Originally posted Saturday, July 28, 2012


“For the last 26 years, the price of gold dictated the price of oil with 99.579 percent accuracy.”

Michael Jagger recently published a column in The Washington Times fact-checking a report by Fox 19 Cincinnati reporter Ben Swann which made the case that the price of a barrel of oil is indirectly set by the price of gold.  Jagger:

NEW YORK, July 17, 2012 – Does the gold price dictate the price of a barrel of oil?  …

For years we’ve been told by the mainstream media that Middle East unrest, supply/demand, transportation hiccups, market conditions or trading activity are what causes major increases.  High oil prices are a major sore spot among Americans…..   Could Ben be right, in that there is another variable in the equation that has been left out and rarely if ever talked about: the value of the U.S. Dollar?

Road Rainbow by Arbyreed at Flickr under Creative Commons License

Most Americans have little to no interest in monetary policy.  Many do not even know what makes paper money valuable, or what money is.  Does the value of the U.S. Dollar really matter?  …  Could the price of gold dictate the price of oil?  Stated differently (statistically), can we say with 99 percent confidence that the price of .0602 ounces of gold will translate into the price of a single barrel of oil?  Let’s find out.

Downloading daily gold and West Texas oil price data from readily available sources, one can perform a calculation to estimate the price of oil based on the price of gold.  For example, if the price of gold for the given day is $326.30, multiply that number by .0602 ounces of gold to get a value of $19.643 per barrel.  Perform that calculation for every daily interval downloaded, and for each interval, compare the calculated value to the actual price for oil by subtracting the calculated oil price from the market clearing price for oil. Rather simple actually.

On a sample of daily interval data from January 2, 1986 to March 3, 2012 (6,457 matching intervals), using basic statistics, a 2-sample t test was performed and the results are eye-opening.  We can say that .0602 ounces of gold times the price of gold produces the price of a barrel of oil, with an standard error of just .421%, or an average difference of just $6.10 dollars between the calculated price and the actual price since 1986.  For the last 26 years, the price of gold dictated the price of oil with 99.579 percent accuracy.

What does this mean?  As Ben Swann stated, it means the strength of the dollar, more than anything else, determines the value of a barrel of oil in the marketplace.  Sure, supply/demand, fear in the Middle East, trading activity all impact the daily price of oil, as seen in the daily fluctuations present in the data.  ….  But in the long run, the analysis proves that the calculated price matches the market clearing price for oil with an average difference of only $6. It means the policies of the U.S. central bank (the Federal Reserve) have a direct impact on our daily lives.

With a dollar defined as a fixed weight in gold a precise unit of account is introduced into the American (and world) economy.  A precise unit of account makes doing business far easier, eliminating the need to tie up capital in hedges against inflation and deflation.  The gold standard, as noted by Lehrman Institute founder and chairman Lewis E. Lehrman in many venues, most recently in Fight the Fiat, originating in The American Spectator and rapidly finding exposure in significant venues on four continents, wherein he states how, under the true gold standard,

With a stable long-term price level, speculators worldwide would abandon unproductive inflation hedges.  This dishoarding would yield immense, liquid savings for productive investment in real goods and services. Equity and true capital investment would gradually displace debt and leverage. Under conditions of stable money and stable exchange rates, savings would be redeployed by entrepreneurs and investors in new and innovative plants, technology, and equipment- minimizing unemployment, as skilled and unskilled workers are hired to work the new facilities.