The relationship between gold and oil continues to be one of the most studied in commodities research. Over the last few decades, the gold and oil price correlation seems to be derived from a cause-effect relationship. Investors sometimes use the gold to oil ratio, a formula used by investors to determine the price relationships, in order to measure economic conditions.
With such a closely tied bond between two of the strongest and sought-after resources in the world, let’s dig deeper into what makes their relationship so intertwined.
How Exactly are Gold and Oil Related?
An important point to note when understanding the relationship between gold and oil is that they are both considered dollar-denominated assets. Hence, assets like gold and oil are priced based on an underlying value in US dollars. Investors choose to opt for this type of investment for two reasons; the strength of the dollar in global markets and hedging against the volatility of currency rates.
Both gold and oil markets are priced in US dollars. Exchange rate fluctuations that cause a rise in the US dollar will normally result in dollar-denominated assets like gold and oil dropping in price.
Inflation also plays a part in gold and oil price correlation. Over the years, it has been observed that a rise in crude oil prices leads to inflation. During such periods, the prices of gold increase, thus making gold a good hedge against inflation. At the same time, when the gold price rises, investors then diversify out of assets like bonds and cash, whose value drops during inflationary periods.
Looking Deeper Into the Gold and Oil Prices Correlation
The relationship between gold and oil begins in the mining process. Oil is heavily used in mining exploration, and as a result, mining corporations are also affected by oil price surges. The price of oil stifles economic growth due to its excessive industrial use in mining, which adversely impacts most other industries.
While this leads to a fall in the equity markets, a situation like this boosts the demand for assets such as gold, making it easier to raise the price of gold higher. Investors who wish to have better foresight can therefore turn to the oil-gold ratio to see the price correlation.
The oil-gold ratio is an indicator of future oil prices, and it can help investors predict the direction of oil prices.
As of the present, the price of barrel oil is $74.63. However, projections state that oil prices could rise to $100 per barrel oil in 2022. This is because of indications of economic rebound from the Covid-19 pandemic meeting low levels of supply.
Conclusion
The relationship between gold and oil is deeply rooted in global economics. From the primary state of production to price surges during inflation and meeting demand or supply, the interrelation between gold and oil will always have a cause and effect on its prices. With expectations of a price hike in the future, investors should be keen to keep watching gold and oil prices.
