Predicting Oil Prices Through Gold

by: Richard Shaw

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, OTCQX:COSWF and others.