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Re: Roberts has yet to get the word
Correct. Silver and soybeans do not correlate because supply and demand for silver and soybeans are unrelated. However, soybeans and silver are both priced in USD, and as the supply and demand for USD changes so does the USD price of all commodities priced in USD. This is less apparent in times of low inflation. In times of high inflation, the effect can confuse even professional traders.
The traders in the 1970s did not understand that the prices of silver and soybeans were moving so much and together because The Great Inflation was a new phenomenon in U.S. economic history. They didn't understand that the pricing factor in common between silver and soybeans was the volatile supply of USD realtive to demand.
Unfortunately, by starting his data series in 1983 with the advent of crude oil futures the author inadvertently choses the post-inflation era. If he went back another decade his gold oil price relationship will look like this.
The assertion that gold and oil prices are uncorrelated is more problematic when viewed in longer term. The fact is that sometimes gold and oil correlate and sometimes they do not. They do when the USD is not functioning well as the world's reserve currency, such as between 1973 and 1983 and from 2001 to 2011, and not when it is, such as from 1983 to 2001.
Even then the correlation is not direct because it is not market-based. It is geopolitical. That doesn't show up in a chart that directly compares the prices of gold and oil.
This chart would meaningful if the prices of oil and gold were market-based. They are not so the chart means nothing.
The author sets out to prove that there is no market-based correlation between gold and oil prices, that naive traders see one where there is none. But the premise is false.
The author is asking the wrong question. It's obvious that there is no market-based price correlation between gold and oil but there is a correlation. As the chart above shows, in the 1970s and since 2001 gold and oil prices increased by roughly the same amount. Why? If not market factors then what is the causation? The answer is in the way gold functions as a reserve asset on the balance sheets of central banks when their USD reserves are riding rapidly as oil prices rise and the U.S. runs an oil trade deficit in the hundreds of billions of dollars per year.
Originally posted by cobben
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The traders in the 1970s did not understand that the prices of silver and soybeans were moving so much and together because The Great Inflation was a new phenomenon in U.S. economic history. They didn't understand that the pricing factor in common between silver and soybeans was the volatile supply of USD realtive to demand.
The subject of the relationship between crude oil and gold arose during a Columnist Conversation last Friday. I offered a number of reasons for why crude oil and gold should be treated separately. One of the most powerful, surely of interest to market technicians, is the long-term ratio of the spread: Its very history provides the best reasons to ignore it.
Laws of Attraction
The chart below depicts the ratio of the weekly average of cash gold expressed in dollars per ounce to the weekly average of cash West Texas intermediate crude oil expressed in dollars per barrel. The history chart begins with the advent of crude oil futures in 1983; this assures us the underlying prices are the result of market-based decisions. Cash prices are used instead of futures prices to avoid the problems associated with rolling contracts and with the convergence between cash and futures. Weekly averages are used to sidestep the anomalies associated with a single price point.
Laws of Attraction
The chart below depicts the ratio of the weekly average of cash gold expressed in dollars per ounce to the weekly average of cash West Texas intermediate crude oil expressed in dollars per barrel. The history chart begins with the advent of crude oil futures in 1983; this assures us the underlying prices are the result of market-based decisions. Cash prices are used instead of futures prices to avoid the problems associated with rolling contracts and with the convergence between cash and futures. Weekly averages are used to sidestep the anomalies associated with a single price point.
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| Source: CRB-Infotech |
The assertion that gold and oil prices are uncorrelated is more problematic when viewed in longer term. The fact is that sometimes gold and oil correlate and sometimes they do not. They do when the USD is not functioning well as the world's reserve currency, such as between 1973 and 1983 and from 2001 to 2011, and not when it is, such as from 1983 to 2001.
Even then the correlation is not direct because it is not market-based. It is geopolitical. That doesn't show up in a chart that directly compares the prices of gold and oil.
This chart would meaningful if the prices of oil and gold were market-based. They are not so the chart means nothing.
First, let's stipulate the obvious: The ratio clearly is at the low point in its history. But does this argue for a mean-reverting trading strategy, one in which you buy low and sell high, hoping for a regression to the long-term average, here 16.56? No: Mean-reversion implies a normal state, one defined by an underlying economic relationship such as substitution. Without such an "attractor" or natural state of affairs operating, we should expect to see a spread with strong and persistent trends defined by the price action of the more volatile asset.
The author is asking the wrong question. It's obvious that there is no market-based price correlation between gold and oil but there is a correlation. As the chart above shows, in the 1970s and since 2001 gold and oil prices increased by roughly the same amount. Why? If not market factors then what is the causation? The answer is in the way gold functions as a reserve asset on the balance sheets of central banks when their USD reserves are riding rapidly as oil prices rise and the U.S. runs an oil trade deficit in the hundreds of billions of dollars per year.
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