Many economists and industry experts suggest that there is a strong correlation between the gold prices and crude oil prices. In today's economy crude oil is one of the most important commodities and energy sources. It is vital for businesses and for individual consumers. Since oil is so important, it should not surprise anyone that it influences many markets. Oil and gold are arguably the most important commodities on the planet today and the ratio of their nominal prices is far from a trivial issue. Oil and gold have had a long association in the minds and hearts of investors. Where one goes, the other seems to follow.
The gold-oil price linkage still looms large for some, with "Gold rises as oil price rebounds" headlines becoming common. But gold-oil price correlation is unlikely to be a defining factor in 2009. As recent history demonstrates, it was only through the boom years of the recently-popped commodity bubble that any correlation was seen. From 2000 until late 2005, there was no significant link between weekly movements in oil and gold prices, but from late 2005 through until late 2008, the link strengthened. Oil and gold prices are now rallying together suggesting the six-month "detachment in their prices" has come to an end.
"Gold gained importance in the past few months as a safe haven. Its demand now seems to be stabilizing as most of the markets begin to improve their performance," said Ahmed Al Abdallah, Managing Director and Head of Commodity Research at Gavekal Research Middle East.
A few macroeconomic factors which are said to be responsible for driving world crude oil prices are inflation, exchange rates, gold prices and OPEC's decision on supply. These have an impact on oil prices either directly or indirectly.
RELATIONSHIP BETWEEN U.S DOLLAR, CRUDE OIL PRICES & GOLD PRICES
If U.S dollar falls, gold will remain the same price for the rest of the world. But, for the U.S, we will end up paying more for the same amount of gold.
If the U.S dollar falls, oil prices will rise for the U.S., but oddly. It will fall for other countries. This is because crude oil is primarily traded in U.S dollars.
Since oil is used in the process of excavating & refining the gold, if oil prices go up, so does gold prices.
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 millennia of human history. 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.
Gold/oil ratio can be calculated using this formula:-
Gold-Oil Ratio = Price of Gold (per oz.) / Price of Crude Oil (per barrel)
Most gold fans and economic historians peg the ratio between the price of gold to oil at 10:1. If the historical ratio between oil and gold is to sustain, either gold has to rise or crude has to drop.
The gold-oil ratio signals:
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.
FACTORS THAT DETERMINE HOW STRONG A CORRELATION GOLD AND CRUDE OIL
Two factors - namely inventory levels of commodities and fears of inflation - may now determine how strong a correlation gold and oil will have in the coming months.
"Gold historically has been a hedge against inflation. It is a safe haven asset of long period," Rhodes said.
Demand for commodities has not picked up even though prices have risen and that may have a negative impact on crude prices putting its correlation with gold topsy-turvy. "The fact is that oil inventories are rising even though its demand is getting weaker and weaker," he said.
Recently commodities prices hit their highest level in six months as crude oil hit $58 a barrel and a worldwide rally took long hold among base metals, freight, precious metals, agricultural and soft raw material prices. The S&P GSCI commodity index, a popular basket of raw materials used by big institutional investors to gain exposure to commodity prices, surged above 400 points for the first time since mid-November rising 7.5 per cent on the week.
On a long-term basis, oil and gold have shown marked correlation. In stark terms, oil prices have exploded and gold prices have shown marked appreciation.
FIGURES OF CRUDE OIL PRICES & GOLD PRICES FROM SEP 2008 TO SEP 2009
DATE
CRUDE OIL PRICES (in dollars)
GOLD PRICES
(in dollar) (per ounce)
Sep 2008
106.89
889.60
Oct 2008
67.81
922.30
Nov 2008
54.43
968.43
Dec 2008
44.60
909.70
Jan 2009
41.68
888.66
Feb 2009
44.76
889.49
Mar 2009
52.38
939.77
April 2009
51.55
839.02
May 2009
66.31
829.93
June 2009
69.16
806.62
July 2009
69.45
760.86
Aug 2009
72.74
816.09
Sep 2009
66.04
871.96
CALCULATION OF GOLD/OIL RATIO ON MONTHLY BASIS
DURING SEPTEMBER 2008
Value of gold per ounce is 889.60 & value of crude oil per barrel is 106.89.
Gold/oil Ratio => 889.60/106.89 = 8.32
As gold/oil ratio is at 8.32 so there is good buying opportunity (for gold). As I already explained above regarding buying opportunities (for gold), when the gold-oil ratio turns up at/below 10 barrels/ounce.
DURING OCTOBER 2008
Value of gold per ounce is 922.30 & value of crude oil per barrel is 67.81.
Gold/oil Ratio => 922.30/67.81 = 13.60
As gold/oil ratio is at 13.60 so there is neither good opportunity for selling (for gold) nor a good buying opportunity (for gold). As I already explained above regarding 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. So at that time we did not make any transaction.
DURING NOVEMBER 2008
Value of gold per ounce is 968.43 & value of crude oil per barrel is 54.43.
Gold/oil Ratio => 968.43/54.43 = 17.79
As gold/oil ratio is at 13.60 so there is neither good opportunity for selling (for gold) nor a good buying opportunity (for gold). As it is near 20 barrel/ounce so there may be a case that we try to buy for gold but it will not be a good decision because it is still below 20 & it is said by analyst that we should wait at this movement of time.
