Gold Boiling in Oil

Adam Hamilton June 30, 2000 3632 Words

"Everything is soothed by oil … because it smooths every part which is rough."
Natural History, Book ii, Sect. 234 Pliny the Elder. 23-79 A. D.

Although our friend Pliny was not pontificating on crude oil, his quote still rings true in a
new context almost two millennia after he uttered it. Interestingly, even before Pliny,
bitumen, globs of jellified crude oil tar, was among the most valuable commercial products
in the world 2,400 years ago. The Nabataeans built a great empire centered in the
legendary city of Petra (in modern-day Jordan) financed by collecting bitumen from the
Dead Sea area and exporting it to Egypt and the rest of the ancient world. They obtained
so much wealth that they instituted a punitive tax on members of society who became
POORER!

In the modern industrial economy that has sprung up around the world in the last century,
bitumen’s present day commercial equivalent, has, in a very literal sense, become the
lifeblood of the global economy. Cheap crude oil has fueled some of the most astonishing
advances of the 1900s, including a vastly increased scale of global trade, the birth of
heavy industry, rapid and (relatively) painless global transport of people, and that
consummate icon of Americana , the automobile. Crude oil, enabling the efficient
movement of goods and people, has brought us into an era where distance is rapidly
becoming irrelevant.

With every good we consume having a small cost component representing the cost of oil
burned in transport, the price of crude oil has far reaching effects on the economy. Any
material changes in the price of oil can rapidly cascade through the global economy and
markets, creating large ripples capable of altering the price structure of almost every good
and service produced. With apologies to Pliny, every economic thing is indeed soothed by
cheap oil, because it smooths out costs of global transport and enables true worldwide
commerce.

Crude oil has astonished analysts and consumers alike in the last 18 months, rocketing up
an incredible 200%. Even folks not interested in studying the markets are seeing the
effects of higher crude oil in their pocketbooks, as gas prices continue to rise at the pump
and more and more companies tack on fuel surcharges. In addition to heralding inflation,
oil has historically had a very high positive correlation with the undisputed king of assets,
gold. In this essay, we will explore the historical relationship between gold and crude oil.

To begin, we will take a look at 55 years of monthly gold and crude oil data in nominal US
dollars. Several themes on this graph stand out dramatically. First, from 1946-1971, gold
and oil prices were flatlined. This lack of price volatility in oil was a great asset to the
booming post WWII US industrial economy. Oil price volatility greatly complicates
strategic industrial planning, and increases risk aversion to new ventures heavily
dependent on crude prices. From 1972-2000, however, gold and oil prices look like an
electro-cardiogram of a hamster on speed. With Nixon’s fateful decision to sever the
critical link between the US dollar and gold in 1971, all semblance of discipline in fiat
currency growth was forever vanquished. The wild gyrations on the right side of the graph
are the direct result of the lack of prudent restraint of fiat currency growth. The second
critical theme to note is the recent divergence of the correlation numbers. From 1946-
1994, gold and crude oil had a very high positive correlation of 0.92. The correlation is
highly logical, as gold and crude have almost always both performed extremely well in
periods of inflation, as they are both REAL assets that always appreciate in fiat currency
terms over the long run. From 1995-2000, however, strange things are apparently afoot
in the gold and crude relationship. The correlation drops to an unbelievable 0.07! So
what the heck happened in 1995 to obliterate a previously rock-solid relationship? The
following graph of the S&P500 versus M3 offers some important clues…

In 1995, for some reason, the US Federal Reserve embarked on an unprecedented binge
of M3 growth. Shortly after the famous “Irrational Exuberance in US Equity
Markets� speech given by Chairman Greenspan, the Fed chose to open the blowout
valves and unleash a deluge of liquidity into the US economy. Like rain from a hurricane,
all the new fiat dollars had to go somewhere, and the destination of choice was the already
overvalued US equity markets. The phenomenal exponential growth of the S&P 500
following the massive goosing of M3 is very evident in the graph. Money available in an
economy and stock market valuations have generally been strongly positively correlated
all throughout history, in many different countries. In the US , M3 and the S&P had a 0.92
correlation between 1959 and 1994. That correlation shot up to an incredible 0.99
between 1995 and 2000, as the Fed fiat fire hose was turned on full bore and stuffed down
the throat of the US equity markets. Like Dr. Frankenstein’s diabolical creation, a
credit bubble was born.

