Global Investing

Barrels and ounces

September 2, 2008

The price of oil was falling sharply on Tuesday after traders stopped worrying about former Hurricane Gustav’s winds, but by at least one calculation it remains very pricey – that is, its link to the price of gold.Some market watchers argue that there is a long-term relationship between the prices of the two commodities. Roughly speaking, this theory would have 10 barrels of crude oil costing the same as one ounce of gold.  Back in March, for example, gold hit a record of $1,030 an ounce and a barrel of oil brought around $105.Oil

By July, however, gold had fallen and oil had risen to the extent that the ratio was not 10 to 1, but 5.9 to1. Some argued at the time that hedge funds noticed this and began to short crude. With the latest tumble, oil is about 27 percent below its high. But against gold, the ratio is still at 7.4 to 1.

The problem is that gold won’t stop falling either, which rather undermines the ratio theory. Perhaps it is all just hooey. If it is not, however, oil would have to dive another 25 percent to reach equilibrium of $79 a barrel against today’s gold price.

Comments
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Another factor in the price of oil verses gold, is the fact that the former happens to be a consumable product that makes the world go around. If there is stress to the processing and distribution capacity, or increased global automobile usage the price of oil will rise according to supply and demand.

It is true that more middle class worldwide means a greater demand for gold, but in times of a credit crunch people will drive to work and sell their trinkets.

 

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