Oil Majors Should Just Buy Real Gold 13 comments
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The current investment climate is riddled with counter-party risk, frauds and broken promises. In an attenuated way probably in violation of the Model Rules of Professional Conduct for attorneys even the SEC is married to Madoff. As the deflationary credit contraction intensifies, holders of capital continue seeking safer and more liquid assets in which to allocate capital. Some neophytes have called this a ‘liquidity crisis’. I suppose they scarcely understand the phrase.
GOLD TO OIL RATIO
The current price of February oil is $46.20 and spot gold is $849.90. The ratio is 18.4 barrels of oil per ounce of gold. The historic averages (click on chart to enlarge) indicate opportunities for buying around 10 and selling around 20. Oil, priced in gold, is getting pretty cheap which is to be expected during a credit contraction environment.
OIL MAJORS ARE CASH COWS
The oil majors generate and hold tremendous amounts of ‘cash’. Unlike the current nomenclature I consider gold cash and fiat currencies such as the Federal Reserve Note Dollar, Euro, Yen, etc. to be ‘like-cash’ which will eventually evaporate just as other ‘like-cash’ assets have such as Auction-Rate Securities, Asset Backed Commercial Paper, etc.
Nevertheless, at the end of 2007 Exxon (XOM) had $86B of current assets and $5.8B change in cash equivalents. Chevron (CVX) had $39B in current assets with $7.4B cash on hand. Total (TOT) had $71B in current assets, $8.8B cash on hand and $5.1B change in cash equivalents. British Petroleum (BP) had $80B in current assets with a measly $1B change in cash equivalents. The runt, ConocoPhillips (COP), still possessed $24.7B in current assets with $1.5B in cash and $639M change in cash equivalents. Combined these five companies had current assets exceeding $300B.
On May 28, 2008 Rex Tillerson, CEO of Exxon Mobil (XOM), speaking at the company’s annual meeting, was quite proud of $7B of share buybacks per quarter for a total of 20% of its total outstanding stock over the last five years. Through either similar buyback programs or mergers the other oil majors have engaged in similar transactions with their monstrous free cash flows.
GOLD IS CHEAP
At all times and in all circumstances, gold remains money and therefore is the most important currency in the world. As required under the International Accounting Standards, gold is a monetary commodity. For example, footnote 14 of the 2007 Annual Report for the Bank for International Settlements states, ‘Gold is considered by the Bank to be a financial instrument.’ Silver, while extremely cheap with a current silver to gold ratio of 78.2, is only a quasi-monetary commodity. Gold is carried in the cash section of the balance sheet.
On May 20, 1999, Alan Greenspan testified before Congress, “Gold is always accepted and is the ultimate means of payment and is perceived to be an element of stability in the currency and in the ultimate value of the currency and that historically has always been the reason why governments hold gold.” Additionally, gold has been flirting with backwardation and fiat currency interest rates are now nearing 0%. The COMEX had available for December delivery a puny 2,855,567 ounces and 45.7% has been demanded for delivery.
During the 1990’s Mr. Rubin had devised the gold leasing scheme with the intent being elucidated by Dr. Greenspan’s testimony in 1998, “Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.”
GATA’s alleged central bank gold price suppression scheme may include the COMEX’s participation. Mr. Robert Landis, a graduate of Princeton University, Harvard Law School and member of the New York Bar, has asserted that “Any rational person who continues to dispute the existence of the rig after exposure to the evidence is either in denial or is complicit.” GATA alleges that the central banks have less than half the gold claimed.
The sophistries weaved by the derivative illusion have confused many otherwise extremely intelligent people to erroneously believe that the sun (gold) revolves around the earth (FRN$). Gold is not a portfolio asset; everything else is. For example, the $700B bailout represented approximately 20% of all the gold ever mined in the world. When there is a real liquidity crisis there are no TARPs, TAFs, TALFs and other CRAPs which are intended to confound, confuse, deflect and misdirect. Why have hundreds of pages on the topic of gold leases requested under FOIA by GATA been redacted by the Federal Reserve for reasons including ‘trade secrets’ and ‘privileged or confidential’ memorandums and letters?
Peter Schiff, the extremely accurate Gerald Celente and others have cited forecasts for gold in excess of $2,000 per ounce. Former Federal Reserve Govenor Lyle Gramley has suggested a revaluation of the Federal Reserve’s gold. A revaluation from the current $42 per ounce to Gerald Celente’s suggested $6,000-10,000 is not unreasonable given the condition of the Federal Reserve’s current tumescent balance sheet. This would also bring the DOW towards its twice historic lows of about one ounce of gold.
My assertion is that the downside risk for the oil majors when purchasing real gold is limited while the upside is prodigious. Humanity’s gold lust has been dormant for nearly a century and when it awakens it will be extremely vehement and go viral. Those who own gold know of what I speak. The yellow metal seems to call out to the inner conscience and resonate with our DNA.
BE THE RISK NOT AT RISK
The oil majors, or anyone else for that matter, can purchase gold and put options. Then they can cause the ultimate liquidity crisis by sending their armored trucks to the COMEX, having them loaded up with the supposed gold and hauling it away. Demanding and taking physical delivery is extremely important because there are approximately 140 ounces of ‘paper gold’ for every ounce of physical gold. This is a key reason why the oil majors should truck away their gold instead using problematic ETFs such as GLD or SLV (GLD) (SLV). Someone will be left holding the bag of worthless paper gold.