Gold has been the most sensitive barometer imaginable to inflation, throughout all of
human history. As the proverbial canary in the fiat coal mine, gold always announces fiat
currency problems (inflation, or debasement as it was called in the past) in advance by
rising dramatically in value. Many brilliant analysts, including the Gold Anti-Trust Action
Committee, have hypothesized that the US government began operations in 1995 to
suppress the price of gold. By artificially capping the gold price in US dollars, the world
financial community would be blinded to the reckless growth in US money supply and
inflation numbers, and be deluded into thinking the US economy was in far better shape
than M3 growth alone would suggest. The alleged methodologies used by the government
in suppressing the gold market include selling gold derivatives contracts in the open
market, persuading other central banks to loan or sell physical gold into the market, and
commissioning certain key money center bullion banks to cap fledgling gold rallies.
Although a discussion of gold market manipulation since 1995 is beyond the scope of this
essay, I strongly encourage everyone to visit www.GATA.org and carefully read the Gold
Derivative Banking Crisis document recently presented to every member of the US
Congress. This document offers a mountain of evidence on why the historic gold and
crude price relationship has all but vanished. Although the canary seems to be dead,
history suggests it is simply feigning. Gold is no ordinary canary, and it has easily burst
asunder all iron bands with which men have vainly tried to bind it.
Continuing our gold and crude oil analysis, we will take a look at gold and crude oil in
REAL inflation adjusted prices. Constant May 2000 dollars are used, inflated by historical
Consumer Price Index growth.

Adjusted for inflation, even $30 oil seems cheap relative to the early 1980s! In terms of
today’s dollars, gold was trading at over $1,500 per ounce in the 80s. Prior to 1971,
in real terms, even the price of oil was declining, obviously very healthy for the US
economy. The consequences of the fateful fiat decision in 1971 are even more apparent
when viewed from a real perspective. The last few years of the chart are also most
interesting. Generally, over the last 55 years, gold and oil have moved in close
sympathy. As the graph shows, however, the recent sharp spike in crude oil prices has
not been shadowed by gold. To further explore this anomaly, we will take a look at the
historic gold to crude oil ratio.

The average gold to crude oil ratio (gold price divided by crude oil price) for several
different periods of time is shown in the graph above. For the last 55 years, an ounce of
gold has been worth about 15x as much as a barrel of crude oil. (This relationship is
exactly the same in nominal AND real dollars.) The dotted blue-line shows the linear trend
of the data, indicating a rising of the gold to oil ratio. Over the last twenty years, for
instance, the ratio has risen to over 17x. Currently, the ratio is at an unsustainable low of
9. This level has only occurred two other times since 1946. Each time levels below 10 are
seen, they proceed a sharp and sustained rally of the ratio back above the historical
average. There is no reason to believe the present low will last any longer than historical
precedence indicates. There are only two events that can bring this ratio back into line. A
sharp rally in gold prices, or a sharp drop in crude prices. Which event is more probable?
A mega-rally in the price of gold, or $15 crude oil?

Before we explore that question, which has phenomenal implications to the future
performance of almost every investment in the world, including global stock markets, we
will take another look at the gold to crude oil relationship from a different perspective…
the cost of oil as denominated in gold.

