How Much Is Gold Worth vs Oil
Gold vs US Dollar
The basic relationship between how much gold is worth and the US Dollar is well known and understood and like any economic indicator, there are periods when the relationship is weak and periods when it is strong. There may even be periods when it breaks down altogether but in the general historical spectrum the relationship is inverse between the two, meaning that when one is strong, the other is weak.
Put simply, when the US Dollar is weak, it takes more of them to buy a given quantity of gold and therefore the price of gold rises. Conversely, when the US Dollar is strong, it takes fewer greenbacks to buy that gold and the gold price falls.
The inherent problem here however is that the good ol’ greenback is after all the king of fiat currency and can be created at will. Pricing in dollars tells us nothing about whether gold is worth more or the dollar simply being worth less.
Gold vs Oil
So what about if we were to examine how much gold is worth against a real commodity like oil? The lifeblood of our society, oil has given us automobiles and machinery, greased the wheels of the industiral revolution and granted us the freedom and wealth we have today.
Is there a relationship between how much gold is worth and the price of oil. Some say there is and that it is linear…i.e. when the price of oil increases, so does the price of gold. One justification is that rising oil prices place upward pressure on inflation thereby stimulating how much gold is worth since a part of gold’s appeal is as a hedge against inflation.
Historical Gold/ Oil Ratio
Let’s start by looking at the historical price of oil over the last 40 odd years. As will become apparent to anyone who studies this topic further in detail, the price of oil and the political situation of the Middle-East, the region where most reserves are found, are tightly integrated.
The Yom Kippur conflict of 1973 between Israel and the Arab states of Egypt and Syria resulted in an Arab oil embargo in response to ‘the US decision to re-supply the Israeli military’. This embargo lasted until March 1974 and resulted in a jump in the oil price from under $5 a barrel to over $10 which ever since then has been the floor in this market.
Just as markets were getting used to this doubling in price, 1979, the year after the Iranian Revolution which resulted in severe disruption to its oil sector, saw another surge which combined with U.S President Jimmy Carter’s decision to order the cessation of Iranian imports and the breakout of the Iran-Iraq war in 1980 pushed the price to $40 a barrel causing shockwaves around the world.
It was not until a substantial increase in production by Saudi Arabia during the mid-eighties that prices eased back to $10 a barrel and subsequently traded in the $10 to $30 range until the millenium after which the oil price has been constantly rising and even reaching over $100.
Understanding The Gold/ Oil Ratio
Now if there exists a relationship between the price of gold and the price of oil, then one would expect to see similar movements in the gold price during this period.
In the simplistic case where a doubling of the oil price results in a doubling of the gold price, a graph depicting the ratio between the two would result in a line of constant value.
Gold-Oil Ratio = Price of Gold (per oz.) / Price of Crude Oil (per barrel)
In fact, what we see is a ratio that fluctuates between a value of 10 and 30. In other words, there are periods when the price of gold is worth 30 times that of oil and when it is worth only 10 times as much and most of the time it is worth somewhere in between. This does not suggest a strong relationship between the price of gold and oil but it does suggest that in general the two do rise together and fall together over the long term. Certainly in the post-9/11 era, the two have been rising together in tandem and the relationship less skewed.
This gold/oil ratio is more useful to economists to identify at a high level when gold is generally over-bought or over-sold. For example, it the indicator hits 30, you know that gold is overvalued and a price correction may be around the corner. (On the other hand, oil may be undervalued and a price surge may be imminent…don’t you just love the free hand of the markets.)
Gold & Black Gold
In the final analysis, it may simply be enough to recognise that both oil and gold are commodities that are of great importance to the global economy and thus to some extent are both going to react to global events in the same way. This is not to say therefore that gold is following oil or that oil is following gold. Rather both are just reacting in their own way to the same stimulus.
After all, oil is the ‘black gold’.