How are different commodity prices related?
Gold is related to silver, oil, and copper. Relationships between commodities are examined to establish if one commodity’s price can fuel another commodity’s price. For example, it’s universally acknowledged that gold and silver prices are related. Silver’s price depends on gold’s price.
Gold and oil prices are also related. A higher oil price would lead to inflation. Inflation would lead to higher gold prices.
What does R-squared show?
To understand the relationship more, we’ve calculated the R-squared. It shows how many of the changes in gold’s price are explained by the changes in crude oil’s price. Its value lies between zero to one. A value of one means that all the changes in one variable are explained by the changes in another variable. For gold and oil price, R-squared comes out to be 0.83 for the period from 1988 to 2014. It means that 83% of the changes in gold price are explained by the changes in crude oil price. This is significant.
How is the gold:oil ratio significant?
This relationship can be measured in terms of the gold:oil ratio. Gold’s price is divided by oil’s price. Peaks in this ratio signify the periods when gold was expensive relative to oil and vice versa. On average, this ratio has been closer to 15:1. Currently, it’s ~12:1. This means that gold is undervalued. Gold’s price could increase—based on this metric alone. However, there are many other factors that investors need to consider before forming a view.
Based on the above analysis, it’s clear that oil and gold move together most of the time. Gold could go higher in the near term. This would favorable for gold stocks like Goldcorp Inc. (GG), Barrick Gold Corp. (ABX), Newmont Mining Corporation (NEM), Agnico-Eagle Mines (AEM), Yamana Gold (or AUY), and exchange-traded funds (or ETFs) like the SPDR Gold Trust (GLD).
Visit the Market Realist Gold ETFs page to learn more about investing in gold.