When Gold Trades at 25 Times Oil

Updated from March 5 Over the past couple of weeks, a duel has raged over the possible existence of a technical trading relationship between the price of gold and crude oil.

Although one commodity analyst says that a clear technical relationship exists only a few days each calendar month, others have said that the two commodities are correlated when their respective prices reach a critical ratio of 25 times.

Supporters of the latter argument say that traders should expect a shift in gold and oil prices whenever the price of gold is at least 25 times greater than the price of oil.

According to the daily price history for the March gold futures contract at the Comex and the April West Texas crude contract at the Nymex over the past two weeks, the 25 times notion has held up fairly well.

A Unique Oil and Gold Trade

On Feb. 23, gold topped out at $997.70 an ounce while crude oil traded around $38.20 a barrel.

997.70/38.20 = 26.12

However, by Feb. 26, the price of gold had sunk to an intraday price of $942.70 an ounce, while crude oil had risen to $44.74 per barrel.

942.70/44.74 = 21.07

By the close of trading on Feb. 27, gold settled $1.90 lower at $941.50 an ounce, while crude prices eked out a slight gain to $44.76 a barrel. Weak economic news likely helped gold and hurt oil. Friday's closing gold-to-oil ratio was: 941.50/44.76 = 21.03.

By the close of trading Thursday, March 5, gold finished the session $21 higher at $927 an ounce, while crude oil fell $1.77 to $43.61 a barrel.

The ratio: 927.00/43.61 = 21.25

Early on Friday, gold was trading for $936 an ounce, while crude oil was fetching $44.70 a barrel.

The ratio: 936.00/44.70 = 20.93. So Friday's ratio appears to be backing down from its recent highs.

Going back to what energy analyst Stephen Schork predicted in his analysis of the gold/oil relationship last Wednesday, he said that "in the very short run, i.e., a two- to three-day period, those looking to trade the spread should short gold immediately following a run in oil prices, but, given market conditions, don't depend solely on a movement in gold prices to affect oil."

If crude oil continues to rally on Tuesday, investors will likely see pressure on gold commodities, stocks and exchange-traded funds.

Traders who believe in this legend are basically looking at the following chart, provided to TheStreet.com courtesy of www.thechartstore.com:

Oil and Gold Exploring the Myth of the 25:1 Ratio www.thechartstore.com

The chart shows that the price ratio of gold to oil has exceeded 25 times only seven times since 1970. Also, on those few occasions when the gold/oil ratio surpassed 25, it didn't stay there for long. Rather, something happened that quickly pulled the ratio back to normal levels.

What's Wrong With This Chart?

At first glance, it seems reasonable to look at the chart and conclude that the same thing will probably happen this time. However, anyone who makes that conclusion is making a classic statistical miscalculation.