Gold and commodities

Alasdair Macleod – 22 November 2013

The relationship between gold and commodities is essentially a simple one. If you look at long-term charts of oil priced in gold for example, you find that they have been more constant than oil priced in paper currencies. In 1965, gold was at $35 and oil was priced at $2.90 per barrel, so priced in gold oil was 0.083 ounces. Today gold is $1250 and oil is $95, so oil is 0.076 ounces. Therefore the price of oil in terms of gold has hardly changed over nearly forty years compared with it rising 33 times measured in US dollars.

What has happened is the purchasing power of the dollar has fallen. Since 1965 the quantity of gold in above ground stocks has doubled, which other things being equal explains a rise in the price of oil in gold terms. At the same time, the Fiat Money Quantity (a measure of total dollar cash and deposits in the banking system) has increased 33 times, which again is broadly consistent with the price of oil measured in USD increasing substantially.

There are significant fluctuations in price from the oil side as well. Before the Lehman crisis in mid-2008, oil peaked at $140 before collapsing to under $40by the year-end, or in gold terms, 0.14oz to 0.05oz, so there is no precision in these relationships. However, so long as economic conditions are roughly stable, over time it will be true that gold, in paper currency terms, will tend to move in line with commodity prices.

For this reason many analysts make the mistake of tying gold closely to the general commodity cycle. This trend assumption ignores the monetary role of gold at a time of great currency inflation and systemic risk. It is hardly surprising, since so far as I’m aware not one commodity analyst even considers the possibility that changes in commodity prices might be due to changes in the purchasing power of the currency.

For this reason, they will either use technical analysis or will focus on prospective demand for commodities in the light of the global economic outlook. Both these approaches are inherently subjective.

The monetary situation today is at an extreme for which the consensus is not prepared. Let us take two simple facts: governments are being funded by their central banks at wholly artificial interest rates; and the global banking system, exposed to government bonds, interest rate swaps and highly-indebted customers, would face a renewed crisis if interest rates and bond yields were suddenly normalised.

Not only has there been significant deviation between gold and commodity prices in the past, but the past is no guide to the current position. Currency inflation is now a significant and escalating problem, and those that think gold will continue to act like any other commodity are almost certainly mistaken.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

2 thoughts on “Gold and commodities”

  1. Hi Alastair,

    Very interesting piece.

    Aside from this, have you any thoughts about a potential effort to drive monetary velocity in Western economies via “Help to Buy” and its derivatives, which some think could include mass forgiveness of US student debt.

    To my mind the UK scheme is highly irresponsible, since it increases debt & makes houses even less affordable, but the UK seems hell bent on going down this path probably for electoral reasons. Debt monetisation and forgiveness elsewhere meanwhile create a disgraceful moral hazard, for both politicians and private citizens.

    It would seem that if you are forcing credit into the economy, even by artificial means, you are sowing the seeds for a gigantic inflation which has so far proved elusive, beyond luxury items.

    So far, “Help to Buy” is being judged a “success” by Krugmanites. Do you think that we could see it being propagated elsewhere, especially as the choc du jour seems to be deflation (TIPS yields nearing 1.5%)?


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