Comparing oil vs. gold physics electricity and magnetism study guide


In the modern economy, oil is just as important, if not more important, than gold. Everything depends on oil, it heats our homes, runs our cars and machinery, and produces our electricity which in turn runs our computers, the internet, entertainment, lights and HVAC. An argument could be made that our currency should actually be based on oil rather than gold. The only problem is portability… who wants to carry a barrel of oil to the grocery store? Oil as a measure of inflation:

Today, I’d like to compare the price of gold with the price of oil. Theoretically, since both are commodities, if it were truly democratic, inflation would raise all prices equally. Thus the ratio of the price of gold to the price of oil would remain constant. So then, as the value of the dollar depreciated (due to an increased supply of dollars) the price of both gold and oil would increase in tandem. This however has not happened. Both oil and gold are subject to external forces that have affected their price. So at times each has been overpriced compared to the other.

Traditionally economists have measured gold in terms of oil i.e. one barrel of oil is equal to some fraction of an ounce of gold (ounces per barrel of oil). But I prefer dealing with whole numbers rather than fractions so I’ve created this chart in terms of the number of barrels of oil a single ounce of gold will buy.

For the period when Nixon set price controls on oil, we also used the free market price of oil (called stripper because some “stripper” wells that were nearing their end of life were exempt from price controls.) We also used the free market price of gold rather than the government fixed price of $35 / ounce. Oil vs. Gold Chart Analysis

In looking at the chart we can see that the average since 1946 has been that one ounce of gold would buy 14.83 barrels of oil. Therefore, whenever one ounce of gold would buy more than 14.83 barrels of oil either oil was cheap or gold was expensive. And conversely, whenever an ounce of gold would buy less than 14.83 barrels, then oil was expensive or gold was cheap.

That makes sense because the price of gold was fixed and that is what eventually led to Nixon having to stop selling U.S. gold to foreign governments (closing the gold window) but also opening up gold sales to U.S. citizens. Once that pent up demand was released from 1970 to 1972 the price of gold shot up 62% while oil increased 6.2%. By 1973 oil was up over 40% but gold was up over 170%. Over 10 years (by 1980), oil was up over 1000% but gold was up over 1600%.

But what about that brief period from 1973 -1975 when gold was expensive compared to oil? Well from 1973 to 1974 oil prices were up almost 97% while gold prices were “only” up 58.13%. The following year oil prices actually fell so from 1973 – 1975 oil was up 61+% while gold was up 65% but then in 1976 gold fell and oil took off so that by 1978 oil was up 214.7% and gold was “only” up 98.6%. So once again when the ratio indicated that gold was overpriced oil performed better.

Neither oil nor gold were good investments for the decade of the 1980’s with gold losing -37.6% over the decade and oil losing -38%. From 1990 – 1999 oil lost another -28.6% and gold lost -27.3%. However by buying the cheap one and simultaneously selling the expensive one “short” you could still have made a tidy profit.

Note that in 1998, oil was cheap or gold was expensive and from 1999 -2000 oil was up 65.6% while gold was basically flat. In the early 2000’s gold was once again very cheap and it went from $271 in 2001 to $1669 in 2012 when oil was cheap again. Remember these are average annual prices, so you wouldn’t need to get the timing exactly right to hit them. Where are we Now?

The average price of oil in 2013 was $91.17 and the average price of gold was $1,411.23 which resulted in 15.48 barrels per ounce or a slightly above average ratio, meaning that gold was slightly overpriced or oil was very slightly under-priced, not generating a signal either way.

By April of 2014 the prices had shifted to $95.20 / barrel and $1293.94 / oz resulting in a ratio of 13.59 barrels per ounce. Thus in April the ratio has moved barely into the gold is cheap side. Over this relatively brief period oil has risen 4.42% while gold has fallen -8.31%.