Monday, January 26, 2009

Gold/Oil Ratio spikes

Milton Friedman underscored that "inflation is always and everywhere a monetary phenomenon." The current economic recession has made deflation the primary concern of central bankers, and rightfully so. The risk of systemic failure of the international financial system weighs heavily on the best and brightest bankers and economists. They may lead us out of the current financial crisis, but investors should be forewarned about the ugly consequences of the current fiscal and monetary plans in place. Look no further than the shifting crude oil and gold pendulum for a glimpse of the future.



The Gold/Oil Ratio has started a steep climb that is starting to look ominously similar to the the period leading up to the great stagflation of the 1970s. Alternatively, it could be the more benign shift to a period of weak crude oil prices, as in 1986 when the Gold/Oil Ratio also skyrocketed. Investors are hoping for the latter scenario, but there has to be considerable concern about the busy U.S. printing press. Inflation is obviously not an immediate concern, but the sudden shift in the relationship of gold and oil commodity values tells us that an unwelcome monetary storm may be brewing ahead. If the gold/oil ratio rallies further it will be concerning.

Below are graphs of the growth of U.S. monetary base and U.S. core-CPI (excluding food and energy). The grey bars represent recessions.


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