Is Gold a Better Hedge than Oil?


"While oil appreciated at a rate better than gold and CPI over the long run, it may not be the better hedge."

When we looked at gold's long-term performance last year, we wondered if, indeed, the yellow metal would match its 1980 highs on an inflation-adjusted basis. As it turned out, gold didn't. But crude oil did.

We figured gold would have to average $1,563 an ounce in 2008 to equal its 1980 record when rises in the U.S. Consumer Price Index [CPI] were factored. Gold, loco London, managed to run up to $1,023 in March, but only averaged $872 for the year. West Texas Intermediate [WTI] crude, by contrast, needed a CPI-adjusted mean price of $95 a barrel in 2008 to equal its 1980 performance. Spot oil delivered to Cushing, Okla., averaged $100 last year.

Traditionally, gold's risen in tandem with oil. That's still the case - more or less, though it's been "less" than "more" recently. Gold's purchasing power is waning now owing to a resurgence in oil prices. An ounce of gold currently buys 17 barrels of oil. Back in February, when oil prices cratered, the gold/oil ratio approached 28-to-1. At oil's zenith in 2008, the ratio neared its record low of 6-to-1. Over the long run, gold's multiple averages a shade under 16x, though the metal's leverage has been slipping recently.

Deleveraging had a lot to do with the run-up in the gold/oil ratio. Slackening demand certainly contributed to oil's downtrend, but the fire sale of assets in the wake of the Lehman Brothers collapse, led by hedge fund selling, really pitched oil prices into the abyss, making gold look relatively strong.

Oil, in large part, fell upon its own sword. After all, it was oil's price rise preceding the banks' collapse that was the source of much of the inflation measured by CPI.

While oil appreciated at a rate better than gold and CPI over the long run, it may not be the better hedge. Sure, one can hedge against inflation, but there are other adversities for investors to consider. In the strictest definition of the word, a hedge is an instrument that moves in opposition to a target asset. The object of hedging is to smooth out portfolio volatility until such time as assets can be liquidated.

Consider this: the 23-year correlation between the S&P 500 and WTI crude is 4.2%. Not a high correlation certainly, but a positive one. Gold, however, is negatively correlated, at -38.6%, to stocks.

In a hedge, you want the hedge vehicle to zag when your primary asset zigs. Simply put, there just may be more zag in gold than there is in oil for long-term stock investors.

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