The above graph shows the ounces of gold required to purchase 100 barrels of crude oil.
This measurement is particularly important for oil producing nations. Oil, of course, is a
wasting asset. Sooner or later, all oil producing countries, including Saudi Arabia and
Kuwait , will run out of oil. As an oil selling country, one’s primary motivation is to
maximize the return on the sales of the wasting asset. For 6,000 years, the only real
store of wealth that has survived every government, currency, and war has been gold. As
an oil producer, there is no better trade for the temporary asset of oil than the seemingly
eternal asset of gold. Although OPEC loves to be able to buy almost 11 ounces of gold for
each 100 barrels of oil they sell, this perspective also shows the current price anomaly.
Historically, the average gold cost per 100 barrels has been in the 6 to 7 ounce range.
There have only been two other times in modern history when the gold price of oil has
exceeded 10 ounces, and each time was an incredibly short-lived spike that soon
plummeted well below the historical average. The 55 year equilibrium cost of oil in terms
of gold can not sustain such high oil valuations, and gold catapulted northward each time
these high relative oil costs were seen in order to bring the gold cost of oil back in line
with historical levels. As with the gold to crude ratio discussed above, the current high
gold cost of oil will not be an exception to history. Once again, only two events can solve
this oil valuation problem. A sharp rally in gold, or a massive drop in crude. The decision
between these two contenders could have a massive impact on the future net worth of
everyone who holds assets valued in US dollars. In order to determine whether gold up or
oil down has the highest probability, some brief technical and fundamental analysis is in
order.

Yet another look at real gold vs. real oil, from 1977 to 2000, from a technical
perspective…

The technical 23 year charts of gold and oil are very similar. Both exhibit formations
known as descending triangles, a type of horizontal triangle that denotes imminent change
as the formation nears its apex. As many technicians have pointed out, a descending
triangle is typically a powerfully predictive chart formation. When a commodity or stock
enters a horizontal triangle with a strong upward movement, like gold and oil have, the
formation is considered bullish. When the triangle is broken, the commodity tends to
move sharply upward. Oil is already exhibiting this characteristic, and is having a
technically significant breakout. The breakouts from descending horizontal triangles are
typically violent, with rapid price movements. Technicians usually expect the breakout to
reach a level at least equal to the base of the triangle, an amazing $85 per barrel for oil, in
this case! From a technical standpoint, the probability of oil trading below $15 per barrel
to bring the gold oil ratio back in line is virtually nil. Gold is the real superstar of the
chart. Gold’s 20 year descending horizontal triangle has reached its apex, indicating a
large probability of an imminent move. In addition, gold entered the triangle with an
extremely strong bull move to a high of over $1,500 per ounce in 2000 dollars. The chart
predicts a very high probability of a violent jump in gold to the upside, similar to oil’s
recent breakout. The chart also indicates a price target for gold of over $1,500 per ounce,
a fantastic gain over today’s depressed levels. From a technical standpoint, the
probability of a rise in gold is vastly higher than the probability of a drop in oil. Although
the technical picture is bullish for gold, it pales in comparison to the fundamentalist slant.
We will leave the charts to the technicians and analyze some fundamentals.

From a fundamental standpoint, the bullish case for gold AND oil is extremely compelling.
First, let’s take a brief look at bullish oil fundamentals…

