Investing.com -- Economic analysts, investors, and market analysts have long been interested in the relationship between oil and gold prices.
Both commodities have a critical role in the global economy as they serve as benchmarks for a wide range of economic activities and reflect trends in the broader economy.
A correlation between these two commodities can provide insight into underlying economic conditions, market sentiments, and potential trends for the future.
Over the past 160 years, the oil-to-gold ratio, which measures how many barrels of oil one ounce of gold can purchase, has averaged around 19 barrels per ounce, with a standard deviation of 8 barrels per ounce, said analysts at Bernstein in a note.
This ratio has fluctuated widely, often in response to significant global events and economic shifts. For instance, the ratio dropped below 10 barrels per ounce during periods of oil scarcity or high demand, such as the late 1800s, the oil shocks of the 1970s, and the China demand supercycle in the early 2000s.
Conversely, it rose above 30 barrels per ounce during economic depressions, financial panics, and when OPEC flooded the market with oil.
As of August 2024, the ratio stands at approximately 31 barrels per ounce, with gold prices near $2,500 per ounce and Brent crude oil just below $80 per barrel.
This level is considered anomalous, as it suggests that oil is historically cheap relative to gold, even though global economic conditions do not seem to warrant such a disparity.
As per Bernstein analysts, this anomaly could indicate a potential reversion to the long-term average, although the path to such a reversion remains uncertain.
Bernstein analysts have outlined several potential scenarios that could bring the oil-to-gold ratio closer to its historical average of 19 barrels per ounce.
One possibility is a significant increase in oil prices, where oil could climb to around $125 per barrel while gold prices remain steady at their current levels.
Alternatively, gold prices might drop substantially, potentially reaching $1,600 per ounce, with oil prices holding stable.
A third, more balanced scenario envisions both commodities adjusting, with gold decreasing to about $2,000 per ounce and oil rising to $100 per barrel.
“Of the three scenarios (not of which seem plausible), the last is most palatable but still highly unlikely in our view. But again, a rate cutting cycle combined with a significant fall in gold price,” the analysts said.
Both gold and oil prices are monetary policy, particularly interest rate changes. Gold prices tend to rise during rate-cutting cycles, as lower interest rates reduce the opportunity cost of holding non-yielding assets like gold.
Bernstein's analysis of nine rate-cut cycles over the past 50 years supports this thesis, showing that gold generally appreciates when the Federal Reserve cuts rates, except when long-term rates fail to decrease.
This pattern underscores the sensitivity of gold prices to monetary policy, which in turn can impact the oil-to-gold ratio.
Given the current anomalous state of the oil-to-gold ratio and the uncertain outlook for both commodities, Bernstein recommends a cautious approach.
Investors may consider more defensive positions in oil stocks, particularly those with stable cash flows and strong balance sheets.
Simultaneously, exposure to gold remains advisable, especially through major mining companies like Barrick Gold (NYSE:GOLD), which Bernstein rates as Outperform.