Oil and the Golden Constant
Since its recent high of almost $108/bbl in June 2014, we have witnessed a stunning collapse, and a subsequent bounce back, in the price of oil. In February 2016, West Texas Intermediate (WTI) was trading at $26/bbl, a 76% plunge from its June 2014 high. It has since clawed its way back to $53.70/bbl (February 20th). Thanks to the “golden constant,” I was able to anticipate the course of crude’s bounce back. Indeed, the price of crude has doubled since its cyclical nadir. Just as I predicted.
Taking the broad lead from Jastram, I developed a model. It employs the price of gold as a long-term benchmark for the price of oil. The idea being that, if the price of oil changes dramatically, the oil-gold price ratio will change and move away from its long-term value. Forces will then be set in motion to move supply and demand so that the price of oil changes and the long-term oil-gold price ratio is reestablished. This represents nothing more than a reversion to the mean. It explains why spot prices of gold and crude are parallel to each other and why the oil-gold price ratio hovers around 0.0721 (see the accompanying chart).
Just how long will it take for the oil-gold price ratio to mean revert? My calculations (based on post-1973 data) are that a 50% reversion of the ratio will occur in 13.7 months. This translates into a WTI spot price of $57/bbl by February 2017. It is worth noting that, like Jastram, I find that oil prices have reverted to the long-run price of gold, rather than the price of gold reverting to that of oil. In short, the oil-gold price ratio reverts to its mean via changes in the price of oil.
The following chart shows the price projection based on the oil-gold price ratio model. It also shows the historical course of prices. They are doing just what the golden constant predicts: oil prices are driving the price ratio back to its mean. The model foretells a WTI spot price of $70/bbl by the end of the year, which is considerably higher than the current price of $55.10/bbl for the futures contract settling at that time.