the pawn shop business and deal mostly in gold.
40 years ago an oz. of gold bought around 12 brls of Oil, about 12 to 1. About 30 years ago when both were peaking it was around 20 to 1. As little as 10 years ago, it was around 25 to 1. In the past 12 months, during a Bubble, it went down to around 7 to 1.
I really do not see a long term correlation between the two that can be called a ratio.
I can easily see a drop in the Dollar which would raise Gold the $1300-1400 range but leave oil below $100 within the next 12 months: Inflationary expectations VS stagnant Demand.
Oil is subject to more variables than gold.
The whole Bretton woods currency system from ww2-1971
was BASED on on a FIXED gold price at 35$.
IS that a FREE market.....
It collapsed, because the French swapped their paper $ for Gold
The US gold stock went from 30.000tonnes to 8000tonnes, before NIXon let the price Free...& went from 35$ to 850 in 1980,back to 256$.
IF gold is NOT ...THE...Monetary Value of Choice, WHY did the US goverment CON_FISCAT ..PRIVAT GOLD in 1933, at..20.67$....
ONLY to Revalue it at 35$...3 years later.....
THE SAME THING IS HAPPENING AGAIN TODAY......WAKE UP......
Soon Opec will wake up, realizing, that they have sold ½ OF THEIR OIL, FOR PAPER
WAR IS ON THE HORIZEN, AND STILL GOLD, NOR OIL REACTS.......
IT WILL.....SOON
** The key is the GOLD/ ? ratio.....try Gold/DOW
Happy new year
Mike
The Russians dumped some 20,000 tons of it during the late 70s thru 80s to purchase basic food supplies as every one of their 5 year economic programs failed.
Central Banks have been selling on the open markets for decades also.
Anyone who believes these were flukes is clueless.
IMO
Gold is hoarded and oil is consumed. The primary energy commodity has changed throughout history and the primary monetary commodity could change based on market preference. Because oil is the primary energy source and gold is the primary monetary commodity therefore the ratio is the primary tool humans have in performing mental calculations of value for expenditures of energy both in the present and future.
Thus, gold acts *like* 'stored energy' because of the production or replacement cost for an additional ounce. Obviously, it is not 'stored energy' like the SPR or a can of wheat. The gold to oil ratio then begins to function like an interest rate in allocating capital between cash balances, current consumption and investment. This is the premise behind the assertion that 'Energy Return On Energy Invested (EROEI) calculations were not even performed.'
It may help if you try thinking in terms of calories instead of FRN$. 'Ultimately, money is about energy.' That energy is either consumed presently or in the future. How are those decisions to be made based on price, value and utility?
As far as gold price manipulation the FRN$ monetary system violates the monetary provisions of the US Constitution which set up a 'free market' for currencies. This illegal unconstitutional manipulation should be obvious to everyone. The 7:1 bubble you mention is closely related to the interest rate manipulation by the Fed.
On Dec 30 09:19 PM R Jensen wrote:
> "The silver (SLV) to oil ratio is not nearly as extreme as gold to
> oil but silver will most likely follow gold, either up or down, at
> a faster rate of change."
>
> Interestingly, back in 1964, a gallon of gas was around a quarter
> (of a US dollar).
>
> If you have a 1964 quarter, you can still buy roughly a gallon of
> gas with it. That's because quarters previous to 1965 are 90% silver.
> Strong dollar = flat gold
> low oil = flat gold
> De-leveraging = flat gold
All three of those have just about run their course. Weak dollar, higher oil, leveling of de-leveraging = higher gold.
Personally, I'd rather bet on oil than gold. In addition to being scarce, it is useful, desperately so if/when supplies get short. It MAY also be less susceptible to manipulation.
Monetary policy from Fed Reserve is veered around keeping low interest rates and this is intended to keep the value of the US currency lower. But I would think this would fail since demand is much lesser for any asset compared to 2007 and prior years.
The Fed Reserve has run its course over interest rates. ZIRP does not help. What helps now is direct currency market intervention (ala Chinese Central Bank) to keep the USD low. This was what brought US out of the 'Great Depression of 1933'.
Only then will energy (oil, ng) start to inflate assuming demand from USA, EU, South Asia and East Asia holds up and assuming that production from OPEC and non-OPEC like Russia, Norway, Nigeria, Venezuala remains flat to low. No amount of production cuts from OPEC will help now though.
As for gold price, assuming Gold-to-Oil ratio should reach 30, then gold ounce price cannot exceed $1200 assuming mean $40 per crude oil barrel. And assuming a currency devaluation of 17 to 20% for fighting the deflation and with appropriate cuts in oil production to keep mean $45 per oil barrel, gold per ounce price has a maximum of $1350.
No more upside to gold price exists. And all gold bugs are wrong if their price is higher.
Kalahasti
LOL
When Russia Invaded Georgia, The USD rose against all currencies including GOLD.