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Why the Discrepancy Between Oil and Gold?

by: Tim Iacono June 10, 2008 | about stocks: DBO / GLD / OIL / USO    

Tim Iacono

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In the last post about oil and gasoline, this rapid fire sequence of questions was asked by Vespucian about gold:

  1. Why do you think gold is only at $900?
  2. With the dollar dropping the way it is shouldn't it be at more like $1,100+ right now?
  3. Are the central banks dumping the stuff?
  4. I find the current discrepancy between oil and gold odd. What's your view?
  5. Could you do a post on it?

It might be easiest to work backwards...

5. Yes.

4. I don't think there's much to be concerned about - it's best to just buy and hold the stuff and not pay too much attention to the week-to-week and month-to-month moves. I never really thought too much of the "oil-to-gold ratio" anyway. Most people would probably say that oil is overbought right now and if anyone can ever make any case for how you properly value gold, I'd like to hear it.

A few charts should help...

The United States Oil ETF (USO) isn't the best proxy for oil futures, but it's handy, so, since the beginning of the year, it's been all oil, all the time:

And this is true if you go back one year to last summer - back then a barrel of oil cost about $65 and an ounce of gold cost about $650. Since that time, oil has more than doubled and gold has gained less than 50 percent.

But if you go back two years, all of a sudden, things look a little more even, much of this a result of the late-2006 energy sell off that pushed oil prices down to about $55 at one point.

It's interesting to note that the oil corrections have been much more severe than gold corrections.

If you go back to their respective lows of about $15 for oil in 1998 and $275 for gold in 1999, then today's prices represent gains of 900 percent for oil but just 300 percent for gold.

I think the supply outlook for oil (i.e., peak oil) is changing everything there is to know about oil prices at the moment - the average oil price last year was only $65.

3. I've heard practically nothing about central bank gold sales lately - the 400 tonne sale by the IMF is hanging over the market right now which may be keeping a lid on prices, but the move from $650 to the current $900 or so in the last nine months was a pretty big move.

It's too bad the central banks can't produce about 10 trillion barrels of oil as easily as they can produce 400 tonnes of gold - that would solve a lot of problems.

2. Going forward, the relationship between the U.S. Dollar Index and the gold price will become less and less important, but apparently it's still important to traders. I for one, think this relationship is overrated as the dollar and gold have risen together before (see 2005) but, admittedly, the biggest moves in the past have come when the dollar loses value against other currencies.

1. Gold is at $900 because that's where it is. It was much lower a few years ago and it will be much higher in another few years - that's how things work with fiat money systems as they work their way toward their eventual conclusion. I wouldn't spend too much time worrying about the month-to-month stuff.

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This article has 20 comments:

  •  
    Jun 10 08:25 AM
    All the goldbugs notwithstanding, most of the new gold mined in the world ends up as jewelry, not coin or bullion. Oil, on the other hand, can be used to do work and create value. Just for example, oil and gas availability have enormously increased crop yields which, as Midas discovered to his chagrin, no amount of gold could ever do. So while there is a growing shortage for both, people who only have money to invest in one and not the other tend to choose investing in oil.
    Reply
  •  
    Jun 10 10:08 AM
    This is simple. All the gold ever mined is still around in one form or another. Oil has peaked and demand is growing a lot more than gold. the difference between gold and oil will get bigger. I will tell you why @
    theinvestingspeculator...
    Reply
  •  
    Jun 10 10:52 AM
    good insight....
    Reply
  •  
    Jun 10 10:52 AM
    Gold bullion in US $ per ounce and the US $ share prices of common stocks of gold mining companies are subject to at least 3 cycles of differing periodicity. The seasonal cycle, the business cycle in the USA, and the long or multi decade liquidity or asset valuation cycle.

    The seasonal cycle for gold and gold stocks in US $ runs up from the end of September to the following April and then goes level or sags until the next September..

    The business cycle upswing in US $ for gold should start in late 2008 and run through 2009, and 2010 before pausing for 2 or three years.

    The long, multi decade cycle, is currently in the collapsing liquidity phase (higher interest rates and lower unit prices for stocks, bonds, real estate, and even at some point commodity prices). Liquidity peaked in 2000 with high stock prices and has been falling ever since. It is now 1938 and commodities are recovering from there 1932 lows.

