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The Gold-Oil Ratio
The Link Between Gold and Oil
Gold and crude oil prices tend to rise and fall in sympathy with one another.
There are two reasons for this:
Historically, oil purchases were paid for in gold. Even today, a sizable
percentage of oil revenue ends up invested in gold. As oil prices rise, much
of the increased revenue is invested as it is surplus to current needs --
and much of this surplus is invested in gold or other hard assets.
Rising oil prices place upward pressure on inflation. This enhances the
appeal of gold because it acts as an inflation hedge.
Gold Price History
The chart below starts with the Yom Kippur war between Israel and its
neighbors in 1973 -- and the resulting Arab oil embargo when crude oil rocketed
from $3 to $12/barrel. This was followed by the 1978 revolution in Iran and the
Iran-Iraq war in 1980 which lasted until 1988. Iraq then invaded Kuwait in 1990,
but the ensuing Gulf War had a limited effect on gold prices.
Data Source:
Gold went into a decline until awakened from its slumber on September 11,
2001. The invasion of Iraq followed in 2003, initiating a strong up-trend, and
prices have lately spurred even higher as tensions escalate over Iran's nuclear
Oil Price History
Yom Kippur started a huge spike in oil prices with the Arab oil embargo in
1973. This was followed by another spike in 1978 at the time of the Iranian revolution,
culminating with the subsequent invasion by Iraq and the start of the Iraq-Iran
war. The Saudis substantially increased production in 1985 and the Iraq-Iran ceasefire
further eased shortages in 1988. The invasion of Kuwait and ensuing
Gulf war caused a brief spike in 1990, but a relatively stable period then followed -- until
1998 when OPEC increased production while demand was falling due to the Asian
financial crisis, causing a slump in prices. Subsequent production cuts saw
price recover, before September 11 and the 2003 invasion of Iraq heightened
fears of further shortages.
Data Source:
Readers need to bear in mind that the above prices are not adjusted for
inflation. In today's dollars, oil traded at
close to $100/barrel and gold above $2000 during the 1980 crisis.
The Gold-Oil Ratio
The easiest way to eliminate inflation from the above charts is to express
the two prices as a ratio. How many barrels of oil you can buy with an ounce of
Gold-Oil Ratio = Price of Gold (per
oz.) / Price of Crude Oil (per barrel)
The gold-oil ratio helps us to identify overbought and oversold opportunities for
gold. The chart below shows solid support between 8 and 10 barrels/ounce of gold over
the last 30 years, with occasional spikes carrying above 20 but seldom
holding for any length of time.
Gold-Oil Ratio Signals
The gold-oil ratio identifies:
Buying opportunities
gold) when the gold-oil ratio turns up at/below 10
barrels/ and
Selling opportunities when the gold-oil ratio turns down at/above 20
barrels/ounce.
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The Gold-Oil Ratio displayed a buy signal, with values below 10, for most of 2006 to 2008.
A sharp drop in crude prices in late 2008 distorted the ratio, causing an incorrect sell signal. Since then, from mid-2009 to 2011, the ratio has oscillated in a narrow range betweeen 12 and 18.
The Gold-Oil Ratio Setup
The Gold-Oil Ratio has been set up for you in a separate project. Select File && Open Project && [Gold-Oil Ratio] on the chart menu or [Gold-Oil Ratio] on the project tabs [&&&&&&&] below the charts.
Related TopicsTitleDescriptionGold is generally quoted in US dolla so any fluctuations in the strength of the dollar are likely to be reflected in the dollar priceof gold.
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Milestones:
Oil Embargo,
During the 1973 Arab-Israeli War, Arab members of the Organization of Petroleum
Exporting Countries (OPEC) imposed an embargo against the United States in
retaliation for the U.S. decision to re-supply the Israeli military and to gain
leverage in the post-war peace negotiations. Arab OPEC members also extended the
embargo to other countries that supported Israel including the Netherlands,
Portugal, and South Africa. The embargo both banned petroleum exports to the
targeted nations and introduced cuts in oil production. Several years of
negotiations between oil-producing nations and oil companies had already
destabilized a decades-old pricing system, which exacerbated the embargo’s
Cars wait in long lines during the gas shortage. (Library of Congress
Prints and Photographs Division, U.S. News & World Report Magazine
Photograph Collection, Warren K. Leffler)
The 1973 Oil Embargo acutely strained a U.S. economy that had grown increasingly
dependent on foreign oil. The efforts of President Richard M. Nixon’s
administration to end the embargo signaled a complex shift in the global
financial balance of power to oil-producing states and triggered a slew of U.S.
attempts to address the foreign policy challenges emanating from long-term
dependence on foreign oil.
