Editor’s note – This article was written in late August, so please keep that in mind when it refers to current prices.
From 1986 through 2014, West Texas Intermediate (WTI) crude oil outpaced gold, but then, the U.S. shale revolution began and near-term concerns over global oil supply were abated. As the U.S. started its ascent toward energy independence, the precious metal began to outpace black gold in 2015, before WTI regained its familiar position, outpacing yellow gold in 2017.
Enter 2020, a year in which everything is seemingly upside down. Gold (relative to its 1986 starting point) is up 361%, while oil is up only 157%, a far cry from its 2007 peak of nearly a 563% rise. As the precious metal soared in 2020, black gold is down year-to-date, leading to a jump in the oil-to-gold ratio.
Using weekly data from January 1986 through December 2019, on average, it would take 17.33 barrels of WTI oil to purchase one troy ounce of gold. From January 1986 through December 2019, this ratio ranged from a low of 6.43 barrels (week ended July 4, 2008) to a high of 42.10 barrels (week ended February 12, 2016), with a median of 16.98 barrels and a standard deviation of 6.14 barrels.
The year with the lowest ratio was 2005 at 7.94 barrels, and the year with the highest was 2016 at 29.24 barrels. Generally speaking, starting in 1986, the trajectory of the cumulative average has fallen (meaning fewer barrels of oil to purchase one ounce of gold), with 2014 hitting the nadir. Since 2014, the cumulative average of oil to gold has risen from 16.09 to 17.33 barrels, as of the end of 2019.
Exhibit 1: Average Oil/Gold Ratio by Year 1986 – August 21, 2020
Source: FactSet as of August 21, 2020 (indexed to January 1986)
Through the week ended August 21, 2020, the cumulative average since the week ended January 3, 1986 has risen to 17.91 barrels. The U.S.’ swift retaliatory airstrike in early January 2020 in response to the bombing of the U.S. embassy in Baghdad quelled fears of a prolonged rise in oil prices. Although oil had climbed to $65 in early 2020, the price fell below $42 by the end of the first week of March. The oil to gold ratio shot up from 24.60 to 40.51 barrels during this period.
The events of 2020 caused a perfect storm in oil’s supply and demand, thereby pushing the ratio to unprecedented levels. COVID-19 lockdowns left world economies at a standstill and spawned massive global government stimulus packages. In the U.S. alone, seasonally adjusted M1 increased 22.4% during the second quarter, with M2 rising 13.6%. To make matters even worse, the Saudis and the Russians started a global price war, which was intended to drive U.S. producers out of business.
The result of the massive oversupply of, and lack of demand for, oil was a collapse of oil prices and a second quarter average ratio of 61.73, with a high watermark of 102.46 barrels per ounce reached in the week ended April 24, 2020. In the second quarter, gold rose only 10%, while oil rallied an astounding 79% (although gold was up only 4%, oil was up 127%, from April 24 through June 30). This strong rally in oil narrowed the ratio to 46.25 barrels by the end of June.
From September 2010 through August 2014, oil formed a wedge, with the low at $75 and high at $115 per barrel (Exhibit 2). When price broke the ascending support line at $96, the downward move swiftly achieved the price objective of $56 per barrel and continued moving lower before turning at the $26 support level established in 2003.
From February 2016 through October 2018, oil prices moved higher despite the U.S. shale production boom and the U.S.’ transition away from foreign imports. In 2019, WTI spent the year in a $42 to $67 range before breaking in March 2020, amid the perfect storm disruption of oil’s supply and demand. Prices quickly fell below the measured move price objective of $17 and has since rallied.
With the current ascending triangle forming in oil, a projected breakout to the upside suggests an achievable $50 target price. While the futures montage is pricing NYMEX WTI with a four handle through July 2027 (August 2027 WTI contract is at $50.05), the analyst community is seemingly more bullish, with consensus forecasting $52 per barrel (ranging from $45 to $60 per barrel) for WTI crude in December 2022.
Exhibit 2: Monthly Adjusted WTI Crude Oil Futures Chart
Source: TradeStation as of August 21, 2020
On the gold front, the chart is very different. From June 2013 through June 2019, gold traded in a sideways range from $1,400 to $1,045 (Exhibit 3). When price broke through the trading range in June 2019, based on a measured move, a $1,755 target was expected (and achieved in April 2020).
Along the way, two flags were formed, with the second suggesting a potential higher price target of $1,965 (reached in July on its way to an all-time high). As gold has soared through the last target price and hovered around $2,000 per ounce, it clearly has reached an inflection point. With gold’s sharp advance, a price retreat from current levels could be expected, but given its current momentum and the ratcheting of global money printing, consolidation at these levels or even another leg-up would not be surprising.
Looking at the NYMEX gold futures montage and consensus estimates through 2025, neither gold investors nor analysts are pricing in a material upside move for the precious metal. Looking into the more immediate future, the December 2022 consensus estimates suggest a price around $1,800 per ounce, ranging from $1,500 to $2,100 per ounce.
Exhibit 3: Monthly Adjusted Gold Futures Chart
Source: TradeStation as of August 21, 2020
As of August 21, 2020, the CBOE Gold Volatility Index was at 23.67 and the CBOE Crude Oil Volatility Index was 33.68, with December 2020 gold at $1,947 per ounce and October WTI oil $42.34 per barrel. The implied 30-day move of gold is 6.83% (suggesting a range of $1,814 to $2,080 per ounce), and the implied 30-day move of oil would be 9.72% (implying a range of $38.22 to $46.46 per barrel). With that said, the alignment potentially could tighten to 39.04 barrels, or even further widen to 54.42 barrels, by the time this article is published in mid-September 2020.
Given 2020’s perfect storm disruption of oil’s supply and demand and the massive injection of stimulus dollars (which could lead to rampant inflation in excess of any implied amount included in current futures prices and analysts’ estimates), it could take some time for the oil to gold ratio to go back below 25.00. If oil gets back to levels of $60 to $70 per barrel, the implied range is 27.86 to 32.50 barrels per ounce of gold, a much more normalized ratio, given the U.S.’ position of energy independence (which was largely non-existent throughout this study period). Based on current December 2022 futures prices, the ratio is suggesting 43.15 barrels, and based on December 2022 analysts’ projections, the implied ratio is 34.94 barrels.
Although energy investors would be ecstatic if the ratio returned to historic levels, it is highly unlikely to happen any time soon. As many in the media talk about having to adapt to the new normal in a post-pandemic life, perhaps there will have to be a new normal applied to the oil to gold ratio.
