India-Iran Oil Deal Sets Stage For $12 Billion Move To Gold

Jan.24.12 | About: SPDR Gold (GLD)

Today's big story that doesn't seem to be getting enough attention is the revelation that India will begin to buy oil from Iran using gold (NYSEARCA:GLD) -- not dollars. This is a big story with a couple major points:

1. It shows the exodus from the dollar is gaining speed. How far off is the tipping point? I post it's not as far off as many would believe. With the major economies of the world facing $7.6 trillion in bond payments due this year, I think the tipping point for a shift out of dollars and into a new monetary system backed by gold is not as far off as it may seem.

2. It shows the increasingly harsh economic sanctions the US has placed on Iran, and the geopolitical tensions between the US and Iran in general, have an effect beyond the two countries involved. India is the second largest buyer of Iranian oil, after China; India spends $12 billion USD (over 200 tons of gold) per year on Iranian oil. Because India has some energy dependence on Iran, it is conceivable that India has a greater interest in protecting Iran than in supporting US sanctions. This is the kind of political environment that sets the stage for widespread war, greater trade embargos, rationing of resources, and all the political and economic headaches that come from people fighting and not getting along.

3. India's decision to purchase its oil with gold, along with central banks continuing to accumulate gold, also shows that gold is finding its way back into the international monetary system. The end game for gold bugs that have been holding to their gold for years is when gold finally gets re-monetized, preferably through a new international monetary agreement. There has been much speculation that the IMF would issue and manage Special Drawing Rights as a new world currency; what gold bugs will want to watch for is signs that SDRs will be backed by gold to some extent, or if nation-states reject the IMF's authority here and gold becomes the world currency on unofficial, implicit terms.

The only way gold does not get re-monetized is if some type of agreement between the US Treasury and major Treasury bondholders can be reached in which the debt is partially cancelled and bondholders agree to take the loss. This would also need to be coupled with significant cuts in US federal government spending, so that the budget was balanced and the issuance of additional Treasury bonds were not needed. The odds of this occurring become slimmer with each passing day, and are extraordinarily slim when we consider that this is an election year and presidential candidates outside of Ron Paul are reluctant to commit to significant reductions in government spending that would bring about greater short-term pain.

As for the immediate term, it is increasingly looking like the bottom is on on gold. We have cleared above the 200 daily moving average, and closed last week above the 30 week exponential moving average. The chart below shows the weekly price of gold with the 30 exponential moving average plotted.

Click to enlarge

These two signs should cause the bears to back off a bit, and their short covering sets the stage for the market go in the opposite direction. Add in the underlying fundamentals and the geopolitical tensions that are exacerbating a run out of the dollar, it becomes clear that gold is still undervalued and has much room to go.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.