What the price of gold is telling us about the price of oil, 2012 edition

It’s time to ask, as we sometimes do: is the price of gold too high relative to oil, or is it the other way around?

The answer: it may depend on the Brent/WTI spread.

Taking a look at the ratio of gold to oil is another way of looking at whether the relationship between these two asset classes — one of which has tremendous industrial and personal uses, and another whose industrial and personal uses pale in comparison to its role as a monetary substitute — might be a way of identifying that one of them is overpriced. Or maybe one is underpriced. Whatever.

A few years ago, we calculated the ratio of gold and oil going all the way back to 1984, and we did it by comparing Handy & Harman’s US daily gold fix to the price of WTI. We didn’t use Brent only because the data on WTI went back further, and the first data on Brent was for what was then known as the 15-day market, which could have distortion relative to the physical market. The dated Brent price didn’t come until a few years later.

That comparison showed the gold-WTI ratio could be as high as the 24-25 level for a period of several days. That meant that during those periods, one ounce of gold could get you 24-25 barrels of WTI. The periods during which that occurred shouldn’t be surprising: when oil prices bottomed in February 2009, after their long slide from the late June-early July peaks of the prior year, and in November 1998, in the midst of the price collapse that was spurred primarily by the Asian economic crisis.

The ratio got down near the 7 and below level in the mirror image of those days: late June-early July 2008, when the price of WTI was on its way to a record high of roughly $147 per barrel.

But the average that we did a few years ago came in at about 15.5 for those many years starting in 1984. And after all the machinations of the past few years, the average from 1984 through Dec. 27 came in at 15.85. So the average roughly held, but it’s up slightly. And the glut at Cushing seems to be a reason.

The ratio near 15 certainly didn’t hold in 2012. The average gold-WTI ratio was 17.82 in 2012, through Thursday. It ranged from lows near 15.5 in mid-March, getting near that level a month later, to highs a little bit more than 20 in early October.

Meanwhile, the gold-dated Brent spread was a beacon of consistency. Its average for the year was almost 15 on the nose. It never got below 13; it never got much above 17.

So we’ll blame Cushing once again for this apparent market distortion. It isn’t a perfect relationship, but there clearly were times during the year that a wider Brent-WTI spread coincided with a relatively high gold-WTI ratio. Not surprising, because that wider Brent-WTI spread meant that WTI was weak relative to Brent, and therefore an ounce of gold could buy more Cushing barrels.

The relationship was far from inviolate; for example, while a period of relatively tight Brent-WTI spreads in early January was accompanied by a gold-WTI spread near 16.8, which is less than the year’s average, a similar Brent/WTI spread in June was concurrent with a gold/WTI ratio of 19.5.

But on the other side, the widest Brent-WTI spreads did coincide with high gold-WTI ratios near 20, i.e., meaning an ounce of gold could buy you a lot of WTI.

If the Cushing barrel ever calms down relative to Brent–when the Seaway reversal is at capacity, if the full length of the Keystone XL pipeline ever gets built, if Energy Transfer Partners turns the Trunkline into a crude line — then gold analysts may want to do some recalculating. Or maybe they’ll just figure gold will ride with Brent, and it’s WTI that will need to change its ways.

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  1. John Kingston at December 30, 2012 7:32 am

    Thanks for the comment, Ron. You can do gold to anything; one of the links in the piece goes back to a discussion spurred by a comparison between the price of gold and the price of rice. Oil has the advantage of being the primary petroleum inflation hedge, far more than gasoline or distillates. In the case of natural gas, the fracking boom has obviously created a new paradigm for gold-US gas, and data on things like international LNG don’t go back far enough for a meaningful comparison. Coal would be an interesting comparison for international prices, since coal in the US has been pressured to the same technological forces that make a gold-natgas comparison a reflection of two totally different eras, pre- and post-fracking boom.

  2. Ron Wagner at December 29, 2012 8:01 pm

    It would be more accurate to compare the price of gold to the price of a basket of petrol, natural gas, and coal in proper proportions. These all compete in the energy market, and influence each others prices. Silver might also be grouped with gold, and compared to get a more accurate idea of what is going on.

  3. virajs at December 29, 2012 10:54 am

    Hey, useful article. I just unwound wti long gold short. It seems to me that wti brent spread cannot outlast June of 2013, and regardless, during times of economic expansion globally you have a ratio as low as 9. Further gold market fundamentals seem pretty bad, with reduced indian imports and increased production. I look forward to reentering, on any swoon in WTI following negative fiscal cliff news etc.


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