    If the US $ keeps falling against foreign currencies which it will since the US is now the 1938 Brittan and Euro-Asia is now the 1938 USA, then commodities should rise as the US $ falls. Or one could buy Euro-Asia currencies. Euro-Asian stocks, bonds, real estate will fall in terms of their own currencies but not commodities which are in short supply.

    Good luck.
    Reply
  •  
    Jun 10 11:42 AM
    All the gold ever mined being around is in its favor as a store of wealth. You can't store wealth as easily in something that disappears. Oil is a commodity and not a store of wealth. That they have traveled together and often have a ratio is true, that they can diverge is true as well, but the current ratio probably says gold will rise. And it will, because gold is a store of wealth more than a jewelry material. When economic times are good, it serves more as jewelry, but times aren't good--we're on the verge of further troubles--and gold will mainly be a primary store of wealth.

    Many of the analysts expect seasonality to falter this year and gold to rise over the summer due to the economy.
    Reply
  •  
    Jun 10 12:23 PM
    "and if anyone can ever make any case for how you properly value gold, I'd like to hear it."

    Tim - One way to arrive at a theoretical value for gold would be to work through the assumptions of the key variables that would need to be answered if the U.S. were to be forced back on the gold standard - a debate that did receive a fair amount of attention in the early 80's. (I might also note a topic that should receive more attention in the coming months as it becomes apparent to the market that the Federal Reserve doesn’t have the required FX reserves to intervene and stop an assault against the dollar).

    The best book that I have read that discusses the role of money in an economy, and discusses the steps that would need to occur if the U.S. were forced back on a gold standard is Murray Rothbard's The Mystery Of Banking. If you apply Murray Rothbard's logical analysis of the workings of a gold standard to today’s insane monetary environment you get an "official price" (more accurately a weight of gold per dollar) that would shock even the most bullish gold bug around – I will leave the math to you as it would take the fun out of the shocking discovering if I shared it with everyone here.
    Reply
  •  
    Jun 10 01:44 PM
    ditto budfoxtoday

    The Mystery of Banking by Murray N. Rothbard can be downloaded for free at:

    www.mises.org/Books/my...
    Reply
  •  
    Jun 10 02:41 PM
    To Budfoxtoday: That book was interesting, but lets face it. The SINGLE MOST obstacle preventing his suggestion to becoming a reality is that THERE IS NO GOLD IN FORT KNOX!!!!! I'll wait while you provide us with PROOF! In the meantime, I will provide the "magic" figure of Rothbard's logic as the "official price" of gold therein: $500 per ounce! Pure BullSpit!
    Reply
  •  
    Jun 10 03:35 PM
    Proving the amount of gold that is actually in governmental depositries is impossible. If you obtained the $500 dollar target from page 268 of Murray's book you might want to go back and notice two things - 1.) First that is not the price Murrary argues for; he argues for the more logical value of $1,690 at the time of print. 2.) The book was written in 1983 and the information used to arrive at the price of $1,690 was from the end of 1981. So you might want to update the math.


    On Jun 10 02:41 PM User 30121 wrote:

    > To Budfoxtoday: That book was interesting, but lets face it. The
    > SINGLE MOST obstacle preventing his suggestion to becoming a reality
    > is that THERE IS NO GOLD IN FORT KNOX!!!!! I'll wait while you provide
    > us with PROOF! In the meantime, I will provide the "magic" figure
    > of Rothbard's logic as the "official price" of gold therein: $500
    > per ounce! Pure BullSpit!
    Reply
  •  
    Jun 10 03:57 PM
    Gold is basically worthless. You cant eat it, burn it, build much with it, or even smoke it. Oil, on the other hand, has real tangible value.
    Reply
  •  
    Jun 10 04:08 PM
    "Gold is basically worthless. You cant eat it, burn it, build much with it, or even smoke it. " doginyourcoffee

    Thanks for your comment. I have not bought as much as I would like to yet. (Please keep dropping, price of gold)
    Reply
  •  
    Jun 10 04:50 PM
    THERE'S NOTHING SURPRISING ABOUT THE PRICE OF ANYTHING!! JUST BE TOTALLY AWARE THAT THERE'S NOTHING RANDOM ABOUT ANY PRICE I.E. IT'S ALL PURE PLANNED MANIPULATION BY "BIG MONEY"; WHO ACT AS A GROUP. BIG MONEY'S DIRECT MURDERER IS/ARE THE MARKET MAKER(S). THEY ARE CROOKS IN THEIR HEART AND WOULD KNIFE THEIR BEST FRIEND AND/OR FAMILY THE BACK TO MAKE A BUCK.

