Gold, Oil and Interest Rates

Gold, Oil and Interest Rates

By Ron Friesen

I am not a certified market analyst or financial professional. I am a businessman, Realtor® and writer with an unnaturally enthusiastic interest in business and how things work. Never stop asking why, I say. With this in mind you understand my articles are not intended as investment advice and are written only to entertain and stimulate constructive thought and conversation among a growing audience, also easily intrigued.

How many barrels of oil can we buy today with one ounce of gold?

After the price for crude oil dipped mid June it has remained virtually unchanged in the past month ending first week July, 2017. The question is this…is oil undervalued? Or is gold overvalued? This question is prompted after cruising the charts. Gold has historically averaged a ratio with oil (barrel) of just below 15:1 going back 70 years. In other words, an ounce of gold could purchase almost fifteen barrels of oil.

What stands out in 2017 is how wide the gap between gold and oil is getting. Using the July 12, 2017 spot prices for gold versus the spot price for WTI crude we could purchase almost twenty-seven barrels of oil with the value of one ounce of gold. This is almost double the seventy year average and is the highest average ratio for any year except 1988 over this period.

Can we continue to rely on traditional relationships between commodity values? Is movement towards equilibrium a reliable forecaster of market movement? I cannot help but wonder if gold is over-valued or oil is undervalued, or if either or neither is true.

As I read and research for general opinion on this subject I hear most commentators bullish about oil. If gold remains steady and oil were to return into the 15:1 ratio with gold one would expect oil to run into the eighty dollars per barrel range as it was in 2008 and again in 2011 through 2014. If we look more closely at oil price per barrel historically, and if we use inflation adjustment, there were prices well over $80.00 per barrel in 1980 and lasting into 1982. This is not an unrealistic expectation, but quite a distance from today’s valuation.

Is there a long-term future for fossil fuel?

Industrial science is juggling development of technologies to exploit many alternative fuels. Progress in electric vehicles remains foremost in headlines and vehicle production, steady but slow, and yet seems to have little significant effect on the big picture to date. Domestic electricity has been an established energy source for industry and home power requirements including heat for some time. The recent City of Vancouver intention to make the use of natural gas prohibitively expensive for new residential and commercial buildings has raised many sets of eyebrows, including mine.

The city’s aggressive energy conservation policies and experiments are an indication of the evolving intensions to conserve energy and reduce environmental pollution. They demonstrate perfectly how energy use self-awareness tends to be more abundant where a local economy is robust. It remains to be seen how the new natural gas policies for Vancouver will benefit the local agenda. The local, enthusiastic drive towards replacing natural gas with electric energy puzzles me.

The cost of building new infrastructure combined with the low net energy from natural resources are inhibiting progress with all fuel alternatives as far as I am aware, electric included. The environmental costs (hydro-electric dams, nuclear energy, coal) of producing electrical energy are high. While we hear peak coal has been reached in China and much progress is underway throughout Asia toward renewable energy integration the challenges remain high. Can peak electric be far behind?

We are at a global energy crossroads with more discussion than decisive action taking place to establish a firm, intelligent direction for future energy solutions.

So, my bet is the price of oil is more likely to rise significantly than the price of gold is likely to drop back below $800.00 per ounce. I’m also betting the historical average ratio between gold and oil will prove resilient until a reliable global energy strategy is established to replace fossil fuel. Time will tell.

What about interest rates movement?

Intuition tells me the relationship between gold and key interest rates should cause the value of gold to drop somewhat, all other influences being steady. Assuming the economic fundamentals support increasing interest rates I would expect pay rates for bonds and dividend-paying stocks to raise with the interest rate. But why would gold prices increase? Interestingly, gold prices historically lag a bit, but do seem to follow key interest rate hikes higher in the spot market.

The Bank of Canada recently raised the key lending rate by 0.25%, to 0.75%. Since this announcement spot gold dropped almost insignificantly by 0.58% later in the week. I’m looking forward to the mid-July movement and looking at how well the recent gains of the Canadian Loonie against USD and Euro currencies sustain.

This story is about gold, oil and humanity. My hope is more people will become interested in and exchange ideas about the value relationships affecting their lives. Few people like to talk about war, much less become involved in it. The reality is human nature has not changed fundamentally over thousands of years.

Safe energy, food and clean air are essential to survival and access to these assets is limited to varying degrees in different parts of the world. In the western world individuals have, for the most part, everything we need…too much in fact. Consumerism since the end of the world wars has grown to verge on maniacal…excessive. Excess leads to wider gaps between social classes and eventually to fighting for survival…competing and fighting for access to basic resources.

To become enlightened people must make the best use of available information allowing them to make superior decisions. Not all information is created equal. It is everyone’s responsibility to be discerning, consider opposing ideas and make superior decisions for the benefit of all. Altruism has a tremendous role to play in the leadership of our time.

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