o Global oil demand is growing rapidly, and projected to keep growing dramatically for
the next decade. China and India alone, representing over a third of the population of the
planet, are industrializing rapidly and will need vast amounts of oil to fuel each of their
billion people plus population economies. Americans, which are estimated to consume
over a third of world oil produced currently will not give up their gas guzzling land yachts
for many years for two reasons. First, families feel more safe and secure driving 6,000lb
tanks than 2,000lb tin cans. Second, with the low savings rate and hand to mouth
existence of most Americans, few can afford new cars based on hybrid gas/electric or
future hydrogen cell technology. There is no global demand relief in sight for many, many
years.
o Global oil supply in production is stagnant. Low oil prices in recent years, coupled with
capital enamored with promiscuously chasing dot com type debacles, has left oil
production infrastructure in deteriorating conditions. In addition, existing wells have been
pumping for many years, often with artificially increased production levels through
techniques such as salt water injection. Artificially stimulated wells tend to rapidly drop off
in production when they near the end of their useful lives. Many of the major oil reserves
in the western world are nearing the end of their expected lives at present production
levels. Although many other large reserves exist which will be tapped, logistical realities
and political hoops indicate it will take many years to bring these reserves online. It takes
time to drill wells, set up transportation infrastructure, and bring new mega-well facilities
to a live state. Political maneuvering, such as the ban in drilling off certain areas of
California (wrecks the movie stars’ views, apparently) and the present US
administration’s staunch resistance to opening up vast Alaskan reserves makes rapid
increases in marketable supply in the western world unlikely. In the east, geopolitical
problems limit new marketable supply as well. Vast reserves exist in the landlocked
Caspian Sea, but they are surrounded by those paragon nations of peace and stability
including Russia , Chechnya , Azerbaijan , Kazakhstan , Turkmenistan , and Iran . For
many years western and eastern nations have been arguing over where to lay a pipeline
from Baku on the Caspian, but no agreement can be reached. The US wants the pipeline
to go through Turkey , which means it would have to go through the warzone in Chechnya
. Iran wants it to run through Iran . ( Iran has also offered to swap oil, filling western
tankers with Persian Gulf oil in exchange for western Caspian Sea oil delivered to northern
Iran .) Bottom line, it is a political mess that will not resolve itself overnight just because
oil prices are rising.

o Many brilliant petroleum analysts believe OPEC is operating at levels over 95% of
maximum production. Only Saudi Arabia is thought to have significant capacity left, and
even the Saudis have not upgraded oil infrastructure sufficiently due to the increasing cost
of their domestic social problems. Lots more oil is NOT coming from OPEC for a long time,
regardless of political grandstanding in the west.

o God forbid, if another war breaks out in the Middle East , oil is going stratospheric.
The region, as always, is rife with tensions. Iraq hates Iran. Kuwait and Saudi Arabia fear
both Iran and Iraq . Syria loathes Turkey . Everyone in the region except Turkey would
like to drive Israel into the sea and retake Jerusalem and the Dome of the Rock (the third
most holy site in Islam). Israel now has nuclear tipped submarine launched cruise missiles
to deter ballistic missile strikes from the Arabs. The whole region is a powderkeg, waiting
for an inherently unpredictable and errant spark. As an added bonus, Iran is currently
heavily fortifying the small island of Abu Musa , which is one of the most important
strategic islands on the planet. Whoever controls Abu Musa exercises unilateral hegemony
over all the oil in the Persian Gulf , as Abu Musa is the “cork� which bottles up the
gulf. If supertankers (the ultimate targets of opportunity in war, as one’s enemies
can’t fight without oil) can’t get out of the gulf, crude oil prices will reach heights
that are unfathomable today.

From a technical and fundamental standpoint, the future for crude oil is bullish. If the
prospects for crude are bright, the near future for gold shines like a supernova. Some
brief positive fundamentals for gold…
o Global gold demand is rising rapidly, fueled by everyday people living in the east who
have seen firsthand the effects of hyperinflation and despotic governments, and
empirically realize gold is the ultimate refuge in financial and political storms. With
Southeast Asia recovering from the recent financial crisis, gold demand is booming. As
history has taught over and over, the western equity credit bubbles WILL burst at some
point, and the consequences will be catastrophic financially. When western investors
began chasing gold to salvage some wealth as fiat paper and overvalued stocks burn,
global gold demand may jump by an order of magnitude or more. All the gold mined in
the history of the world would fit in a space a little larger than a 60 foot cube. When the
bubble bursts, there simply isn’t enough gold to go around.

o The annual rate of increase in the global mined supply of gold has continued to
dwindle. At recent prices of $255 to $290 per ounce, most mines in the world are
unprofitable and many are being mothballed. When the inevitable gold rally of legend
arrives, it will take many years to spin up capacity to meet demand, for the same reasons
discussed above in the oil fundamentals. The bullish supply and demand fundamentals for
the gold price in the next few years are phenomenal.

