Gold/Oil Ratio: Indicator of Economic Health

The gold-oil ratio is an important indicator of the global economy’s health.  Because gold and crude oil are both denominated in US dollars, they are strongly linked. That is because as the US dollar rises, commodities priced in USD fall, and vice versa. As the dollar drops, commodities generally go up. Another important link between gold and oil is inflation. Because energy comprises about one-third of the Consumer Price Index (CPI), when crude oil rises it impacts inflation. Gold, a traditional inflation hedge, follows that as higher oil prices lead to increased inflation, the gold price goes up as more investors buy gold to diversify out of inflation-losing assets like bonds and cash. Gold and oil are further related in that a spike in oil prices dampens economic growth because so many industries depend on it and its derivatives as a fuel source, i.e., natural gas, gasoline, and diesel. (Diesel fuel is a major input for gold mining operations, therefore as fuel costs rise, so do a producer’s costs per ounce, which can lead to lower output. If this happens across the industry, lower gold supply versus demand will increase prices).

A drop in global growth, particularly in the two largest economies, the United States and China, might signal a recession is coming which is almost always bullish for gold prices. The figure below shows the historical ratio between the NYMEX Gold price and West Texas Intermediate (WTI) Crude.

Figure 1. Gold to Oil Ratio, front month contracts

WTI Crude futures fell 0.7% to settle at $80.73 per barrel on Friday amid concerns that global oil demand growth could be impacted by a strong U.S. dollar and escalating conflict in the Middle East. This decline came despite signs of improving U.S. oil demand and falling fuel inventories, which pushed crude prices to a seven-week high the previous day. Data released on Thursday showed that U.S. crude stockpiles declined by 2.55 million barrels last week, surpassing forecasts for a 2 million barrel draw.

Gold held steady around $2,360 per ounce on Friday, hovering at two-week highs and set to post its second weekly gain. This comes as soft US economic data reinforced bets that the Federal Reserve might lower interest rates this year and amid rising geopolitical tensions in the Middle East. Last week’s data revealed a slowdown in the labor market and price pressures, followed by weak retail sales data on Tuesday, indicating that US economic activity remained sluggish in the second quarter. Additionally, initial claims for unemployment benefits decreased slightly last week, while new housing construction in May fell to its lowest level in nearly four years.