EDITOR: | February 17th, 2015 | 2 Comments

The Golden Ratio or the Oily Rule….?

| February 17, 2015 | 2 Comments

There is one Classical economic strain of thought that feels that there should be a corresponding move in all commodities if gold moves against all currencies. Thus gold goes up against the dollar then copper should also go up. If gold declines against the Euro then nickel should decline. Ironically one might observe that this group do not think that other commodities are “as good as gold” but paradoxically that they should maintain their value in proportion as if they were in some way lesser proxies. This way of thinking tends towards ratios against gold for the commodities. The most popular of these ratios are gold against oil and gold against silver. The proponents of the first are less dogmatic than those of the latter. In fact one had better not get between a silver “bug” and their favorite ratio of gold to silver or one may come in for trampling!

At the moment the Holy Grail for silver “bugs” is to see silver back at the ratio that was “established” when gold crossed $1000 in early 2008 and silver briefly hit $22. It was like all their Christmases had come at once. When gold retreated to $650 in October 2008 silver was back under $10 which was like being blasted back to the Dark Ages for a silver “bug”. In the crash of 2008 the ratio blew out to 83:1.

When the rally in gold began in late 2008 the silver crowd have been rubbing their lucky rabbits’ foot, lighting candles to Macumba deities and dancing naked by the full moon to try and get their ratio down to its true destiny (i.e. 50 to one). Their hopes were more than fulfilled when the spike to $50 in early 2011 took the ratio down to 31:1. Since then disappointment has been their daily meal.

Therefore the ratio at its peak was a tad above 30 to one while at the darkest hour it was back at over 80 to one.


Historically though the ratio was closer to 15 to one over the years when bimetallic currencies ruled (essentially until the end of the 19th century). The hot button issue of US elections in the 1880s and 1890s was the gradual eclipse of silver. Curiously one might even speculate that silver’s relative decline coincidentally (or maybe not) dates back to when it became an industrial metal in the photographic applications. Silver bugs rather ironically are constantly touting new applications for silver (the latest being biocides) while gold’s advocates feel no need to underpin demand with industrial applications, beyond jewelry.

As far as the silver/gold ratio is concerned we feel that silver should be seen as primarily an industrial commodity and as a precious metal/monetary store of value as a secondary function. When gold and platinum got so phenomenally expensive that they were out of the range of the Indian jewellery trade (or anyone else’s for that matter) then silver potentially gets another day in the sun for that application. Silver in the gold bugs’ minds is not “as good as gold” but still one might argue that if silver is the poor man’s gold then in an age of the beggaring of the middle-classes then maybe there is potential for the metal to have another day in the sun. .

But What of the Oil:Gold Ratio

On the oil front, when we were ensconced in our think tank days, we used 15 barrels to the ounce as the Golden Rule of Oil. It is curious to note that the ratio bore such a close resemblance to that which was a rule of thumb for silver. Indeed oil’s rise to prominence was happening as silver’s relevance (as a store of value) was fading. Was oil the new party in the bimetallic dynamic duo?

In any case the 15 to one oil/gold ratio was a bit of a rubbery rule, more the result of folk myth around the think tank than any historical series of relevance. Even the guru in residence debunked the rule as not having much backing it beyond (post-gold standard) trends. As the chart below shows between 1971 and 2009, the ratio did indeed oscillate around the 15:1 trend.


Oil was not a widely traded commodity (and WTI was not even heard of) in the late 19th century. From 1932 until 1973 the price of gold was not a relevant measure either as it was tied up in FDR’s attempt to create a gold standard on a false construct of non-convertibility. We used the term “false construct” as a true gold standard allows flow from the paper currency to the metal and vice versa. If it relies on coercion (in FDR’s case a prohibition on holding the physical) it clearly means there is either not enough gold to back the currency or that popular sentiment, if left unrestrained, would clearly not vote for the paper instead of the metal. Oil for most of the same period (at least in the US… and by sheer size of the US in the oil business… was steered by the Texas Railroad Commission).

Post-1973 the oil/gold ratio went on a wild ride with two major periods (the first and second oil shocks) of restraint of supply of the former commodity with the first 10 years of “liberation” of the gold price while the first years of gold’s liberation were accompanied by low supply of the metal from mining, as production had been choked off by uneconomic prices for the preceding 40 years.

Below we show a chart of the gold:oil ratio over the last three years. We used the price of the United States Oil Fund LP (USO) in the comparison. This is an exchange-traded security designed to track the daily price movements of West Texas Intermediate light, sweet crude oil. This ETF trades on the NYSE Arca. As is clear from the chart the relationship between gold and oil has come seriously unstuck in recent times. The downtown at the very end is the result of oil’s recent mini-rally and gold pulling back after its Swiss revaluation-fired run.



With the gold/oil ratio way out of kilter (23.3 to one) at the moment (if there is indeed a ratio) then does this imply that gold is too high or oil too low? If one feels that oil is a prime inflation driver (or deflation driver if we go back to the nadir of WTI in 1999) then one might argue that the stimulus is oil, and gold is the follower. But then again gold may just be reflecting the monetary degradation that stimulates oil producers to demand more for their output. In which case gold’s rise follows bad policy decisions that is manifested as a side effect in oil’s moves.

Despite whatever loose money decisions there are at the moment, inflation is not a genie escaped from the bottle.. yet. Gold is too high without real inflation. A gold price of $1,230 would imply an oil price in the mid-$80s if the ratio has any veracity. Only time will tell..


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  • Chris Berry

    Keep an eye on the performance of the USD. I haven’t thought through what this may mean for the ratios above, but continued USD strength surely means lower gold prices. Also, a stronger USD is likely a result of weakness in other parts of the word versus US economic strength, which may mean that oil prices (based on soft demand) will stay low (when coupled with continued excess supply from fracking, etc).

    February 17, 2015 - 1:55 PM

  • Michael Roat

    We have central banks around the world with pro inflation policy stances. It’s an obvious idea to soon begin accumulating inflation hedge assets including precious metals, energy and shipping given there attractive valuations and high probability of an inflationary environment in the not too distant future. The deflation trade is myopic at this point.

    The reason is because we’ve had a deleveraging and that differs from ordinary deflation or the business cycle because the cause is largely beyond the powers of central banks. It is a long wave cycle driven by the accumulation of 100 years of debt that renders traditional monetary policy ineffective because demand for loans is insufficient and the zero bound is already reached. Monetary policy rests on the assumption of an adequate number of willing and capable borrowers. QE has shown to not cause immediate inflationary effects although longer term, and we are entering that time period, it may well be inflationary. The banking system has massive reserves. The labor market is tightening. Capacity utilization is at a high level and household debt service payments to income ratios have returned to a historical norm.

    I agree for gold to rebound it’s going to take a reversal in the USD. I predict 5% inflation in the United States and a depreciating dollar within a couple years driven by an expansion of credit and the response being a major backing up in interest rates from the Fed. I believe we are back in 2004 economically. Gold prices don’t necessarily inversely correlate with interest rate movements if the increase in rates is because of higher inflation. In the near term a 2015 rate hike is an impediment to gold prices if inflation stays muted and I believe it will for now, but in the medium to longer term I’m bullish on gold, energy and shipping especially given the current valuations. These companies are are extremely inexpensive if the horizon is inflationary.

    February 17, 2015 - 7:42 PM

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