    MONEY IS THE ROOT OF ALL EVIL; AND MANKIND'S INHERENT GREED MAKES HIM THE LOUDEST "ROOTER".
    Reply
  •  
    Jun 10 05:20 PM
    Gold is basically worth a lot. For instance, you can eat it, burn it, build with it and even smoke it. How? Any country in the world is, and will be, happy to accept gold as payment for food, coal and other heating items, lumber and all necessary building materials, and cigarettes, cigars and pipe tobacco. And as the dollar keeps declining, the people who pay with gold will eat like kings and the people who buy their dinner with dollars will have only one benefit - they will never have to worry about losing weight. As for oil, it benefits the entire population via corporations. But if a truck drove up to your house and deposited 100 barrels of oil in your front yard, could you eat it or build with it or burn it or smoke it? No. Utilization would only be available if you sold it for dollars, leaving you in the same condition as you were before. As the dollar falls, it buys less and less. That is why some people like to hold gold. It holds its value over time and is accepted allover the world.
    Reply
  •  
    Jun 10 05:25 PM
    The above was for Poet Sam.
    Reply
  •  
    Jun 10 05:34 PM
    To Gerrele, I have heard that LOVE of money is the root of all evil. And it seems more logical to conclude that LACK of money is really the root of all evil. Just try getting along without it for a few weeks. So, on that basis, the ideal condition would be the comfort of not having to worry about not having enough money to be reasonably comfortable.
    Reply
  •  
    Jun 10 07:20 PM
    gerrele,

    your instincts are correct, but greed is a given and not necessarily bad. What is intolerable is FRAUD and THEFT. These are the twin foundations of fractional reserve banking. The Mystery of Banking by Murray N. Rothbard, an extremely famous libertarian, is availabe for free at: www.mises.org/Books/my...
    Reply
  •  
    Jun 11 02:20 AM
    misterchan:
    I can just as easily get anything with my guns and oil to run my car as you can get with your gold and I can get that too.
    It's not a consumable and the supply keeps increasing, it's hard to store (and protect), the industrial uses of it have declined compared to silver, rhodium, platinum, copper, etc.
    Oil on the other hand -
    Reply
  •  
    Jun 11 05:31 AM
    To Bill: With my gold, I can hire security guards to take your guns away and have you arrested, keep law and order, etc. Gold is money. Oil is not.
    Reply
  •  
    Jun 11 04:06 PM
    The price of gold is not a reflection of supply and demand (there is a huge oversupply of mined gold above ground). In fact, the price of gold is a barometer for the health of the monetary system. A rising price of gold indicates trouble. For that reason, central banks do manage the price of gold within certain limits in order to keep the confidence into the present system. In such a system, buying gold means acquiring insurance against the unthinkable event.

    Gold is money (according to J.P Morgan). No form of money can store wealth. Oil is wealth. More generally, wealth is any form of assets which allow survival now and in the future. (If you can not attract a woman, you have no future.) Although it is true that gold can be exchanged into real wealth, that should not tempt us to think that gold is wealth. If nobody is going to share food with you, you are going to perish regardless of how much gold you own. The acceptability of gold in the market depends on the marginal surplus of real wealth. If the farmer is starving, he will not share with you his remaining food. Ownership of gold does not protect against the risk of drowning and starving to death. For that reason gold can not be wealth.

    Regarding the gold/oil ratio, that ratio will continue to go down. People who do not believe that do not understand the consequences of peaking energy production. For the next 20 years, oil will be a better investment than gold. The oil market can not be controlled since it is too large. The gold market being very small has and continues to be controlled. Gold will continue to underperform inflation. Nevertheless, we can not afford not to hold gold.
    Reply
  •  
    Jun 12 05:58 PM
    Destination $3000 Gold.
    Reply
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