Gold to oil ratio: Gold heading higher on rising energy prices

New York (Dec 24)  The gold to 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 being a traditional inflation hedge, it 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 does a producer's costs per ounce, which can lead to lower output. If this happens across the industry, lower gold supply versus demand will hike 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 chart below shows the historical ratio between the gold price and West Texas Intermediate (WTI) crude. Simply put, the gold to oil ratio is how many barrels of oil can be bought with an ounce of gold.

MillsNews