Friday, April 01, 2005

Gold Oil Ratio

In late March the gold oil ratio hit an all time low of 7.7. The maths behind the gold oil ratio is simple, it means that an ounce of gold now costs only 7.7 times as much as a barrel of crude oil, each priced in dollars. This is an all time low in the gold oil ratio.

The gold oil ratio expresses the interrelationship between the commodity that forms the foundation of our entire global economy and the commodity that has been the ultimate form of money for six thousand years of human history.

Oil forms the foundation of the extensive global trade today and hence the world economy. Virtually everything we consume in the first world is transported via oil-powered ships, trains, airplanes, or trucks. Without oil, the incredibly intricate global logistics network on which we heavily rely today would grind to a halt. The world would be thrust back into the Steam Age before flight and global trade would implode. In this oil-powered young Information Age, oil truly is the king of commodities.

And gold always has been and always will be the ultimate monetary standard. Empires and nation states rise and fall, and history is littered with once mighty fiat currencies that became worthless as their sponsoring governments slid out of favor. But gold is the standard by which all other currencies are judged, the only real money of world history. It is highly sought after universally, it is very scarce in the natural world so its supply can’t inflate rapidly, and it is very valuable relative to the tiny volume it occupies … the perfect money.

The gold/oil ratio is such a crucial measure because it expresses the entire complex interrelationship between the king of commodities and the only timeless real money in a single data series. This ratio allows us to discern when gold or oil prices are probably out of whack and hence a mean reversion is highly likely. If we can figure out which component of this ratio is most likely to lead this mean reversion, gold or oil, then we can position trades to ride the move.

With the gold/oil ratio at an all-time low and the gold cost of crude oil at an all-time high, conditions have never been riper for a powerful mean reversion. And as tight as global oil supply and demand fundamentals are, the only practical way this mean reversion can be executed is via a massive new gold price upleg.

Read more about the gold oil ratio here.

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