Friday, June 19, 2009

Clarification on gold (2)

One of the appeals of gold is that it maintains its purchasing power over long periods, even though its price in real terms (see chart in preceding post) can vary significantly at times. Some gold-standard advocates say that gold should be the reference point for all things, since it is a forward-looking indicator of the dollar's purchasing power. (A rising gold price means the dollar is likely to lose value in the future as the prices of all things rise—a process otherwise known as inflation.)

This chart is an example of using gold to measure the value of oil. The chart is simply the price of a barrel of oil (Arab Light, in this case) divided by the dollar cost of one ounce of gold. In short, the chart shows how many barrels of oil one ounce of gold will buy. Once again we have what looks like a mean-reverting process, with the average "price" of an ounce of gold being 18 barrels of oil. When an ounce of gold buys less than 18 barrels of oil, oil is expensive relative to gold, and when it is more than 18 barrels of oil, oil is cheap relative to gold. Right now oil seems somewhat expensive (oil has risen from $40/bbl at the end of last year to just over $70 today, while gold has only risen from $882 to $935).

I'm not trying to draw any conclusions from this, just throwing it out for possible discussion.


Donny Baseball said...

I think you are wise to not draw any conclusions, oil is such a crazy animal. To begin with, due to its inelasticity of supply, oil is hyper sensitive at the margin to small changes in demand. While I do attribute some of oil's dearness this decade to easy US monetary policy I also attribute it to the fact that Chinese demand came rocketing out of the blue when they joined the WTO early in the decade. Going forward we have game changers on the demand side with an emerging giants in Brazil and Canada as well as new smaller players like Angola and Ghana. Loose monetary policy might make oil dearer than it needs to be, but I see a supply glut relative to demand over the next several years.

Donny Baseball said...

sorry, I meant to say game changers on the "supply side"