As a result of all the delivery notifications in December the COMEX currently has 1,304,994 ounces or about $1.1B. The entire eligible COMEX stockpile represents an immaterial 0.36% of the current assets of the five oil majors. The oil majors could drain the COMEX with a rounding error. It would be 14% of what Exxon Mobil was spending per quarter buying back stock. Why buy back stock when oil is so cheap compared to gold? Why not just buy physical gold and truck it away? Is there a potential failure to deliver for the stock?
There is extreme instability in the worldwide monetary and financial system accompanied with the counter-party risk of the banks. The oil majors, or you for that matter, can easily eliminate counter-party, Herstatt and settlement risks with gold clause contracts and by using credible, transparent and reliable digital gold currencies. This turns bullion hoards into a functional currency for ordinary daily transactions either with international parties or domestic employees. Under 31 U.S.C 5,101-5,118 gold clauses are legal and enforceable. As the economic pain from the current system intensifies more rational market participants will seek out alternatives which will only increase the velocity of gold and its perceived value.
CONCLUSION
Because (1) oil is a bargain, (2) shares are plentiful, (3) gold is extremely cheap money in short supply relative to the size of their balance sheets, and (4) to reduce risk therefore the oil majors should just buy and take delivery of physical gold instead of buying back their own shares.
Finally, it appears almost like gross negligence and an extreme breach of fiduciary duty for executives and boards of directors to continue ignoring the risks and perils of the current monetary and banking system when safe alternatives exist. This area may become ripe ground for shareholder derivative suits. For example, Mr. Tillerson’s $13M compensation and $54M of stock is rather low compared to the compensation of other oil and gas executives like Bob Simpson of XTO Energy who earned $72M and has $600M of stock. Lawyers, here are some deep pockets to go after!
Disclosures: Long physical gold and no positions in XOM, CVX, TOT, BP or COP.
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This article has 13 comments:
How anyone reconciles the effect of supply/demand on prices, and then refers to such ratio analysis is beyond me. My pet question refers to the 3 Magi and Christmas (appropriately enough). The three gifts were gold, frankincense and mir (sorry if the spelling is wrong). The question is, what was the ratio of gold to oil in those days, and by extrapolation, what is the long term ratio of oil to frankincense ?
No answer, usually (most times because no-one even knows what the other two substances are, much less why they were deemed to be comparably as valuable as gold).
Skate where the puck is going to be not where it is and it appears we are skating in opposite directions and only one can be right. Markets are great though because they financially reward those who choose correctly.
dieuwer, exactly my point. The reason why what Shell is doing is wrong is because oil is not money, as such hoarding decreases rather than increases price and the negative interest rate for oil is too expensive relative to gold (which is cheaper to store 20 barrels of oil or 1 ounce of gold?). Shell should stop buying oil and start buying and hoarding gold.
ANTS, if you did not read the article then why did you comment?
Oil was not an integral part of the economy 2,000 years ago. However, the commodity ratios were probably very consistent back then such as wheat/gold, etc. In the current case, the 70 year gold/oil ratio is extremely consistent.
To get to your pet question, I think a better question to ask is how big is yellow, but perhaps you should do some further research. First, the oil the 3 Magi delivered was not the same black gold we use today but a luxury good. Second, there is a historic gold/silver ratio. Third, Judas threw out relative prices for such luxury goods as oil and myrrh (this is the correct spelling). Therefore, you could derive the approximate price. More research would be needed to determine the long-term pricing ratio. However, because of the Roman inflation the pricing data may be inaccurate and need adjustments but that is a start.
Additionally, it is asserted the gifts were probably chosen for the symbolism not their economic properties or relationships. Gold is the Ancient metal of Kings; fit for the King of Kings. Frankincense when burned was believed to carry prayers to heaven which is fitting for the High Priest. Myrrh was an embalming ointment to signify his future death and was used in his burial (John 19:39).
As a shareholder in an oil company, I would be horrified if management were to start trading in gold on the basis described. In fact that of itself would be an extreme breach of management duty to shareholders, which is to produce oil. Look at Metallgaslshaft if you want to see what happens when management starts to consider fiddling in commodity markets.
As to ratio of commodity prices, I'm just passing on some personal history. When I started resources analysis, it was suggested that we could look at various ratios. But it was pointed out to me that a mining company just has to be aware of supply issues in particular, and on reflection that is the most important issue in project planning. Thats why they spend so much time estimating industry cost curves and why they are obsessed with production costs. They learned long ago that basing mine planning on price forecasting is a waste of time.
It is obvious that governments all around world are printing endless quantities of paper money trying to inflate world economies out of coming depression.
Consequently, these paper-money must be converted into something tangible that will hold its value no matter what.
These tangible assets are gold, oil, gas, quality farm land and other valuable assets no government can print.
It is mind boggling how oil and gas producing states continue to exchange their oil, gas and other valuable commodities for useless pieces of paper called US$.
Remember that the USA foreign trade deficit is gigantic, i.e., the USA buys a lot and sells very little.
Does anyone have a answer
After all, this used to be the case by default for all current assets before 1971.
"For example, footnote 14 of the 2007 Annual Report for the Bank for International Settlements states, ‘Gold is considered by the Bank to be a financial instrument.’ "
Because the oil majors operate in so many different countries they hold many different currencies. My assertion is they should buy the only currency that does not contain counter-party risk. Additionally, the 5 oil majors could drain the entire COMEX warehouse with an immaterial 0.36% of current assets. How is the cash portion of their balance sheets currently allocated between $, A$, NZ$, C$, Euro, Yen, etc.?