Below is an extract from a commentary originally
posted at www.speculative-investor.com
on 27th April 2006.
There isn't a consistent
relationship between gold and oil. In fact, the number of
barrels of oil it takes to buy one ounce of gold tends to
make huge swings -- from below 10 to above 25 and then back
again -- and doesn't spend much time at all near its long-term
average of 15. These huge swings are illustrated on the following
chart of the gold/oil ratio.
With respect to the current situation, the only
reasonable conclusions we can draw from the historical performance
of the gold/oil ratio are:
a) At the end of last August, in the immediate
aftermath of Hurricane Katrina, gold was as cheap relative
to oil as it has been at any time over the past 35 years,
and although it has out-performed since that time it is still
very cheap relative to oil.
b) Over the past 35 years there have, prior
to last year, been 4 times (1976, 1982, 1990 and 2000) when
the gold/oil ratio dropped into single digits. In each case
the ratio rebounded to above 15 within the ensuing 2 years.
Now, just because markets performed in a certain
way in the past doesn't mean they will perform that way in
the future. It could be argued, for example, that there's
been such a big change in oil's supply/demand situation that
the gold/oil ratio will continue to move lower over the coming
Our view is that the gold/oil ratio made
a major bottom last year and will, as a minimum, move up to
15-20 within the next two years. There are two main reasons
First and as explained in previous commentaries,
there is a lot of evidence that inflation expectations remain
quite low despite the many obvious signs of an inflation problem.
This suggests that few people appreciate the bullish case
for gold -- gold has, we think, been pushed higher as part
of a general commodity play rather than as a monetary play
-- and, therefore, that the market hasn't yet begun to really
discount gold's bullish fundamentals. On the other hand, is
there anyone in the world who isn't well versed on the bullish
case for oil?
Second, a sharply higher gold price would
have no direct effect on commerce whereas a sharply higher
oil price would hinder economic growth (and thus sow the seeds
for a reduction in oil demand). A rising gold price might
be perceived as evidence of an emerging inflation problem
and might therefore create upward pressure on interest rates,
but then again it might be possible for the media and the
monetary authorities to explain away a substantial rise in
the gold price as a reaction to geopolitical tensions, or
China's growth, or gold buying by Arab sheiks, or falling
mine supply, or something else unrelated to the true cause
(inflation). The bottom line is that the gold price could
rise to a multiple of its current level without making a significant
difference to the economy (except to the extent that it affected
inflation expectations), but the oil price could not do the
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