Is there a strong correlation between the prices of gold and oil? It depends on which data are used to measure. Many price movement studies suggest that the correlation between the two commodity prices over time is quite strong. Typically, these studies rely on data covering extensive periods of time and show that when oil increases in price, gold will inevitably follow. On the other hand, there are correlations calculated from data that show a weak relationship between the two prices. The data in these cases usually cover periods as short as years or months.
“From 1965 to 1994, the monthly correlation between gold and oil weighed in at a very impressive +0.879. From 1995 to 2000, however, this correlation seemingly vanished with a negative 0.133 reading,” according to a May 2004 article by Zeal LLC. “Since 2000 though, the historical oil and gold correlation has been restored, now again running positive at +0.715.” It would seem that gold may be well correlated with oil in the long term, but it is not necessarily so in the short term.
While oil prices have exploded and gold prices have shown marked appreciation, protagonists of a tight long-term correlation between the two evoke previous historical price movements such as those in last half of the 1970s. From the mid-1970s to 1980, oil prices rose from around $20 USD per barrel to more than $100 USD per barrel in 2008 dollars. Gold followed along and roughly quadrupled in price during that same time period.
Were gold prices driven by oil prices, or were the two commodity prices driven up by other forces acting on each with similar effect? This brings up the important question of causation. The crises of the ’70s were caused in large part by supply disruptions and occurred during a period of pronounced inflation. In the last decade oil prices have spiked once again, surpassing even the increase in real price that was experienced in the ’70s.
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Supply issues still play a role, however this current spike is more owing to an increase in global demand. Inflation is also less of a factor in the current U.S. economy than it was in the ’70s. If gold behaves the same way in a proportional sense that it did with respect to oil as observed in the ’70s, investors will again see real gold prices rise to more than $2,000 USD per ounce.
Some investors insist that the current gold bull will continue to follow this course of pronounced appreciation. The conclusion may be well-founded, but not if only on the basis of price correlation. Price correlation is just one of many tools investors must deploy in making informed decisions. There are no absolute certainties in markets, just degrees of certainty.
Still, there is no dispute that gold has been on the climb since bottoming out in 2001. With little confidence in the dollar or in the equity markets, it is likely that investors will continue to bid up the price of gold. Also, the possibly that OPEC will switch to pricing oil in euros instead of dollars could further devalue the U.S. dollar, making gold even more attractive. Indeed, the investor who bought gold in 2001, with prices around $250 USD per ounce, and still holds the asset at the current price, hovering just over $900 USD, is surely pleased with its appreciation so far.
On the other hand, gold is often seen as a wealth preserver during inflationary periods rather than a get-rich-quick investment opportunity. A balanced portfolio can certainly include gold as a portion. Any investment strategy, though, that relies heavily on gold is a bet against the dollar. With this in mind, gold investors and speculators need to approximate when they expect the dollar to rebound and plan accordingly.
Investors interested in riding the gold bull need to research more than just the oil-gold relationship as a basis for decisions by considering the other factors in play. Some long-term studies show gold also to be strongly correlated with economic indicators other than oil prices, such as the S & P 500 and 10-year T-bills, according to a Gold-Eagle editorial. Investors should also study the circumstances surrounding the tight gold-oil relationship of the ’70s, and consider the similarities/differences in respect to the current oil bull.
What does the future hold for gold? In the short term, gold prices should continue to increase, but just when will they top out? When they do top out, what other opportunities will have been lost? Moreover, if gold prices spike as dramatically in the coming years as was the case in the ’70s, then a sharp correction could follow.