By 1973, OPEC had demanded that foreign oil corporations increase prices and cede
greater shares of revenue to their local subsidiaries. In April, the Nixon
administration announced a new energy strategy to boost domestic production to
reduce U.S. vulnerability to oil imports and ease the strain of nationwide fuel
shortages. That vulnerability would become overtly clear in the fall of that
The onset of the embargo contributed to an upward spiral in oil prices with
global implications. The price of oil per barrel first doubled, then quadrupled,
imposing skyrocketing costs on consumers and structural challenges to the
stability of whole national economies. Since the embargo coincided with a
devaluation of the dollar, a global recession seemed imminent. U.S. allies in
Europe and Japan had stockpiled oil supplies, and thereby secured for themselves
a short-term cushion, but the long-term possibility of high oil prices and
recession precipitated a rift within the Atlantic Alliance. European nations and
Japan found themselves in the uncomfortable position of needing U.S. assistance
to secure energy sources, even as they sought to disassociate themselves from
U.S. Middle East policy. The United States, which faced a growing dependence on
oil consumption and dwindling domestic reserves, found itself more reliant on
imported oil than ever before, having to negotiate an end to the embargo under
harsh domestic economic circumstances that served to diminish its international
leverage. To complicate matters, the embargo’s organizers linked its end to
successful U.S. efforts to bring about peace between Israel and its Arab
neighbors.
Partly in response to these developments, on November 7 the Nixon administration
announced Project Independence to promote domestic energy independence. It also
engaged in intensive diplomatic efforts among its allies, promoting a consumers’
union that would provide strategic depth and a consumers’ cartel to control oil
pricing. Both of these efforts were only partially successful.
President Nixon and Secretary of State Henry Kissinger recognized the constraints
inherent in peace talks to end the war that were coupled with negotiations with
Arab OPEC members to end the embargo and increase production. But they also
recognized the linkage between the issues in the minds of Arab leaders. The
Nixon administration began parallel negotiations with key oil producers to end
the embargo, and with Egypt, Syria, and Israel to arrange an Israeli pullout
from the Sinai and the Golan Heights. Initial discussions between Kissinger and
Arab leaders began in November 1973 and culminated with the First
Egyptian-Israeli Disengagement Agreement on January 18, 1974. Though a finalized
peace deal failed to materialize, the prospect of a negotiated end to
hostilities between Israel and Syria proved sufficient to convince the relevant
parties to lift the embargo in March 1974.
The embargo laid bare one of the foremost challenges confronting U.S. policy in
the Middle East, that of balancing the contradictory demands of unflinching
support for Israel and the preservation of close ties to the Arab oil-producing
monarchies. The strains on U.S. bilateral relations with Saudi Arabia revealed
the difficulty of reconciling those demands. The U.S. response to the events of
also clarified the need to reconcile U.S. support for Israel to
counterbalance Soviet influence in the Arab world with both foreign and domestic
economic policies.
The full impact of the embargo, including high inflation and stagnation in oil
importers, resulted from a complex set of factors beyond the proximate actions
taken by the Arab members of OPEC. The declining leverage of the U.S. and
European oil corporations (the “Seven Sisters”) that had hitherto stabilized the
global oil market, the erosion of excess capacity of East Texas oil fields, and
the recent decision to allow the U.S. dollar to float freely in the
international exchange all played a role in exacerbating the crisis. Once the
broader impact of these factors set in throughout the United States, it
triggered new measures beyond the April and November 1973 efforts that focused
on energy conservation and development of domestic energy sources. These
measures included the creation of the Strategic Petroleum Reserve, a national
55-mile-per-hour speed limit on U.S. highways, and later, President Gerald R.
Ford’s administration’s imposition of fuel economy standards. It also prompted
the creation of the International Energy Agency proposed by Kissinger.
Last modified: October 31, 2013
This essay has been tagged with the following entries from the . Follow the links to find more resources on each subject:Energy Lessons for Europe and the U.S. from the 1973 Arab Oil Embargo&|&Charles D. Ferguson
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Energy Lessons for Europe and the U.S. from the 1973 Arab Oil Embargo
Across eastern and central Europe, anger is rising over the cutoff of Russian natural gas due to the dispute between Russia and Ukraine. While feeling angry is justified in such a crisis, the governments in this region would be best advised not to get mad at Russia but to get more secure in energy supplies and smarter in energy usage. They and the Obama administration could learn valuable lessons from how the United States responded to the 1973 Arab Oil Embargo.
