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A Monday Morning Musing from Mickey the Mercenary Geologist
Contact@MercenaryGeologist.com
September
3, 2018
Today I document and
analyze gold and oil prices and their ratios from January 1970 to August
2018. This is the second part of our research and analysis on gold-oil ratios
since World War II.
As a reminder, we use
monthly average London gold prices provided by Kitco.com and monthly average
oil prices for West Texas Intermediate Crude (WTI) sourced from the United
States Energy Information Administration (EIA).
Last week, I reviewed
prices and ratios of gold and oil from 1946 thru 1969 when both commodities
were fixed by fiat in US dollars.
In a series of three
steps from 1971 to 1973, the United States withdrew from the 1944 Bretton
Woods agreement, devalued the dollar, and freely floated it against gold.
When other industrialized countries floated their currencies in March 1973, a
new world economic system was established with the US dollar as the world’s
reserve fiat currency
The monthly average price
chart for gold (red) and oil (blue) from January 1970 thru July
2018 is shown below:
 
The chart shows that the
prices of gold and crude oil are most often positively correlated but oil is
generally more volatile. At times there is a strong negative correlation.
Both commodities are subject to exponential rises, parabolic falls, and
short-lived spikes.
Over the 584-month
period, gold to oil ratios exhibit wide variance, extreme volatility, and a
very broad range from lows near six to highs above 30:
The ratios are distributed
in a positively skewed bell curve with a mean of 15.9, a median of 16.2, and
very few outliers on the lower end:
The distribution is shown
in tabular and histogram formats below:
Distribution
of Au:WTI Ratios1970-2018
From our data set and the
distribution of monthly average gold to oil ratios from January 1970 thru
August 2018, observations follow:
·Ratios < 8.0 are
quite unusual, occurring over 11 months or less than 2% of the time. They
occurred in November 2000, six months during the spring, summer, and fall of
2005, and from May to August of 2008.
·Ratios from 8.0 to 10.0
constitute one-tenth of the record.
·Au:WTI from 10.0-12.5
comprises over a fifth of the monthly ratios.
·The ratios between 12.5
and 17.5 occupy nearly a third of the distribution.
·Ratios from 17.5-23.0
make up slightly more than one-fifth of the data.
·The 23.0-30.0 interval
covers about one-tenth of the months in our compendium.
·The 12 monthly outliers
at > 30.0 comprise slightly more than 2% of the total record. These
abnormally high ratios occurred twice in 1973, 1986, and 1988 respectively,
and six times during the summer and winter of 2016.
Our treatment begins in
January 1970 when both gold and oil prices were largely fixed with an
anomalously low ratio at 10.4. The ratio remained quite low at 11.5 or less
until the so-called Nixon Shock in August 1971 when the “gold window” was
closed. This action was followed by two official dollar devaluations before
it was completely severed from gold in February 1973. Other industrialized
countries floated their currencies on world exchanges a month later.
Rampant US inflation from
oil imports, the Vietnam War, expanding social programs, and the Federal
Reserve expanding money supply resulted in a five times increase in gold
prices in the early ‘70s.
In July 1973, gold soared
to $120 an ounce while oil remained fixed at $3.56 a barrel. The gold-oil
ratio rose dramatically to nearly 34. In the next five months, WTI was
officially priced at $4.31/bbl but because of ample supplies, actually sold
for less than that on the open market.
In 1956, King Hubbert
predicted that US oil production would peak in 1970. And indeed that came to
pass in late 1970. Production declined rapidly and imports doubled from three
million to over six million bbl/day in 1973.
Turmoil hit the
industrialized world in October when OPEC initiated an embargo targeting
eight countries that supported Israel during the 20-day Yom Kippur War. The
embargo lasted for six months and the posted WTI price rose 235 % to $10.11
in January 1974. Despite a steadily rising gold price that reached over $170
in April, this effectively halved the gold-oil ratio to its common range in
the middle teens.
Fallout from the
devaluation of the dollar, its free-float to gold, and the rise in oil prices
led to the 1973-1974 stock market crash. The Dow lost 45% of its value, there
was a severe recession with GDP contracting over two percent, and inflation
surged to 12%.
With steadily increasing
prices for both commodities, the gold-oil ratio remained low for the entire
remainder of the decade, generally from 10 to 15. It briefly fell below 10
from mid-1976 to early 1977 when the set price of WTI was bumped 15%.
The Iranian Revolution in
early 1979 and the eight-year Iran-Iraq War that started in 1980 were catalysts
for a commodities boom from early 1979 to mid-1981. Both gold and oil had
exponential rises. Global oil supplies were cut by about 14% by these two
events, another recession ensued, and rampant inflation followed in the early
’80s.
