There’s something about the trinity of Oil, Gold and Stocks that catches the fascination of modern investors. I spent sometime last night looking at the correlation between these. Though, I have data on the prices of the three for the past 62 years (since WW II), in order to make this exercise relevant to modern times, I chose to do it from 1970 onwards. It was right after man landed on moon and the era of scientific, engineering and industrial evolution leap-frogged to levels only dreamt about before. From an analysis perspective, I chose to study the correlation between the 3 around the following data points:
A. Oil crisis of 1973
B. Stagflation of the late 70s (1975-1980)
C. The Paul Volcker effect of the early 1980’s
D. The Clinton years (1992-2000)
E. The dot-com bust(early 2000s)
F. Recent Times (2008)
Studying the patterns pivoted at the events above, I felt it’ll be an interesting exercise to see what distinct signals emanated prior and post these events and to see if anything interesting shows up. For the purists out there, this is just an analysis of the market psyche for these three investment types.
Looking at the two charts, the observations that bubble up are:
- Oil went up, so did Gold and the Dow stayed flat
- Gold grew at a higher rate than Oil
- Remember, gold had an advantage in 1973 as in 1971, President Nixon abandoned the Bretton Woods regime and suspended the dollar’s peg to gold as U.S. fiscal deficits from overseas spending caused a massive drain in U.S. gold holdings.
- Oil got denominated in dollars after the 1973 crisis
2) Stagflation of late 1970s
- Oil and Gold continued to flourish, Oil more so while the Dow remained almost flat
- Gold and Oil peaked in 1980, Dow barely moved
- Inflation rose to 13%, oil prices were high and pegged to the dollar
3) The Paul Volcker effect of the early 1980’s
- Volcker’s method of bringing inflation down through high interest rates had a positive impact to the Dow, Dow started trending up and Oil and Gold prices came crashing down
- Gold was impacted more severely than Oil. Oil has geo-political sentiments associated with it, which often times works to its advantage
4) The Clinton years (1992-2000)
- Dow loved these years and grew at an astonishing rate
- Interestingly Gold and Oil stayed flat and didn’t go down
- Towards the end of Clinton’s term Oil prices grew and Gold stayed flat, starting the downward trend of the Gold/Oil ratio. This may be due to one of many factors: Geo-political reasons, increasing demands, limited supply, anticipation of a President who supported the old economy? I don’t know but I definitely need to understand this better.
5) The dot-com bust:
- This brought Dow down and Oil and Gold again took off. 9/11 had just happened and wars were being fought and war plans being drawn. As a result, Oil which is very sensitive to these events had a much steeper increase. To Gold’s credit, it grew at a pretty decent rate while being resistant to political events.
6) Recent times
- Gold continues to grow at a slightly slower rate than before
- Oil is growing very steeply, as we all know
- Dow is down to 2003 levels
- Gold/Oil ratio is trending down mainly due to Oil’s magnificent climb (unfortunately)
- Economics which used to favor Gold before are more skewed to Oil now. However, the Gold/Oil ratio has stayed nearly constant in the past 38 years. Given this, it may be inferred that quite possibly, Gold will go up and Oil may go down in the next few months to maintain this historic equilibrium.
- Increase in interest rates and curtailing of inflation historically drives the Dow higher.
- When Dow goes up, it curtails the price of both Gold & Oil albeit it has a much stronger influence on Gold than Oil. Oil prices can go up even when the Dow’s flourishing due to the ultra-sensitive and political nature of the Oil supply-demand equation.
- When the Dow starts trending down, Gold’s a good investment. Get out of Gold (unless it’s your portfolio hedge) when Dow starts to rise.
- Oil has a much stronger influence on Dow than Gold in the recent times. Oil hikes drive Dow down and that in turn drives Gold up. There’s a lag time here which surfaces a good investment opportunity if you are considering Gold.
I don’t own any Gold stocks and this analysis is driven by my personal quest to understand the correlations between Oil, Gold and Stocks with market conditions. Make your own inferences and do let me know if you see anything else of interest in the two charts.