o Mountains of evidence continue to accumulate that western central banks have

conspired to suppress the price of gold to mask reckless expansion of fiat currencies.
Virtually irrefutable evidence also exists that many years of future gold production are
already spoken for, because several large money-center banks have borrowed many
thousands of tons of gold, which they promptly sold in the open market and used the
proceeds to invest in equities. These “naked shorts� will have to buy gold in the
open market to pay back their gold loans to bullion banks and central banks. It will
probably take a decade or more of heavy buying to repay this borrowed gold, which is
incredibly bullish for the metal. Also, as we see today, many governments historically
have tried to suppress the price of gold. As King Solomon wisely said, “There is
nothing new under the sun.� EVERY gold suppression effort in history has failed, and a
large gold rally always ensues upon failure of the manipulation, blasting to a new high gold
price level well above the market clearing equilibrium price. Today’s suppression
efforts will come to the same fiery end.

o As the real charts above show, gold is at 25 year real lows. All investments are
cyclical, and gold is the ultimate smart money contrarian play of the first decade of the
new millenium. There is not an asset class in the world that is as beaten down as gold.

So, very conservatively, completely ignoring all the incredibly positive technical and
fundamental factors for gold discussed above, what does the current gold oil relationship
indicate the short-term price of gold should rise to?

This graph speaks for itself. The heavy solid lines indicate the projected gold price (left
axis) at a given crude oil price per barrel (bottom axis) at the various historical gold/crude
relative valuation ratios noted earlier in this essay. The gold percentage gain axis on the
right (thin dotted lines) is the percent gain in gold from a market price of US$290/oz.
Once again this graph is incredibly conservative, not factoring in any of the amazing
fundamentals for gold and oil discussed above.
Great fires of demand are being stoked under the massive cauldron of crude oil as you
read this essay. The surface of the oil is beginning to boil. At the bottom of the cauldron
gold languishes, at ice-cold temperatures, defying all logic and physics. As the oil begins
to boil more and more violently, and the cauldron heats up, this gold boiling in oil will not
stay cold for long. It will absorb the relentless heat of the maelstroms of oil price
increases and fiat inflation scalding it from all sides. Sometime soon, gold will heat up so
much it will explode out of the seething cauldron and into the stratosphere. Are you and
your portfolio prepared?

Got gold?

What's Behind the Record Price of Gold?

What's Behind the Record Price of Gold?

By Corey Binns, Special to LiveScience

posted: 15 January 2008 ET

The price of gold continues to hit record highs this week, trading above $900 an ounce, but the
precious metal has been highly valued for thousands of years.

The latest high prices for gold are part of an upward trend that began in April 2001. Analysts
explain the bull market in gold by pointing to a slowing economy and the metal's increasing
scarcity in the ground.

“Gold is inversely correlated to the dollar,” said George Milling-Stanley, an analyst for the
World Gold Council, an organization funded by gold mining companies. “Gold is a safe haven in
times of political as well as economic turmoil.”

Trouble is, this extremely rare commodity is getting harder to find.

Miners don’t happen upon rich veins of gold today like they used to. Big mining companies
nowadays hope to find mere flecks. Although gold is mined in more than 60 countries, it is
estimated only 167,600 tons of gold have ever been mined. In comparison, 999 million tons of
iron are extracted annually.

Hard-to-reach pots of gold have become harder and harder to find, and not many new gold
mines have come into production in recent years. With the absence of big new discoveries,
demand for gold continues to grow, as does its price.

Still, with inflation taken into account, the price is nowhere near as high as it seems.

Golden elements
Most of the gold collected today becomes jewelry. According to the U.S. Geological Survey, 84
percent of the gold produced in 2006 was used for jewelry and the arts.

Gold’s chemical symbol Au comes from the Latin word aurum, which means shining dawn.
Combining gold with an alloy element such as nickel or palladium turns gold white.

Beyond its charm, gold’s unusual properties have put it to good use.