DURING DECEMBER 2008
Value of gold per ounce is 909.70 & value of crude oil per barrel is 44.60.
Gold/oil Ratio => 909.70/44.60 = 20.40
Finally after a long waiting time of nearly 2.5 month there comes a time that we can sell the gold. This is the time when we can sell for gold in the hope for earning good return.
DURING JANUARY 2009
Value of gold per ounce is 888.66 & value of crude oil per barrel is 41.68.
Gold/oil Ratio => 888.66/41.68 = 21.32
As it is clear that this ratio is going better & better month after month so we can say that at that time opportunity for selling gold is going better & better in terms of gold.
DURING FEBRUARY 2009
Value of gold per ounce is 889.49 & value of crude oil per barrel is 44.76.
Gold/oil Ratio => 889.49/44.76 = 19.87
This figure during the month of February tells that it is not a good opportunity for selling in terms of gold as it is below 20.
DURING MARCH 2009
Value of gold per ounce is 939.77 & value of crude oil per barrel is 52.38.
Gold/oil Ratio => 939.77/52.38 = 17.94
This figure shows that during this month there is neither a good opportunity for buying nor a good opportunity for selling in the hands of investor.
DURING APRIL 2009
Value of gold per ounce is 839.02 & value of crude oil per barrel is 51.55.
Gold/oil Ratio => 839.02/51.55 = 16.28
DURING MAY 2009
Value of gold per ounce is 829.93 & value of crude oil per barrel is 66.31.
Gold/oil Ratio => 829.93/66.31 = 12.51
After seeing the figures of 3 months we can say that gold/oil ratio is decreasing at a great rate which is not good for those who were looking for selling opportunities( for gold).
DURING JUNE 2009
Value of gold per ounce is 806.62 & value of crude oil per barrel is 69.16.
Gold/oil Ratio => 806.62/69.16 =11.66
As this ratio allows us to discern when gold or oil prices are probably out of whack and hence a mean reversion is highly likely. This figure tells that oil prices are probably not out of whack.
DURING JULY 2009
Value of gold per ounce is 760.86 & value of crude oil per barrel is 69.45.
Gold/oil Ratio => 760.86/69.45 = 10.96
DURING AUGUST 2009
Value of gold per ounce is 816.09 & value of crude oil per barrel is72.74.
Gold/oil Ratio => 816.09/72.74 = 11.22
This ratio allows us to discern when gold or oil prices are probably out of whack and hence a mean reversion is highly likely. This figure tells that oil prices are probably not out of whack.
DURING SEPTEMBER 2009
Value of gold per ounce is 871.96 & value of crude oil per barrel is 66.04.
Gold/oil Ratio => 871.96/66.04 = 13.20
As most gold fans peg the ratio between the price of gold to oil at 10:1. If the historical ratio between oil and gold is to sustain, either gold has to rise or crude has to drop.
MATHMATICAL CALCULATION
We will also mathematically calculate the correlation between crude Oil prices & Gold prices in order to know how much these two are correlated with each other. In order to know the correlation between these two I am using the Karl Pearson Coefficient of Correlation.
CRUDE OIL PRICES(x)
GOLD PRICES(y)
x*x
y*y
xy
106.89
889.60
11425.47
791388.16
95089.34
67.81
922.30
4598.20
850637.29
62541.16
54.43
968.43
2962.63
937856.67
52711.64
44.60
909.70
1989.16
827554.09
40572.62
41.68
888.66
1737.22
789716.59
37039.35
44.76
889.49
2003.46
791192.46
39813.57
52.38
939.77
2743.67
883167.65
49225.15
51.55
839.02
2657.40
703962.95
43251.48
66.31
829.93
4397.02
688783.8
55032.66
69.16
806.62
4783.11
650635.82
55785.84
69.45
760.86
4823.30
578907.93
52841.73
72.74
816.09
5291.11
666002.88
59362.39
66.04
871.96
4361.28
760314.24
57584.24
TOTAL807.8
11332.43
53773.03
9920119.9
700851.17
KARL REARSON COEFFICIENT OF CORRELATION
√N∑X*X-(∑X) (∑X) √N∑Y*Y-(∑Y) (∑Y)
: = N∑XY - ∑X∑Y
:= 13*53773.03 - 700851.17
46508.55 - 537588.99
: = -1801.78
-491080.44
: = 0.004
As this value is between -1 & 1 so we can say that there is a correlation between crude oil prices & gold prices.
But mathematically there is no direct correlation between gold and oil prices. The key correlation over a long period of time is between the gold and US dollar. Another currency that investors resort to when dollar weakens is Gold. Typically a weaker dollar means higher gold prices. And that is an inverse relationship," Rhodes said. A weak dollar has been repeatedly cited as one of the causes behind oil touching $147 a barrel in July 2008.
CONCLUSION
After understanding the relation between crude oil prices & gold prices both theoretically & mathematically & after seeing the gold/oil ratio figures on monthly basis from September 2008 to September 2009, we came to know that both the commodities have great deal of relation with each other. If there comes a change in gold prices than there comes a change in crude oil prices also & the inverse is also true. If we see the figures of September 2008 of both crude oil prices & gold prices that is during the month of September 2008 both are at highest peak but at the end of September both comes to their lowest level, if we see the past 1 year figures of both. So in the end we can say that prices of both are closely correlated with each other.
