Comparing the price of oil and gold

The oil-to-gold ratio bottomed out last summer at 6.17 - that means it took 6.17 barrels of oil to buy an ounce of gold, which represented a 25-year low for the price of gold in barrels of oil.

This week it took nine barrels of oil to buy an ounce of gold. But gold is far from getting expensive in terms of barrels of oil.

In 1988 this ratio reached its all-time peak of 33, though that was due to weakness in the oil price and not the strength of the gold price. Nevertheless, if the same ratio were reached with oil at its present price that would put gold at $2,000 an ounce.

$1,000 an ounce gold?

Perhaps then the upside target for the gold price of $1,000 within a few years set by Newmont Mining this week was a shade pessimistic. There is also the question of the oil price itself to consider.

Opec's move to limit supplies this week confirms the oil cartel's intention to support much higher oil prices than we have seen in the past two decades. Oil ministers have not forgotten the lesson of 1998 when a crass move to boost output in the face of falling demand after the Asian Crisis crashed oil prices to $10 a barrel.

The back-chat from ministers was that $40-50 a barrel is now an acceptable price range; three years ago we had a $22-28 per barrel price range. Does that mean that gold should therefore be double the price it was three years ago?

Given that the world supply of gold is inflating by only 1-2% a year, then there does appear to be a pricing anomaly, which is now being addressed in the marketplace. For gold prices could be comfortably at $700-$750 an ounce just to catch up with the inflation of oil prices.

For investors perhaps a cyclical rotation out of oil stocks and into gold and precious metal related assets is an obvious next step, and to judge from recent movements in the gold price this might be already happening.

An oil and gold price spike?

However, the possibility of another spike in oil prices should not be entirely discounted. Random events like the huge explosion at the Buncefield oil depot in the UK this week are a stark reminder that oil markets remain relatively tight, and that unanticipated events can easily rule this market and send prices higher.

It could well be, however, that gold and oil prices begin to move in tandem, and that the days of gold trading at a 25-year low in relation to the oil price are now over.