This analysis was distributed earlier this week as a Deep Dive offering to subscribers of FreightWaves’ SONAR market dashboard. The author is SONAR’s market expert on oil.
If you think the price of gold says nothing about the inherent value of commodities — or the value of anything — then you can stop reading right now.
But if you are even a bit of a gold bug who thinks the price of a commodity or any product can and should be measured in how much gold it takes to acquire it — the idea being that gold is the ultimate store of value and the measure of it relative to the cost of acquisition is a true sign of price — then keep reading.
If you’re in that second category and you consume oil in whatever form — diesel being most likely — please know that you had a very good year in 2019.
When crude oil markets were first freed up in the ’80s, there was a great deal of focus on the ratio between gold and crude. Part of it was that the costs of production around the world varied so widely; part of it was the fact that markets had been so controlled by pacts between buyers and sellers that a true free-market value of oil was hard to come by. Now that the market was openly trading this commodity, what was its value? Measuring it against gold was one of the first analyses taken by the early group of traders.
Here are the numbers that you need to know: 15, 19.69 and 24.55.
Fifteen was, for a long time, the ratio that was assumed to be “normal.” (Note that our ratios assume West Texas Intermediate oil as the point of comparison because the S&P Global Platts data we use goes back the farthest for WTI.) If you had an ounce of gold, you could buy 15 barrels of oil. That ratio has begun to blow out, as we will discuss, but the fact remains that if you measure gold vs. oil going back to 1984 — the start of the data history we are using — the ratio is 16.95. It was 16.65 three years ago, but to move the needle on a 35-year average, you need big shifts.
The reality is that there have been big shifts. In 2016, the most recent trough of the weak post-2014 market, the ratio for the full year was close to 30. At times that year, it exceeded 40. That was understandable because oil that year fell below $30/b at one point and therefore you could buy a lot more barrels of oil with 1 ounce of gold.
To show how much the ratio can swing, consider that at the all-time high price of oil in July 2008, the ratio was 6.43. A year later, with the Great Recession in full swing and the price of oil having plummeted from more than $140/barrel, the ratio was up to about 14.
The 19.69 figure is what the ratio was in 2018. And the 24.55 figure is what it was this year. The simple conclusion to draw from that is that the average price of oil in 2019 — if you assume the price of gold as a stable store of value — fell this past year.
“I look at it as crude oil is a commodity that has ample supply and more is coming on,” Mike McGlone, a commodity strategist at Bloomberg Intelligence, said of the relationship between the two prices. “Virtually all the fancy technologies are working against oil in terms of price.” He specifically mentioned broad efforts at decarbonization as one reason.
Meanwhile, McGlone said, the world supply of gold rarely varies by more than 2% per year.
McGlone looks at a variety of relationships between gold and other commodities and currencies. He noted that gold in 2019 made new highs against a wide variety of currencies, such as the euro and the Indian rupee. “And it’s just a matter of time for the dollar,” McGlone said. Gold is the “great equalizer” for currencies, “and currencies have a tendency to be debased.”
Overall, as McGlone noted, crude had a “decent bounce” for the year. But a lot of that has to do with the fact that it, like all financial assets, had an extremely negative December 2018. Christmas Eve 2018 will long be remembered by financial professionals and investors not for the presents they got under the tree later that night but for that day’s massacre in equity and commodity markets. WTI that day settled at $42.68/b, down almost 6.4%. (The S&P 500 dropped more than 2%, its biggest Christmas Eve decline ever.) WTI’s high for 2019 was $66.30 on April 23. By the middle of last week, with WTI above $60, its gain for the year was 30.9%.
Gold, meanwhile, was lower at the start of the year, in line with the rest of the financial complex, but did not undergo anywhere near the decline that oil did last December. It kicked off the year at about $1,282/oz, hit a high of $1,537.85/oz in early September and last week was at about $1,475/oz, a gain of 15% on the year.
Still, the average ratio for the entire year widened even though the full-year percentage gain for oil was more than gold. But with the ratio starting at more than 27 because of the depressed oil market of December 2018, it stayed at an elevated level for much of those early months of 2019. The trend was down from that early January ratio, resulting in the full-year average ratio of 24.55.
McGlone said the data at the end of 2018 should have been seen as a warning that oil might weaken relative to gold in 2019. He studies the Commitment of Traders report of the Commodity Futures Trading Commission, which showed that at the end of last year, “crude oil positions were near a record long and that’s a good sell indication. Gold was record short at the same time.”
When McGlone looks to 2020, he sees conditions that would make the ratio rise even farther. What gold did in 2019, McGlone wrote in a recent report, was “the best annual performance for dollar-denominated gold in a decade.” The gold market is on “sound footing,” he wrote, “notably turning higher vs. copper and crude oil.”
And while crude’s performance in 2019 may have been a significant upward move, McGlone repeated what he said separately: It started out so low it was a lot easier to go higher than lower from there.
Lest you think an analyst like McGlone never looks at fundamentals, it’s clear he does. The oil market going into 2020, even after the recent new round of reductions planned by OPEC, is marked by forecasts or further rising non-OPEC production that will grow at a rate faster than the increase in global oil demand. And that points to lower levels, he wrote. “When a predominant focus in a market is how much the top cartel needs to reduce supply, we’re in a bear market.”
Ultimately, “the only way I think to get it to spike higher is a substantial shift in the trends that drove it lower,” McGlone told FreightWaves. And those trends include U.S. consumption that has been mostly flat and U.S. oil production that has been anything but.
Looking at the numbers now and over history can lead to only one conclusion: So-called “permanent” relationships are not set in stone. The average ratio going back to 1984 might be a bit more than 16, but it has edged up virtually every year I’ve done this end-of-year review. It was a bit more than 14.5 in 2013. Then when the tidal wave of new U.S. output started to overwhelm markets the following year, and in 2015, the ratio was 24.18 on its way to 29.54 in 2016.
And now McGlone, without saying it specifically, sees the ratio going even higher because he sees downward pressure on crude and upward pressure on gold. That would mean 2020 is another year lending credence to the idea that the 15 ratio that analysts became fixed on so long ago is now a distant memory. But it doesn’t eliminate the idea that if you believe gold is a stable store of real value, the relationship between the two still matters. Keep that in mind if you’ve got exposure to the price of oil.
If you don’t think the relationship might impact the price of crude, remember this other point that McGlone made: With algorithms written by quantitative analysts, “they can set up systems that are able to accurately grab trends in markets.”
Another trend that he sees is the relationship between equity markets and oil. In November he wrote, “As long as equities keep surging, crude oil — far from the uncorrelated market it had been — will stay aloft, in our view. Without continued fuel from sustained record highs in the stock market into 2020, the oil bear market risks a next leg lower, similar to 2014-15.”