The connection between oil & gold
Roy W. Jastram in ‘The Golden Constant: The English and American Experience 1560-2007’ finds that gold maintains its purchasing power over long periods of time, with the prices of other commodities adapting to the price of gold.Taking a lead from Jastram, let’s use the price of gold as a long-term benchmark for the price of oil. The idea being that, if the price of oil changes dramatically, the oil-gold price ratio will change and move away from its long-term value.
Forces will then be set in motion to shift supply of and demand for oil. In consequence, the price of oil will change and the long-term oil-gold price ratio will be re-established. Via this process, the oil-gold ratio will revert, with changes in the price of oil doing most of the work.
For example, if the price of oil slumps, the oil-gold price ratio will collapse. In consequence, exploration for and development of oil reserves will become less attractive and marginal production will become uneconomic.
In addition to the forces squeezing the supply side of the market, low prices will give the demand side a boost. These supply-demand dynamics will, over time, move oil prices and the oil-gold price ratio up. This is what’s behind the old adage, there is nothing like low prices to cure low prices.
By Steve H. Hanke, Special to Gulf News