Breaking down the correlation between oil and gold prices by Investing.com

Investing.com — Economic analysts, investors and market analysts have long been interested in the relationship between and prices.

Both commodities play a critical role in the global economy as they serve as benchmarks for a wide range of economic activity and reflect trends in the wider economy.

A correlation between these two commodities can provide insight into underlying economic conditions, market sentiment and potential trends for the future.

Over the past 160 years, the oil-to-gold ratio, which measures how many barrels of oil an ounce of gold can buy, has averaged about 19 barrels per ounce, with a standard deviation of 8 barrels per ounce, analysts at Bernstein. in a note.

This ratio has fluctuated widely, often in response to significant global events and economic changes. For example, the ratio has fallen below 10 barrels per ounce during periods of oil shortage or high demand, such as the late 1800s, the oil shocks of the 1970s, and China’s demand supercycle in the early 2000s.

Instead, it rose more than 30 barrels per ounce during economic crises, financial panics and when OPEC flooded the market with oil.

In August 2024, the ratio is around 31 barrels per ounce, with gold prices close to $2,500 an ounce and Brent crude just below $80 a barrel.

This level is considered anomalous because it suggests that oil is historically cheap relative to gold, even though global economic conditions do not appear to justify such a disparity.

According to Bernstein analysts, this anomaly could indicate a potential long-term mean reversion, although the path to such a reversion remains uncertain.

Bernstein analysts outlined several potential scenarios that could bring the oil-to-gold ratio closer to its historical average of 19 barrels per ounce.

One possibility is a significant increase in oil prices, where oil could rise to around $125 per barrel while gold prices remain flat at current levels.

Alternatively, gold prices could fall substantially, potentially reaching $1,600 an ounce, as oil prices remain flat.

A third, more balanced scenario sees both commodities adjusting, with gold falling to around $2,000 an ounce and oil rising to $100 a barrel.

“Of the three scenarios (of which they do not seem plausible), the last one is the most pleasant, but still very unlikely from our point of view. But again, a rate cut cycle combined with a significant drop in the price of gold,” analysts said.

Both gold and oil prices are monetary policy, especially interest rate changes. Gold prices tend to rise during rate cut cycles because lower interest rates reduce the opportunity cost of holding non-yielding assets like gold.

Bernstein’s analysis of nine rate-cutting cycles over the past 50 years supports this thesis, showing that gold generally appreciates when the Federal Reserve cuts rates, unless long-term rates fail to fall.

This pattern highlights the sensitivity of gold prices to monetary policy, which in turn can affect the oil-gold ratio.

Given the current anomalous state of the oil-gold ratio and the uncertain outlook for both commodities, Bernstein recommends a cautious approach.

Investors may consider more defensive positions in oil stocks, especially those with stable cash flows and strong balance sheets.

At the same time, exposure to gold remains recommended, particularly through large mining companies such as Barrick Gold (NYSE: ), which Bernstein rates as outdated.