TYING INTEREST RATES TO THE GOLD-OIL RATIO

Commodity prices play a major role financial markets globally and impact the world economies in a significant way. Record prices in agricultural commodities, energy and metals have brought about a new aggregate demand element that enriches exporting countries’ revenues and casts a pall on trade balance in importing countries. Gold and oil prices have made records and left forecasters challenged because of the unprecedented levels that these commodities attain. As opposed to looking at these two commodities separately, an examination of their interrelationship can provide a valuable overview of the global economy, and the economy of the US in particular.

There were times when oil was trading between $1 and $1.5 per barrel, this is when the US dollar was backed up by gold, $35 per ounce. The dollar got out of the gold standard because the US was unable to back its dollar at the rate of $30 per ounce of gold. The dollar weakened in relation to value and gold prices shot up from below $40, an ounce, 1971, to over $60 an ounce in 1972.

Oil producer’s exports value was eroded by the weakening of the US dollar, this forced the oil cartel to hike oil prices from below $2 a barrel, 1971 to $13 a barrel- 1974. The dynamics brought the relationship between gold and oil into a balance once again, bringing the gold to oil ratio to a triple value (34.0), compared to two preceding years. The soaring inflation in the US prolonged the decline of the dollar and the price of gold was boosted by the escalating geopolitical tensions, this brought about the rebalancing of the gold/oil equation and consequently brought a historic average gold to oil ratio of about 15.0 monthly.

The measurement of the prices of gold against oil provides an important perspective on these commodities’ true value. This is because it offers a useful and different alternative to the measurement of the commodities individually using the currency against which they are usually priced. The prices of the two commodities have an overall similarity in trends against the dollar and this leaves most traders with no indications as to which between the two has more secular strength and which one is a leader in commodity dynamics. Oil prices are influenced by a number of fundamentals such as OPEC supply decisions, weather, inventory data, global growth and geopolitics, Gold prices, on the other hand, are controlled by central bank purchases and sales, geopolitics, inflation, production and money policies.

There is more than meets the eye in the gold-oil relationship. The prolonged gold/oil declines that have existed since 1972, have proved to be the US economy’s drag, this has caused recession in most of the cases. This situation has exposed the fact that oil prices in relation to gold prices, have increased sufficiently to a point of impacting global growth and slowing the demand of oil in the world. In many cases, the prices of gold and oil might be on the rise, but it is the increase pace of one of the commodity in relation to the other that determines the possible impact it will have on the growth of the economy.

The rising demand for energy and industrial metals is responsible for the boost of these commodities’ prices. There are however some advances in oil that might result in the significant changes in oil prices, that outpace any gains in the prices of gold ultimately weighing on the ratio.