Update: Crude Oil, Priced in Gold 24 comments
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At the start of the summer, when oil was setting records and trading at ~$135/barrel I showed an interesting graph which showed the price of oil in gold.
I wanted to show that even priced in this currency - which many feel is superior to the beleaguered US dollar - crude oil was just too expensive and ready to come down to more realistic levels.
Since then the price of crude oil has fallen to ~$96 and many see it continuing the slide lower.
Elizabeth asked for a followup now that a few months have passed so here is a more recent chart:
Still Expensive?
To get an idea whether oil is still expensive, priced in gold, it depends how far you want to go back. If you look back just a few years, it has a bit more to fall. But if you go back to 1994 or 1999, then oil could potentially fall much, much more.
Consequences
While attempts at a new financial bailout is plodding through the halls in Washington, the consequence of any sort of bailout is that the price of oil will remain high. This article from Forbes explains why.
My personal conviction is that there should either be absolutely no bailout - allowing rotted financial institutions to declare bankruptcy. Or if the government gets involved, it should be state capitalism, not socialism. Which means that the US should follow the Swedish model and ask for equity. If they want to hammer out a deal quickly, they can use similar terms that Buffett got from Goldman Sachs (GS).
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This article has 24 comments:
One point to remember is that oil is a consumed commodity in a tight supply, while gold deposits are vastly larger than anyone can ever use, hardly any of it is consumed, governments are sitting on huge piles of it in vaults, and more of it is being mined each day. In time, the ratio between the two must change, and long term it can only move up--oil will cost more in gold terms.
You couldn't be more wrong about gold, and upon reading some of your other posts I suspect that's no accident.
Credit Suisse noted in November '07:
www.mineweb.com/minewe...
"In a recent "Gold Note," Credit Suisse Research Analyst David Davis said, "Our studies indicate that the dynamics surrounding the gold supply and demand has begun to change inexorably towards a diminishing supply of gold and increasing investment demand, which will ultimately impact the gold price."
"When Credit Suisse strips out the secondary supply of gold, coming from central banks and producer hedging, "we find that over the last 18 years, apart from three occasions, the supply of gold has been in deficit."
Gold has been produced in deficit to demand for many years. The difference has been made up by central banks, who claim to view gold as a "barbarous relic". Well, they have stopped selling it, at least the real physical kind, so I guess it ain't really that barbarous.
I suggest they could do themselves a big favor and just totally divest themselves, and float forever free on a sea of ever-expanding fiat money. What a wonderful world that would be!
Right?
The author is quite right ot point out the relationship between gold and oil. Both are functioning as currencies, oil ever since Bretton Woods 2. What do you think the real purpose of the strategic petroleum reserve is? It's a national oil repository, which can be sold in an emergency to short oil against the dollar.
Why must oil fall? There is no economic law that finite commodities in tight supply must revert to the mean. Particularly in a declining currency.
Hence the comparison to gold?
But gold is not a stable currency, and is also effected by some of the same forces driving oil. (inflation hedge).
If anything, as peak oil moves beyond the US fields which are in decline, to the Middle East, the supply/demand will become even tighter. Oil becomes more dear.
Longer term, prices must rise in stable currency. You could have just as easily written that Oil has much more to gain looking out to 2015 as demand marches upward, and production fails to keep up with demand.
The best minds (Maxwell, Goldman Sachs, Wulff) all point in the same direction--higher prices down the road.
But your comparison is not to a stable currency--but Gold--which is interesting, but is widely know to be a manipulated commodity.
You could have compared the price of oil in mangoes and rice and it would give you a different result, but still interesting.
I read the Forbes article:
"It was a perfect storm. The Federal Reserve was cutting interest rates and people were running away from the dollar as it lost value. Hedge funds, pension funds and mutual funds started pumping money into commodities because they were the safest place and the safest of them all was crude oil. There were too many dollars chasing too few physical assets. That's the bottom line."
I would not call it a perfect storm, but the perfect climate. We still have too many dollars chasing too few physical assets. Its the same climate.
The Forbes Article makes the case, in my mind, that we are at the early stages of a bull market in commodities. The dollars fundamanetals have only declined.
There is nothing to break the long term trend of a declining buck. There is nothing, long term, to break the oil supply/demand imbalance. (yes, demand destruction is baked in for short to medium term)
Therefore, oil will continue to be an inflation hedge.
Therefore, oil will continue to see so called "speculation" from those protecting their declining dollars.
Nothing has changed in the long term picture. (albeit credit contraction could drive short to medium term contraction of money supply).
long term, nothing has changed, thats the bottom line.
What exactly are you implying when you say "I suspect that's no accident"? I have no positions in gold or related instruments. I will neither gain nor lose if gold prices go up or down. I have several posts on this site related to the conspiracy theory about physical versus paper gold. I am not trying to promote anything except common sense and critical data analysis.
What you call "increasing investment demand" for gold simply means private investors are buying gold from central banks and other inventories. Gold is moving from one vault to another; none of it is consumed. Sure, it's no different than demand for a company's stock, but it is different from demand for a consumed, dwindling resource like oil.
If you think gold will hit $2,500 an ounce by 2010, good for you. I like to quote Warren Buffett who said about gold:
'It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.'
On Sep 30 03:40 PM swrichmond wrote:
> Owen,
>
> You couldn't be more wrong about gold, and upon reading some of your
> other posts I suspect that's no accident.