Pure gold is relatively soft, with the same hardness of a copper penny (try finding a penny
made of real copper, however). It is the most malleable and ductile of metals. Only copper and
silver are better at transferring heat and electricity than gold. In addition, gold is extremely
resistant to corrosion. Only a solution of cyanide can dissolve the hearty metal.

Gold’s properties have made it an essential industrial metal in technologies such as computers,
communications equipment, spacecraft, and jet aircraft engines.

The visors of astronauts’ helmets are coated in a thin layer of gold that reduces glare and
keeps them cool.

Gold Standard

Artisans of ancient civilizations used the precious metal to decorate tombs, jewelry, figurines,
and beads.

The oldest known objects worked from gold were discovered at a burial site in Bulgaria and
were made by members of the ancient Thracian civilization in 4400 B.C.

Since then many societies worldwide have used gold for jewelry and as money. Its monetary
value shone so brightly that it was a factor in driving Europeans to explore the New World .

During the 1800s, the United States and many other countries relied on a system of money,
called the gold standard, which fixed U.S. currency to the price of gold and silver.

The system was rocked when the SS Central America and its three tons of treasure sunk off the
coast of South Carolina in 1857. The loss led to the economic depression that lasted until the
Civil War.

In 1900 the Gold Standard Act officially set a golden value for the dollar, but the act did not
live long. In 1933 President Franklin D. Roosevelt outlawed private ownership of gold, except
for jewelry.

The Bretton Woods system of 1946 (which established rules for financial relations among the
world's major industrial states) allowed foreign governments to sell gold to the United States
treasury for $35 an ounce. But in 1971, President Richard Nixon ended the system, and
officially ended the gold standard. Since then world currencies have not been formally linked to
gold.

In the money

The latest price surge is not the first driven by economics and politics.
During World War I, a shortage of manpower closed many gold mines. Mines were brought
back into production during the Depression. In 1934, the price of gold was raised from $20.67
to $35 an ounce, and production increased to more than 4 million ounces annually.

Although the $1,000-an-ounce mark does have an unfamiliar and ominous ring to it, the World
Gold Council’s analyst Milling-Stanley points out that the benchmark is deceiving.

The previous all-time high of $850 in 1980 was the result of “a slew of special circumstances,”
Milling-Stanley told LiveScience, such as inflation, 40 years of pent up investing and the
perception that Jimmy Carter was a weak president.

After 28 years of inflation and a weak dollar, it will take a big push in the markets to surpass
the 80s high in real terms. Gold would have to hit $2,200 an ounce in today’s dollars to match
the 1980 price, Milling-Stanley said.

Inflation Risk

By Glenys Sim

Nov. 6 (Bloomberg) -- Gold held near a 27-year high in Asia after oil prices rebounded, fueling demand
for the bullion as a hedge against inflation.
Gold, heading for its seventh straight annual gain, has rallied 27 percent this year on the back of record
crude oil prices and a weakening U.S. dollar. Oil for December delivery rose 0.7 percent to $94.65 a
barrel in after-hours trading on the New York Mercantile Exchange at 11:44 a.m. Singapore time.
``It's pretty quiet this morning, with investors taking a break from the recent rally,'' Ellison Chu, manager
of precious metals at Standard Bank Asia Ltd. in Hong Kong, said. ``People are still friendly towards
gold as we're seeing a lot of buying on dips. Gold should be supported around the $802-$803 level.''
Bullion for immediate delivery gained as much as $2.70, or 0.3 percent, to $809.20 an ounce, and
traded at $808.83 at 11:44 a.m. Singapore time. Spot gold reached $811.20 an ounce yesterday, the
highest since January 1980. Silver for immediate delivery was little changed at $14.72 an ounce.
``All the factors favoring gold are still in place -- the dollar weakening, high oil prices,'' said Chu. ``At the
current level we don't see much physical buyers but they do emerge when price drops near $802.''
The dollar traded at 114.60 yen in Singapore, from 114.55 late in New York yesterday, and was at
$1.4477 per euro from $1.4469. Dollar-denominated gold prices tend to rise when the U.S. currency
falls as the metal becomes cheaper for non-U.S. investors.
Gold for December delivery on the Comex division of the New York Mercantile Exchange was little
changed at $811.40 an ounce at 11:46 a.m. in Singapore, after reaching a 27-year high of $814.20 an
ounce yesterday.
Tokyo Gold
In Japan, the most active gold futures contract rose above 3,000 yen for the first time in 23 years. The
contract for October deliver was up 0.8 percent at 3,008 yen a gram ($817 an ounce) on the Tokyo
Commodity Exchange at 11:47 a.m. Singapore time.
Gold priced in Japanese yen began trading on the electronic system owned by ICAP Plc, the world's
largest broker of transactions between banks.
``We have had strong interest from our customers for this metals pair,'' Darryl Hooker, global metals
manager, said today in a statement. ``Gold/yen can offer traders a new way to manage their risk
exposure, as well as offer current and new users attractive new arbitrage opportunities. ''

