The ‘crisis-ratio’ set a new record

In financial markets, a high gold/oil ratio indicates ‘problems ahead’

The prices of gold and oil usually rise and fall in sync. Conventional wisdom is that rising oil prices push up inflation, thereby increasing demand for gold as a hedge and vice versa.

Since 1980, the median gold/oil-ratio (that’s how many barrels of oil can be bought with one ounce of gold at respective market prices) is slightly above 15 – see chart below.

Another pattern of this chart shows that a substantially higher gold/oil-ratio indicates severe problems on capital- or forex-markets and the stock-exchange. So it’s fair to say, that the gold/oil-ratio is a noteworthy crisis-ratio for investors:

• Falling oil prices – from 32 USD to 9 USD/barrel between November ’85 and April ’86 – let the gold/oil-ratio spike to a record-high above 32. Back then, the weak global economy and energy-saving initiatives (in particular after the nuclear accident in Chernobyl) had caused oil demand to slow, while at the same oil-producing countries were increasing production. Cheap oil and a US-Fed that lowered the interest rates made the Dow Jones to surge significantly – but only to collapse in the single biggest daily loss of 22% a year later. The gold/oil-ratio topped again at over 32 in November 1988, when the cease-fire after the war between Iran and Iraq let to an even higher oil-production.

• In 1994 and 1997, the gold/oil-ratio climbed the next time remarkably to over 27. In parallel, the ‘Tequilla’-shock in Mexico in 94/95 and the Asian forex-crisis in 97/98 disrupted the financial markets worldwide.
• The so called ‘Tequilla-crisis’ was a currency crisis sparked by the Mexican government’s sudden devaluation of the Mexican Peso against the USD in December 1994, which became one of the first international financial crises ignited by capital flight.
• The Asian financial crisis started in July 1997 in Thailand (with the currency collapse, when the government was forced to float the local currency – the bath – due to a lack of foreign reserves) and spread over much of Southeast-Asia, in particular to Indonesia, Hong Kong and Malaysia.

• In the 21st Century, a spike of the gold/oil-ratio to 28 happened in 2008 (Lehman bankruptcy followed by the global financial crisis) and then again in 2011 to 22 (the still not solved Greek-drama).

So when I checked the ‘crisis’-ratio this morning with WTI (that’s US-crude-oil) at 38 USD/barrel and the ounce of gold at 1250 USD – my calculator showed ’33’ – that’s the highest value in more than 3 decades.

If financial history prevails, we could be very well on the eve of a next severe capital crisis (China?) although today’s relationship between gold and oil is probably more a function of the dramatic slide in crude rather than the strength of the gold price.

A high gold/oil-ratio puts capital markets on high alert.