Gold spiked 400% from the
low $200s in January 1979 to $843 an ounce in January 1980, a price level not
reached again for 28 years. Its January monthly average was $675. Oil went up
260%, from $15.85 in April 1979 to a record high of $39.50 in April 1980.
Ratios were not much affected, staying mostly at the mid-teen level except
for the spike in gold in January-February 1980.
In April 1979, President
Carter began deregulation of oil that had remained in place since Nixon
instituted price controls in 1973. In January 1981, President Reagan signed
an executive order finally allowing US oil to trade freely in the open
market.
In late 1981, an oil glut
developed with slowing of economic activity in industrial countries,
increasing production driven by high prices, and a decrease in consumption
spurred by conservation measures. Oil and gold prices trended somewhat lower
over the next four years and the ratio generally ranged from 11 to 13 thru
1985.
In early 1986, the Saudis
got fed up with other OPEC members’ non-compliance with production quotas,
opened the taps to full capacity, and flooded the world with surplus oil.
Prices dropped like a rock, bottoming at little more than $10 in the US and
$7 in the Middle East.
The gold-oil ratio jumped
into the 20s and stayed above that mark thru February of 1989. It reached
highly anomalous levels above 30 for two months during 1986 and for two
months in 1988. Gold traded above $400 while WTI was generally priced in the
high teens after the market readjusted.
This long-lived drop in
oil prices severely affected the USSR’s balance of payments, leading to
economic instability and its demise in 1991.
When the Exxon Valdez ran
aground in southern Alaska in March 1989 and spilled 250,000 barrels of crude
oil, prices popped above $20 for the first time in nearly two years. Au:WTI
fell below 20 for the first time in more than three years.
The next big shock to oil
markets happened when Iraq invaded Kuwait in August 1990. While gold hardly
reacted to this geopolitical event, oil doubled in price. It averaged $39.57
a barrel in September and the ratio fell below 10 for that month. But much
like the Gulf War, high oil prices were short-lived and in January 1991 were
back to the $20 level.
The Soviet Union
collapsed in December 1991 and the prices of gold and oil barely moved. For
the next six years both commodities were range bound, in the $300s for gold
and high teens to low twenty dollar range for oil; ratios were in the middle
intervals. The 1997 world economic recession known as The Asian Contagion knocked
gold below resistance at $300 in December of that year and oil fell below $12
in November 1998.
Gold remained below $300
for the next 3.5 years and many mines were shuttered. Fueled by the dotcom
bubble, US stock markets were roaring by mid-1999 and world oil prices surged
to $33 a barrel in November of 2000. Very low ratios were the result,
commonly less than 10.
Tech stocks took NASDAQ
to record highs above 5000 in March 2000 and its subsequent crash took 78%
off the market value at bottom in October 2002.
Despite the chaos that
ensued after the 9-11 terrorism in 2001, this geopolitical event that
continues to negatively affect America’s economic well-being and foreign
policy had no discernible effect on gold and oil prices or ratios.
Soon an incipient bull
market for commodities commenced when gold broke thru 4.5 year resistance at
$310 in April 2002. Oil remained in the $30 range before starting its rise in
conjunction with gold going above $400 in late 2003.
Thus began a five-year
boom across the sector with record highs for the major world-exchange traded
commodities including gold, oil, copper, and uranium. Gold and oil rose
concomitantly and ratios were uniformly very low including record outliers
below 7.0 in the spring and fall of 2005 and in mid-2008.
Gold reached a high of
$1008 in mid-March 2008 and averaged $968/oz that month. Oil’s all-time high
of $145/bbl was set in June and the ratio hit an all-time low of 6.4.
Then Lehman Brothers
failed in September and the global economic crisis followed. All commodities,
including gold and oil, went parabolic within a couple of months. Gold fell
to $714 in mid-November as speculators liquidated holdings to cover margin
calls. Oil touched $30 in late December.
The downturn was
short-lived for gold with safe-haven buying in early 2009. Gold-oil ratios
more than doubled to levels in the mid- to high-teens versus the outlying
single-digit base of the previous two years.Oil recovered slowly but steadily
as a second leg of the secular bull market for resources commenced.
Gold soared in an
exponential pattern, hitting its all-time high of $1895 an ounce in
mid-September 2011 with a monthly average of $1772. A two-year top became a
predictable parabolic fall in May 2013. Gold reached its nadir at $1049 in
mid-December 2015 for a 45% drop off the all-time high.
