While many analysts on Wall Street forecast gold to head lower in 2014, they fail to realize that its historic ratio to oil points to a much higher price. It seems like everything today is based on financial wizardry rather than fundamentals of a physical economy.
The economy has moved so far away from the fundamentals that it no longer has any idea how to function without total market rigging. The Fed and central banks believe they can continue to control the markets, however the weight of all that paper crap will overwhelm them at some point in time.
I recently wrote the article, Silver To Hit New Highs As The Quality Of Analysis Sinks To New Lows. In the article I provided information on how the historic Oil-Silver Ratio would relate to a much higher price of silver today.
For example, the price of silver would be $92.67 today based on the average Oil-Silver ratio during 1961-1970. For quick reference here is the table from the article:
Present Silver Value At Prior Silver-Oil Ratios (based on $111.30 Brent crude oil)
1981-2000 (3.8 ratio) = $29.30
1971-1980 (2.1 ratio) = $52.95
1961-1970 (1.2 ratio) = $92.67
Some of my readers asked me how the historic Gold-Oil ratio would impact the price of gold today. So I decided to look at the data and put this article together.
From 1961-1970 the price of gold behaved similar to silver — basically flat compared to price of oil. Of course this was due to the fact that the Fed & Central Banks had to manipulate the gold market through the London Gold Pool to keep the price fixed at $35 an ounce.
However, the London Gold Pool fiasco started to get into trouble by the end of the decade as the price of gold increased to $41.39 in 1969… shown in the chart below:
If we consider the average Gold-Oil ratio for 1960’s decade it was 20 to 1. Which means one ounce of gold could buy 20 barrels of oil when gold was still functioning as a monetary metal.
After Nixon dropped the Dollar-Gold peg in 1971, all hell started to break loose in the gold market as the price of the yellow metal shot up to $97.32 by 1973. You will notice that the Gold-Oil ratio increased substantially in 1973 compared to 1971.
The reason for this was due to the fact that the price of gold (1971-$40.80, 1973-$97.32) increased to a much larger degree than oil (1971-$2.24, 1973-$3.29). This is shown in the next below:
As the price of oil nearly quadrupled in 1974 to $11.58 from the impact of the Arab Oil Embargo, the Gold-Oil ratio fell to 13.8. Even though the price of gold declined a bit in 1976, it moved higher in tandem with the price of oil by the end of the decade.
After the Dollar was no longer pegged to gold, the average Gold-Oil ratio during 1971-1980 declined to 15.9 compared to 20 in the previous decade.
When I crunched the numbers for the Gold-Oil ratio for the years 1981-2000, I was quite surprised that the average was higher than the previous time period.
You will notice that from 1986 to 1999, the gold price trend line was above the oil price line. Thus, we had very high Gold-Oil ratios during this time period.
The reason for the lower price of oil is that several new large fields came online. We had the North Sea Oil Field come into production, Alaska Prudhoe Bay and a ramp up of the Gulf of Mexico.
Interestingly, gold was valued higher to oil than I assumed… even higher than the 1971-1980 time period when it reached a record of $850 an ounce.
The lower price of oil is what pushed the average Gold-Oil ratio higher to 18.6 in 1981-2000 compared to 15.9 in the prior time period.
Now… let’s look at what took place since 2000. Here we can see a few noticeable trends. First, during the majority of this time period, the oil price line was higher than gold. Second, the average Gold-Oil ratio is much lower than in any of the previous time periods.
If we disregard the 2009 Gold-Oil ratio as it was a huge anomaly and focus on 2010 and 2012, the price of gold valued in oil terms was at its highest. Furthermore, even though the price of gold hit a record in 2011, the average price of gold was 2012 was higher.
Average Gold Price
2010 = $1,225
2011 = $1,572
2012 = $1,669
2013 = $1,411
So, when the price of gold was attempting to break-out above $1,800 in September of 2012 and surpass its 15 to 1 Gold-Oil ratio, the Fed & member banks came into the markets and decided enough was enough (shown by the nice Red Arrow).
This was also true with Silver:
(NOTE: the chart should read Oil-Silver ratio)
An interesting factor as it pertains to energy and gold can be seen in the table below. I have been compiling data for diesel consumption in the top gold miners. Not only is the amount of diesel consumption per ounce of gold produced increasing… so is the price of diesel.
The majority of the diesel used by these mining companies is in the extraction of the gold ore. A small percentage of overall diesel consumption is used in construction of mine sites as well as a source of electric generation in remote locations when electricity is not available.
In 2010, the top 5 gold miners produced 24.7 million oz of gold consuming 18.7 gallons of diesel per ounce to do so. If we go by the U.S. price of a gallon of diesel in 2010 ($2.99), these top gold miners spent $1.38 billion for this fuel cost. Thus, it took approximately $55.91 in diesel-fuel costs per ounce of gold to extract the ore.
If we make some conservative assumptions based on past trends, the estimated cost of diesel to extract gold in 2013 will more than double to $113.68 an ounce. This is quite interesting once we consider that the current price of gold is $1,227 compared to the average of $1,224 in 2010.
The figures in the table are used as a form of reference. Diesel prices throughout the world are higher or lower than the average shown in the U.S., but, at least it gives us a basic idea of just how much fuel costs are rising in the production of gold.
The gold miners are consuming more energy than ever to produce gold today, however Wall Street believes the price of gold needs to fall below $1,000 in 2014. So it goes… as Wall Street becomes more insane, so do the markets.
Getting back to the Gold-Oil ratios, let’s look at what the gold price would be today based on the past ratios:
Present Gold Value At Prior Gold-Oil Ratios (based on $111.70 Brent crude oil)
1981-2000 (18.6 ratio) = $2078
1971-1980 (15.9 ratio) = $1,776
1961-1970 (20.0 ratio) = $2,234
If we go by the 1961-1970 historic Gold-Oil ratio when gold was a monetary metal, than the price of gold would be worth $2,234 today. Of course this does not consider all the other factors such as the upcoming collapse of the global fiat currency system, U.S. Treasury Market and the majority of paper assets.
With the current price of Brent crude at $110 and gold at $1227, the Gold-Oil ratio is 11.1, lower than the 12.6 average for 2013 and 11.6 average for the decade.
As the Fed & Wall Street continue to delude the public that the proper value for the price of gold is to head lower, the energy fundamentals are pointing to a much higher figure. Financialization and Bull Excrement rule the day in the economy.
Fortunately, those few who still adhere to the fundamentals will benefit tremendously when the $100’s of trillions of paper claims falls under the weight of Newton’s Law of Gravity.