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Gold vs Oil

Many economists and industry experts suggest that there is a strong correlation between the spot gold price and oil, and typically this analysis relies on data covering a long period of time, which tends to flatten out any inconsistencies in the theory. In general these theories suggest that when the price of gold increases so does oil, and when oil price fall, then gold prices will follow. If investing and trading were really that simple then we would all be multi billionaires and I wouldn’t be sitting here writing this item. If you do listen to, or watch the financial channels and newswires regularly, then I’m sure you will have seen the headlines that oil had another bad day and that gold prices followed, or that oil prices have risen sharply sending gold to new highs! These and other headlines leave one with the impression that daily crude oil prices drive the spot gold price market, which is simply not the case. Whilst there are undoubtedly positive correlations between the two commodities over certain long periods, there are others where an inverse correlation can be shown to be the principle relationship, and in my view it is too simplistic and naive to suggest that one dominates over the other. If we consider some facts for a moment, then I hope this will make the point. From the mid 1960’s and for approximately a 30 year period the correlation between gold prices and oil prices averaged around +0.88. Now for those of you new to correlation this simply means that they both moved in the same direction and anything between 0.80 and 1.00 is generally considered to be a meaningful relationship. From this period until the new millennium of 2000, there was no correlation whatsoever and in fact the average was negative at around -0.15. Since 2000, the correlation has returned to a positive one, but not so strongly with an average of around +0.70, which in my view is weak, and certainly not one I would rely on for long term trading. Indeed in the last few months we have seen daily oil prices falling dramatically with no equivalent percentage fall in the price of gold.

So were gold prices driven by those of oil in this period, or were they simply driven up by other forces. My own view, for what it is worth, is that changes in the oil price are neither here nor there as far as the price of gold bullion or coins are concerned. Under the current monetary system the directions of the long-term price trends in oil and gold will tend to be the same because inflation is a primary driver of both markets, but it is what’s happening on the monetary front, not what’s happening with oil supply and demand, that matters to the gold market. Investors and traders who simply rely on the gold to oil relationship as their only research would be well advised to base their decisions on other factors, of which there are several. The first of these is inflation, and when inflationary pressures start to enter the market, gold is often seen as a wealth preserver during such times. Secondly I would look at the relationship of gold to the S & P 500, and also at the 10 year T bills – several studies having shown a strong correlation here. Finally I would look at gold to silver and gold to the US dollar.

As William Rees-Mogg, former advisor to UK Prime Minister Margaret Thatcher, once said, “people rightly buy gold when they see inflation ahead. I believe today inflation should cause us to be very anxious once again”. He was speaking in the late 70’s when inflation was hurting every country around the globe. In the United States at the time, inflation was running at around 13% with the cost of living increasing by 16% in just one year, or looked at another way, the value of money had dropped by almost 1/6th. In today’s economic landscape of low or zero interest rates, it is ( in my view) the inflationary or deflationary pressures that will set the tone for gold prices, not the correlation with oil.