Oil prices were volatile
during this time, ranging mostly from the mid-$80s to low $100s a barrel.
Ratios fell within our most populated range in the mid-teens.
These ratios shifted
dramatically when oil crashed in Q4 of 2014, falling from an average of $106
in June to $28/bbl in January 2016. Gold was overvalued with respect to WTI
(ratio >23.0) during the three-year crude oil downturn.In fact, it reached
the two highest ratios ever in January and February of 2016 at 38.5 and 37.8
as all hard commodities bottomed.
Late January 2016 was the
nadir of a five-year down market for gold and it rallied strongly from there,
topping out at $1341 for the month of August. Oil prices also bottomed but
remained severely depressed until mid-2017. Ratios were at high to anomalously
high intervals until recently.
In 2018, gold averaged
over $1300 from January to May. A long summer downturn combined with a strong
US dollar took gold to a 2.5-year low of $1173 in mid-August. While gold has
fallen, oil has rallied to a post-crash high ranging from $65 to $74 per
barrel.
Recent performance
illustrates that commodity ratios always normalize in due course; we have
seen that over the past few months with gold and oil. At 17.3 - 17.6 from
June to August, the gold-oil ratio is now within its most common 48-year
historical range and is not far off the mean of 15.9 and median value of
14.7.
Fluctuations in the
relative prices of gold and oil are driven by:
·overall health and
growth of the world’s economy.
·economic and/or
geopolitical uncertainty resulting in accumulation of gold as a safe haven;
·supply-demand
fundamentals for crude oil, which is used mainly as fuel for internal
combustion engines but also for power generation, heating, and chemicals;
·geopolitical events that
cause disruptions in oil supply and delivery;
·buying and selling of
gold by central banks;
·trading and speculating
in paper markets of both commodities including bullion exchanges, ETFs,
futures and options, and other derivative markets.
Physical trading of gold
and oil are huge markets. That said, their paper and derivative instruments
are orders of magnitude larger than the physical supplies available and
constitute the two largest markets traded on world commodity exchanges.
The gold to oil ratio is
useful to determine if one commodity is valued fairly with respect to the
other and is a useful parameter to predict future price movements. The ratio
can also help determine the timing of speculations in the physical commodity
itself, futures, options, and other derivatives, and/or equities and
businesses that are part of the supply chain.
In the previous 24-year
period (1946 to 1969), prices were fixed by fiat and an ounce of gold bought
on average 13 barrels of oil. In this 48-year interval (1970-2018) with the
dollar floating against gold starting in 1973 and completely deregulated WTI
prices after 1980, an ounce of gold on average bought about 16 barrels of
oil.
However, the greatest
change has been the high variance and extreme volatility of gold-oil ratios.
Folks, this is a good
lesson in how capitalism works.
In a free marketplace,
prices move up and down for a variety of reasons, some of which are tabulated
above for gold and oil. A free market presents multiple entry and exit points
for investors, traders, and speculators to profit. I embrace this volatility
and suggest that you should, too.
Now on to practical
matters:
As followers are aware, I
view gold as the only money. It is my insurance policy against financial
calamity and economic collapse. I do not invest or speculate in gold.
As a hoarder, my basic
strategy for accumulating gold or other precious metals is to buy during
downticks in price regardless of bull or bear market cycles.
And indeed folks, this is
what I did over the past few weeks when the price of gold headed south.
Ciao for now,
Mickey Fulp
Mercenary Geologist
Acknowledgment: Troy McIntyre is the research
assistant for MercenaryGeologist.com.
The Mercenary Geologist
Michael S. “Mickey” Fulp is a Certified Professional Geologist with a
B.Sc. Earth Sciences with honor from the University of Tulsa, and M.Sc.
Geology from the University of New Mexico. Mickey has 35 years experience as
an exploration geologist and analyst searching for economic deposits of base
and precious metals, industrial minerals, uranium, coal, oil and gas, and
water in North and South America, Europe, and Asia.
Mickey worked
for junior explorers, major mining companies, private companies, and
investors as a consulting economic geologist for over 20 years, specializing
in geological mapping, property evaluation, and business development.In
addition to Mickey’s professional credentials and experience, he is
high-altitude proficient, and is bilingual in English and Spanish. From 2003
to 2006, he made four outcrop ore discoveries in Peru, Nevada, Chile, and
British Columbia.
Mickey is
well-known and highly respected throughout the mining and exploration
community due to his ongoing work as an analyst, writer, and speaker.
Contact: Contact@MercenaryGeologist.com
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