Predicting Oil Prices Through Gold 7 comments
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If you assume (and that is an uncertain assumption) that gold is fairly priced, and that oil is in search of its fair price, it may be possible to glimpse the “fair value” of crude oil by examining the historical price relationship between the two commodities.
Here is a 20-year, weekly chart of the price of West Texas intermediate crude divided by the price of gold bullion.
click image to enlarge
The 10-year average ratio in 2000 was about 0.06. Today the 10-year average ratio is about 0.10. A visual inspection suggests to us that 0.07 might be a central tendency (although most of the lower values were in the decade of the 90’s, and most of the higher values were in the decade of the 00’s).
The current low price ratio of about 0.48 was approximately reached or exceeded in 1994, 1995 and 1998 (3 of 20 years).
Today WTI crude is at about $41. Gold is at about $855.
Applying the averages we might think of a “fair value” for oil in the $51 to $86 range. If we apply the apparent 0.07 central tendency, we might think of an oil “fair value” of about $60.
That range of prices is not so different than other sources of estimates.
The Saudi oil minister recently said that $70 is the necessary price for oil to be attractive to all sides for various reasons
We have read that the cost of finding and lifting new oil from deep ocean wells (the largest expected source of oil reserves replacement) is about $70 to $75.
In a September 2008 article, we used different criteria to predict that oil would probably fall to about $70, but discussed some scenarios that could go below $30, as well as to $90.
The most recent Department of Energy - Energy Information Agency prediction for imported light sweet crude in 2010 is about $82.
These observations may be useful to those interested in oil or gold funds such as USO, GLD, BPT, COSWF.PK and others.
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This article has 7 comments:
The math certainly works in both directions -- either gold or oil price, or both changing, but gold may be a more universal and enduring representation of value. That is a judgement each individual investor must make. We think the other factors that suggest oil must rise put more weight in favor of oil price change. The fact is that the price of each changes constantly, but over time they may have some key relationship. Another argument against what we have said in this article is that gold has a long and ancient history and role in economics, whereas oil is quite new by comparison, and that oil when from seemingly infinite in supply to seemingly limited in amount and capacity to keep up with growth -- that might argue that a long-term central price relationship cannot be found.
The value of gold is determined largely by its perceived "safe-haven" end-of-the-world characteristic as a defensive "store-of-value" - something which is very real and useful in the minds of most gold investors, I suppose.
Oil, by contrast, is one of several crucial input components to modern economic activity - what you could call a "facilitator" / "creator-of-value" with respect to such vital functions as manufacturing (plastics, etc), transportation, etc.
Thus, one has been and likely will remain a largely static and emotional prop, while the other has been and will remain for the foreseable future an essential that "greases" the wheels of modern prosperity (notwithstanding the advent of alternative energy sources).
Let's remember that correlation is not equivalent to causation. Thus, the use of "correlated" assets in making investment decisions should not be given undue weight. And this is especially relevant when you consider, as pointed out by Richard, that the ratio of gold to oil has "shifted" dramatically between the 1990s timeframe and the more recent 8-9 years.
The old adage of being able to buy a suit for an oz. of gold now vs 100 years ago always seemed rather trite.
One would think that a 100 years of inflation would have had more impact than just being reflective of past inflation. Besides, this holiday season showed that many a good suit could be bought for Far less than $800.
Gold has been perceived as a Currency for 5,000 years but here it sits at sub-$1,000. Surely, the inflation rates of the last 200 years should have had a greater impact on its price.
So, to me, it is all a matter of perception and the value of gold lies in the eyes of the perceiver.
I do not know where Gold will find its equilibrium point in the present environment. I do know that there is a lot of hype in the Media about it. The Contrarian in myself says its time to short it. IMHO
I do have respect for Marc Faber who is bullish gold and metals...
one of those things that will play out over a 3-4 year period..good or
bad...depending on the effect of government printing and stimulus..
none of us really know how this thing plays out..if depression is on the
table then everything is dead for the next 3-5 years...
It doesn't to me.
I am not concerned when gold itself has a run up, often times it is just making up for years of torpidity and lanquidity.
I greatly appreciate the industrial uses for gold, and the ornamental uses as well and yes , it does have an appeal for hedges against the risk of default of fiat currencies. But , thus far these factors have affected me directly only nominally, and thus, I do hold nominal amounts of gold thru the Permanent Portfolio fund, and other sources. I will make adjustments when I think they are appropriate.
Such is not the case with OIL, however, a most special commodity. Iit warms my body on cold days and nights, and takes me where I want to go, sheds light on my books, and powers my machinery and computer with great efficiency, and helps fill my stomach with food as every farmer will tell you.
Hence, I place a higher value on OIL, than I do Gold, although gold is certainly appreciated.
Seems to me , it's not a case of either/or, , but a carefully gauged weighting of the two, and there, each individual must devise his own criteria as best he can.