Gold vs Oil Chart
Which is Over Priced? Oil or Gold?Updated 4/16/2013Was gold in a Bubble? Does the recent correction mean anything? With the value of the dollar constantly changing it is hard to tell what it all means. After all, can you imagine trying to build a house if everyday when the workers arrived you gave them a different size ruler?With commodities in general skyrocketing in price (or the dollar devaluing) is there any way to tell what the real value of something is? How much is anything really worth? Is Oil overpriced? How about Gold? Is it overpriced? Is it cheap now that the price has come down? Looking at these commodities in the standard way it is often difficult to tell.We could look at the inflation adjusted price of Gold but that requires that we rely on (and believe) the government stated inflation index. But that is just one way to look at the price by comparing it to U.S. dollars. We could also look at its price in Euros or at what the price looks like to the people in China or India. And each of those are based on the values of their currency and how much they are inflating.Oil Priced in Ounces of Gold:
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But a different way to look at it would be in comparison to the price of other commodities. Theoretically in an ideal world, if the supply of currency is inflating, then all commodities should increase equally.But in the real world that isn’t true. There are inequalities partially because money doesn’t flow equally initially. Eventually it will even out as traders arbitrage high priced commodities against lower priced ones.But how do you know which commodities are over priced and which are under priced?Very simply you just divide one price by the other to get a ratio. If we look at the ratio of Gold to Oil we will see how they relate without bringing dollars into the equation.Assume for a moment that an ounce of gold is exactly $1000 and a barrel of oil is $100. Lets look at how many barrels of oil an ounce of gold would buy. So we are looking at barrels per ounce of Gold. So if Gold is at $1000 /oz and Oil costs $100 per barrel it is obvious that one ounce of gold would buy 10 barrels of oil, right? 1000/100 = 10Note: Many economists measure it the other way around, but I prefer barrels per ounce because if you do it the other way around the numbers come out messier i.e. as a fraction.And if several years ago, gold was at $500 an ounce and oil was at $50 the ratio would be the same. So we need to look at the historical ratio and see what a reasonable number of barrels per ounce is. (Another way to look at it would be in ounces of Gold per hundred barrels of oil.)We used the free market price of gold rather than the government fixed price of $35 / ounce. We also used the free market price of oil (called stripper) rather than the government fixed price for the period it was fixed.
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