On October 16, 1973, the Arab countries of OPEC embargoed oil supplies to the United States in retaliation for Washington's decision to aid Israel during the Yom Kippur War. U.S. oil use prior to the embargo had been increasing and was projected to continue increasing with no end in sight. When the embargo struck, the United States produced 17 percent of its electricity with oil. About 31 percent of U.S. homes used oil for heating. Gas-guzzling cars and light trucks averaged a paltry 14.5 miles per gallon. Even though the United States had notice of an impending oil price increase, the embargo forced action.
The U.S. government and consumers responded to the energy crisis on multiple fronts, including: forming a strategic petroleum reserve, replacing oil-based electricity with coal, natural gas, and nuclear energy, substituting oil-based heating with electricity and natural gas, and increasing energy efficiency in vehicles and appliances. By the mid-1990s, more than two decades after taking these steps, the United States used oil for only two percent of its electricity, cut home heating oil usage in half, and almost doubled vehicle fuel efficiency standards.
But the United States can and must do better in the future. Cheap gasoline prices throughout most of the 1990s until the last few years abetted many Americans' desires for fuel gulping SUVs. And with the recent drop in gasoline prices, the concern is that sufficient numbers of Americans may not get on board with buying more fuel efficient vehicles. Europeans have generally embraced greater fuel efficiency mainly because their governments have levied high enough gasoline taxes that encourage conservation. The United States should learn from this European practice.
U.S. oil reserves are also in a danger zone. While the U.S. Strategic Petroleum Reserve had maxed out in 1985 at 118 days of protection, if imports are shut off, increasing U.S. demand for imported oil has reduced the reserve's ability to buffer supply shocks. Today, this reserve only provides 58 days of protection, but the International Energy Agency advises 90 days of reserve.
Although many eastern European countries have invested in strategic gas reserves, several of them, like the United States, fall short in having adequate capacity. For instance, Croatia only has three weeks of reserve and depends on Russia for 37 percent of its gas. While Bulgaria has a larger reserve of two months, it depends far more heavily on Russia to provide 96 percent of its gas.
Bulgaria's gas shortage has spurred Sofia to express interest in restarting a Soviet-era nuclear reactor. To be admitted into the EU, Bulgaria, Lithuania, and Slovakia were required to shut down some Soviet-designed nuclear power plants that had not met Western safety standards. On January 12, Slovakian Prime Minister Robert Fico said that he would order the restart of a reactor--only two weeks after it was closed--if gas flows are not resumed soon. And a nonbinding referendum last fall in Lithuania showed overwhelming--nine-to-one--support for keeping open the Ignalina reactor, which is a more advanced version of the Chernobyl reactor that experienced a devastating accident in 1986. Lithuania has committed to shut down the last Ignalina reactor in December.
Bulgaria, Lithuania, and Slovakia should abide by their decisions to close these older generation reactors. The lesson learned from the U.S. experience is that safety should not be sacrificed for energy security. The 1979 Three Mile Island reactor accident taught that the U.S. needed to take a much more proactive stance on nuclear safety. Largely through enhanced safety and better operational practices, the United States has increased the proportional use of nuclear-generated electricity from 9 percent in 1975 to 19 percent today even though no new reactors have been ordered in more than 30 years.
Several central and eastern European countries are planning new reactors and should build those that meet the highest safety standards. But it will take at least until 2020 for these reactors to generate electricity due to the long time for construction and the increased global demand for parts and people to build the reactors.
If these countries cannot rely on more nuclear plants for more than ten years, they will likely burn more coal. But without carbon dioxide capture and storage technology, these coal plants will run afoul of EU restrictions on reducing greenhouse gas emissions. While no large-scale commercial coal power plant is using this technology, the current crisis presents an opportunity for the EU to provide financial and technological assistance to these countries to develop and deploy this type of coal plant. Like nuclear plants, these advanced coal plants will take many years to build.
Countries in this region can further reduce Russian gas dependence through conservation and energy efficiencies. These offer the greatest payback in the near term. Another longer term measure is to make far greater use of renewable sources such as geothermal (which is abundant in many parts of eastern Europe), wind, and solar energies.
There is no immediate fix. Eastern and central European countries, however, have considerable leverage in placing themselves on a more secure energy footing. But they will need more than a decade to significantly reduce their growing dependencies on Russian gas. The time for Europe and the United States to act is now.
Charles D. Ferguson is the Philip D. Reed Senior Fellow for Science and Technology at the Council on Foreign Relations. He is writing a book on energy policy and government decision making.
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