The Gold-Oil Ratio

The Link Between Gold and Oil
Gold and crude oil prices tend to rise and fall in sympathy with one another. There are two
reasons for this:

1. Historically, oil purchases were paid for in gold. Even today, a sizable percentage of oil
revenue ends up invested in gold. As oil prices rise, much of the increased revenue is
invested as it is surplus to current needs -- and much of this surplus is invested in gold
or other hard assets.
2. Rising oil prices place upward pressure on inflation. This enhances the appeal of gold
because it acts as an inflation hedge.

Gold Price History

The chart below starts with the Yom Kippur war between Israel and its neighbors in 1973 --
and the resulting Arab oil embargo when crude oil rocketed from $3 to $12/barrel. This was
followed by the 1978 revolution in Iran and the Iran-Iraq war in 1980 which lasted until 1988.
Iraq then invaded Kuwait in 1990, but the ensuing Gulf War had a limited effect on gold prices.

Gold went into a decline until awakened from its slumber on September 11, 2001. The
invasion of Iraq followed in 2003, initiating a strong up-trend, and prices have lately spurred
even higher as tensions escalate over Iran 's nuclear program.

Oil Price History

Yom Kippur started a huge spike in oil prices with the Arab oil embargo in 1973. This was
followed by another spike in 1978 at the time of the Iranian revolution, culminating with the
subsequent invasion by Iraq and the start of the Iraq-Iran war. The Saudis substantially
increased production in 1985 and the Iraq-Iran ceasefire further eased shortages in 1988. The
invasion of Kuwait and ensuing Gulf war caused a brief spike in 1990, but a relatively stable
period then followed -- until 1998 when OPEC increased production while demand was falling
due to the Asian financial crisis, causing a slump in prices. Subsequent production cuts saw
price recover, before September 11 and the 2003 invasion of Iraq heightened fears of further
shortages.

Readers need to bear in mind that the above prices are not adjusted for inflation. In today's
dollars, oil traded at close to $100/barrel and gold above $2000 during the 1980 crisis.

The Gold-Oil Ratio

The easiest way to eliminate inflation from the above charts is to express the two prices as a
ratio. How many barrels of oil you can buy with an ounce of gold:

Gold-Oil Ratio = Price of Gold (per oz.) / Price of Crude Oil (per barrel)
The gold-oil ratio helps us to identify overbought and oversold opportunities for gold. The chart
below shows solid support between 8 and 10 barrels/ounce of gold over the last 30 years, with
occasional spikes carrying above 20 but seldom holding for any length of time.

Signals

The gold-oil ratio identifies:

• Buying opportunities (for gold) when the gold-oil ratio turns up at/below 10 barrels/ounce; and
• Selling opportunities when the gold-oil ratio turns down at/above 20 barrels/ounce.

This article contains information upto year 2000 but its a good one to understand the
relationship between oil prices and gold prices.

Malik Mansoor Ali

Market & Liquidity Risk Analyst

National Bank of Pakistan