Record high gold oil ratio: a harbinger of doom?

All it takes to buy 37 barrels of oil, at spot prices, is one ounce of gold.

Thanks to an increase in the price of gold coupled with plunging oil prices, the gold-crude ratio – a measure of how many barrels of oil that can be bought with a single ounce of gold – is at a record high of 37x.

The prices of oil and gold often rise and fall in tandem, with rising oil prices spurring demand for gold as a hedge against inflation. The current ratio shows that oil is very cheap relative to gold. According to research from Convergex, the 30-year average gold crude ratio is 17x, indicating crude oil should be trading around twice as high than its current price in order to maintain its historic price relationship with gold.

“The spike in the ratio has more to do with oil than gold as the extent of the drop in the price of oil, in dollar terms, is far more than that of gold,” said Jean Pierre Verster from 36ONE Asset Management.

Gold appears to be supported by geopolitical fears and concerns about inflation, while a supply glut driven by the shale oil boom in the United States, Saudi Arabia’s refusal to cut production, and a weak global economic environment has seen oil prices come under acute pressure. The lifting of sanctions against Iran this week has also added to oil’s woes.

According to Zero Hedge over the past 30 years, a spike in the ratio has resulted in “something systemically serious” on a global scale (see chart below).

(Click to enlarge)

But Verster advises caution when dealing with ratios. “The movements of the two parts can sometimes lead to strange and non-intuitive outcomes. This ratio has blown out, but it doesn’t necessarily mean much,” he said. He also noted that a spike in the ratio doesn’t necessarily point to a coming crisis. “It didn’t spike in 2003; it didn’t spike before the dot-com bubble and it didn’t spike before the Gulf wars. It spiked at the end of 1998, during the Russian rouble crisis and not before it.”

“The more extreme the ratio gets, the more likely it is to change,” said independent analyst Ian Cruickshanks. Reviewing long-term oil price data, he said oil is currently within the $10 to $40/barrel range in which it traded from 1980 to 2003. Thereafter, a surge in liquidity in financial markets, spurred by the US Federal Reserve after the 9/11 terrorist attacks, caused prices to spike all the way up to a peak of $140/barrel in 2008. He said the financial crisis caused prices to fall to a previous peak of $40/barrel before recovering the $100 to $120/barrel range maintained until 2014.

“If oil prices remain low, the price of energy will not drive inflation. The new hedge against inflation will be the dollar and not gold, which is bad news for commodity producers like South Africa,” Cruickshanks said, forecasting GDP growth of 0% this year.

The International Monetary Fund expects the South African economy to grow by 0.7% this year as a slump in commodity prices and weak demand persist.

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