Gold or Oil: What's a Better Inflation Hedge? 35 comments
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A reader recently wrote in with kudos for our April article on the gold/oil ratio ("How Much Oil Can Gold Buy?"). The ratio, if you're not familiar with it, measures gold's purchasing power in barrels of crude.
That got me thinking about what else gold can buy. Gold is constantly advertised as an inflation hedge, so many people think that owning the metal provides constant insulation from the ravages of rising consumer prices.
Year-by-year through 2008, it turns out crude oil has actually beaten gold at the inflation game, at least when measured against the Consumer Price Index [CPI]. In a way, this makes perfect sense, since so much of present-day inflation stems from petroleum costs. 2009 may break oil's record, but we'll get to that in a minute.
Let's look at the macro picture first - or, rather, pictures. For our analysis, we'll use average yearly prices over the past four decades, so we'll be sure to encompass both the pre- and post-Nixon markets (remember, it was on Richard Nixon's watch that the Bretton Woods scheme was scuttled, decoupling the U.S. dollar from gold).
The 1970s were, to say the least, inflationary. From a $39 average price in 1968, gold climbed to a 1980 peak of $615, where it then languished for two decades. The gold market finally sparked to life in the early days of the new millennium, when, in 2007, gold ripped through its 1980 high. Since then, prices have continued to rise: Gold's average price in 2008 was $872.
Long-Term Appreciation: Gold Vs. Oil
Source: IOGA, LBMA, BLS
Through 2008, oil's price trajectory looks fairly similar to gold's. Crude peaked at an average price of $91 a barrel last year.
Apparently, oil, which had played the weak sister to gold in the early days of the new millennium, has now outpaced the yellow metal.
What's more, these price charts don't reflect the impact of inflation on gold and oil prices. Factor that into the mix, and you'll discover that neither gold nor oil has really smoked their old highs. Inflating the commodities' historic prices to 2009 dollars tells us that gold needs to average $1,607 this year to match its 1980 performance. That's an 84% jump - a pretty tall order to be sure.
For oil, the bar was set a lot lower this year. To match its 1980 performance, oil would only need to average $98 a barrel, just 8% above its 2008 price. Whether or not that will come to pass is another matter.
Inflation-Adjusted Appreciation: Gold Vs. Oil
Source: IOGA, LBMA, BLS
Keep in mind that the charts depict the compound performance of these two commodities since 1968. If you look at their performance on a year-by-year basis, things look a bit different. The CPI adjustment factor used in these charts rarely backtracks: Inflation is the norm, deflation the exception. The average annual inflation rate since 1968 has been 3.6%, and there's nary a negative year to be seen. So far, at least.
The median annual outperformance of gold to CPI is 1%. Oil does a bit better, albeit by a slim margin. Oil's annual gains were 1.7% better than CPI's.
Now, before you rush out to buy oil ETFs or ETNs, take note of this: Oil's taken a beating in 2009. The average price of crude now is about half of what it was last year. Gold, however, hasn't given up ground; in fact, it's on pace to show a gain for the year. Whether things will turn around by year's end is an open question.
But that brings us full circle to the gold/oil ratio. When it comes time to hedge inflation, the ratio provides some clues as to the better hedge. Gold is ascendant when the ratio turns up from a bottom; oil has the advantage when the ratio turns down from a top.
Happy hedging.
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For the average investor, the cost of rolling over a futures contract monthly, or paying the contango in advance by buying a further out futures contract, is a huge drag on any potential profit in oil.
Currently the one year forward in oil is about 10% over spot while one year gold is about 1/2% over spot.
tinyurl.com/m8z8ed
When the hybrids start kicking in and the alternative energy does too. along with a receding producive world economy oil can get destabilised.
Its more about how the ETFs dont really hold all the silver and gold they pretend to but actually play the spreads as well. I think an ETF or two will collapse one day . and i dont think oil will do much if a major derivative trading house gets compromised.
So for the rainy day Gold or Silver are still the ultimate non fiat currency of stability and insurance. Millionaires come and go very quickly in these economic times but Gold will hold its value more or less depending on the dollar plunge protection teams efficiency ... Yet Gold could still triple in the next few years and then more. However before this happens the powers that can deflate the value of any commodity have to lose thier grip somewhat..
P.S.- I vote for silver to outperform both. It is being consumed at a rapid clip, can be physically held, and is historically cheap in both Ag/Oil and Ag/Au ratios.
The average three-month roll since 1985 is -17 cents a barrel. That means there's more likely a PROFIT, rather than a LOSS, awaiting a long-term oil investor.
The likelihood of a inverted market increases, in fact, in a bull market (when inflation's more likely).
Investors can use ETFs like USL, rather than USO, to minimize the contango affect.
On Aug 20 11:31 AM kohalakid wrote:
> chap08 makes a point that is overlooked in this article.
>
> For the average investor, the cost of rolling over a futures contract
> monthly, or paying the contango in advance by buying a further out
> futures contract, is a huge drag on any potential profit in oil.
>
>
> Currently the one year forward in oil is about 10% over spot while
> one year gold is about 1/2% over spot.
Buying a commodity in backwardation with the hope of "earning" from the monthly roll can generate profit from the roll at the same time you are getting killed on the P&L side.
On Aug 20 02:44 PM Brad Zigler wrote:
> Something to keep in mind: historically, the oil market's spent more
> time in backwardation than in contango.
>
> The average three-month roll since 1985 is -17 cents a barrel. That
> means there's more likely a PROFIT, rather than a LOSS, awaiting
> a long-term oil investor.
>
> The likelihood of a inverted market increases, in fact, in a bull
> market (when inflation's more likely).
>
> Investors can use ETFs like USL, rather than USO, to minimize the
> contango affect.
>
www.youpolls.com/detai...
.
In any event, here's an excerpt from Morningstar on USO:
"...Due to market liquidity and the absence of carrying costs, using futures is in many aspects a better way to invest in oil than by owning the commodity directly. However, the strategy does have some flaws. Investing in futures can be tricky: As futures contracts near expiration, commodity funds like this one have to roll those contracts to the next month's so as to avoid taking ownership of the physical commodity. The catch is that the futures curve--that is, the prices of contracts with progressively longer terms--can take an upward (known as "contango") or downward ("backwardation") slope. That slope can cause futures and spot returns to decouple. For instance, until recently, contango caused oil futures returns to lag spot prices. In fact, this fund's returns have routinely lagged and surpassed spot prices since its April 2006 inception. The upshot is that those dynamics can make funds like this an imperfect hedge of crude oil prices.
That said, it's not necessarily a fatal flaw (nor unique, as all futures-based commodity ETFs face this challenge). In fact, of the current crop of oil futures-based products, we think this fund's low cost and simplicity make it one of the better choices. ..."
On Aug 20 12:04 AM Snoqualman wrote:
> Good idea to own both, but gold is certainly easier to hold and store.
> As a commenter on another article recently put it: "Oil goes down,
> USO goes down. Oil goes up, USO goes down." I'm still wondering
> how those of us without a supertanker, or even just a regular tanker,
> can speculate on oil price rises.
I think the skyrocketing cost of oil played a significant part in bringing down the economy.
Tom Kloza of Opis noted last Christmas that the U.S. was spending about $1 billion / day less on gasoline than had been the case in July. blogs.opisnet.com/arch...
Sucking even half of that much money out of the economy wouldn't exactly be inflationary even if the costs for transportation, fertilizer, plastics etc. shot up accordingly. People would have to cut back elsewhere, and in a big way.
On Aug 20 02:08 AM Freya wrote:
> High Oil brings inflation with it, so I don't really see how it can
> be a Hedge against itself. Gold is a hedge against rising inflation.
>
>
> Both gold and oil are roughly at the same level now as when they
> started in the beginning of 2009.
>
> Oil "took" a beating earlier this year. Gold Demand "Is" taking a
> Beating: go.infomine.com/?re=13...;tg=news.mining.com/2009/0...
On Aug 20 11:31 AM kohalakid wrote:
> chap08 makes a point that is overlooked in this article.
>
> For the average investor, the cost of rolling over a futures contract
> monthly, or paying the contango in advance by buying a further out
> futures contract, is a huge drag on any potential profit in oil.
>
>
> Currently the one year forward in oil is about 10% over spot while
> one year gold is about 1/2% over spot.
On Aug 19 06:06 PM jimboy wrote:
> A lot of investors expecting inflation envisage radically different
> scenarios and this effects the choice of hedge:
> (1) reflationary policies will succeed and a robust recovery will
> push up inflation [won't happen but if you think it will go for oil]
>
> (2) secular trends like population growth and oil scarcity will push
> up relative prices of commodities, oil, food etc regardless of recovery
> [go for oil]
> (3) reckless fiscal and monetary policies being pursued to end the
> recession won't work and will begat more of the same eventually leading
> to inflation without real recovery [go for gold]
> (4) like 3 but with fiat currency armageddon at the end of it [go
> for gold]
> Oil might run gold close with scenario (3) depending on the strength
> of the global economy outside the US and what sort of oil hedge you
> have in mind. In the case of the more extreme (4) it's got to be
> gold.
On Aug 20 01:24 PM Crude Oil Trader wrote:
> Pretty simple......Gold.
> ..Both are environmentally unfriendly to produce, widely consumed,
> etc...
“Environmentally unfriendly” / produce – consume
Here’s another interesting juxtaposition of terms I find infuriating at times. Why is it producing, i.e. mining/manufacturing/g... tangible goods, is couched in this “environmentally unfriendly” terminology when wildfires, hurricanes, and other “natural” disasters that “consume” environmental resources is perfectly acceptable?
I find it quite “natural” to provide a more enjoyable, productive and visually appealing environment for me and mine to spend our mutual time cultivating. It beats the heck out of living in a cave, peeing in the corner and waiting for manna to fall from heaven. We’re productive, consuming creatures with an ability to design also. It’s certainly not evil to develop the resources that add enjoyment, value and health while reducing wastefulness and true evil, or “unfriendly” policies / impediments / threats to our sustaining of these activities.