>
> Credit Suisse noted in November '07:
> www.mineweb.com/minewe...
>
>
> "In a recent "Gold Note," Credit Suisse Research Analyst David Davis
> said, "Our studies indicate that the dynamics surrounding the gold
> supply and demand has begun to change inexorably towards a diminishing
> supply of gold and increasing investment demand, which will ultimately
> impact the gold price."
Gold IS consumed, in the electronics industry, dentistry, and jewelry. Much of it is reclaimed, but demand continues to outstrip supply.
I reiterate: if gold has no real value, the central banks should divest themselves of all of their holdings immediately. Think of the money we could save when we closed Fort Knox. Yet, for some barbarous reason, they have chosen not to. Central banks with low holdings (Russia) are buying more. We put it in the ground and pay people to guard it because we value it. If we didn't value it, no one would look twice.
Physical gold and silver continue to diverge from the paper kind. A year ago the premiums paid to buy small investor-sized PM's were 1/4th of what they are now, IF you can find anything to buy. All that is left are 1000 ounce Comex silver bars and kilo bars of gold. The US Mint has for all intents and purposes stopped supplying gold coins. Why do they want to keep it? They had no trouble at all supplying a much larger surge in demand around Y2K. What's different this time?
I think the Central Banks are trying to avoid backwardation by dribbling physical PM's into the marketplace, restraining investor demand with high premiums.
As for gold not being consumed--that's part of the point of gold and why it operates as a store of value and a currency. You don't eat your dollars or manufacture chairs with them.
In fact, the fundamentals have not changed and the U.S. is in deep trouble, which will eventually show up again in the dollar index.
Fiat money, backed by nothing, makes no sense and is unworkable.
When the dollar was backed by gold, the US central bank held gold for which dollars could be redeemed. When Nixon made the dollar non-redeemable in gold, oil became the most important commodity in relation to dollars / fiat currency. Since economies run on energy, and since oil is the most BTU-intensive, easily transportable yet reasonably available energy source, it seems apparent that the most valuable "thing" that a nation can buy on the international market with fiat money would be oil. If that is the case, then the perceived value of a fiat currency, especially the world's reserve currency, would be measured by the amount of oil it can buy.
If large oil producing nations (e.g.Saudi Arabia) could be induced to regulate the amount of oil in the markets to maintain a relatively stable oil price, then the buying power of the world's reserve currency could be maintained relatively stable, providing a stable monetary regime for world economic activity. If the world's largest military promised to defend that oil supplier from any attack, to maintain the supply, to maintain the Saud family control of it, and if the Saud family promised to sell oil denominated in dollars, then the dollar could remain supreme and there would be relative monetary stability for the West. The dollar is, in effect, redeemable in oil. Anyone trying to buy oil must first sell things to the US in order to get dollars with which to buy oil. US consumers are guaranteed a steady flow of consumer junk that they buy with dollars.
If oil is the de facto commodity backing of the US Dollar, then, once the US domestic supply of oil is depleted, then the US completely loses control of the value of the dollar. In order to regain some ability to intervene in the ability of the dollar to buy oil, what better way than to stockpile oil? It is a direct play of dollars against oil. If the dollar buys too little oil, the US can buy dollars with oil, increasing the supply of oil and reducing the supply of dollars.
Saudi Arabia is in essence a giant bank, where the world borrows oil, and pays interest in the form of wealth transfer. It makes sense then for the world's most powerful army to guard it.
Our old enemy, Russia, has too much oil of its own, which gives it too much influence in the oil markets and hence in the value of the US dollar. It was essential to increase the US's domestic supply by seizing Iraqi oil. The Russians counter by befriending Venezuela, a major oil exporter, and by invading Georgia (on a pretense) in order to threaten control of Caucasus oil.
We are building huge military bases in Iraq. We will never leave voluntarily. Loss of control of oil = loss of control of the buying power of USD = loss of dollar's reserve currency status = loss of US international power.
I have to say that your reasoning regarding the oil/dollar market is absolutely brilliant. I had not considered things in this light before, but after reading your thesis, it makes perfect sense to me. Hats off to you.
> jack
Has this guy ever heard of peak oil?
Natural resource production is not like production in other sectors of the economy.
Oil prices are not based on repetition of past historical cycles, they are based on supply and demand. If someone wants to hypothesize low oil prices based on that, then have at it. One could for example argue that we are headed for a global economic depression and oil demand will plummet, so that the demand drops even faster than the supply drops under Peak Oil.
Or you could claim we are going to find a bunch more somewhere. Of course, we haven't found any major new fields for decades, but hope springs eternal.
But the rationale this guy gives for low oil prices is idiotic.
It sure did seem to me that oil's movements were related more to moves by hedge funds than anything else. Now that hedge fund redemptions are beginning in earnest it will be interesting to see how the price of oil holds up.
By the way, with the huge amounts of dollars floating around out there, it might even be difficult for really big players to move in and out of the gold market without totally disrupting it. I would think the oil market is far bigger and able to absorb money more readily.
The developed nations have seen flat or even slightly declining oil consumption due to things like conservation.
However, a couple billion people in China and India who never had an automobile now would like to have one. In recent years their economies have been growing at a rapid rate and oil consumption has risen in tandem.
That more than offsets reduction in oil demand in the developed countries. Furthermore, reducing demand in developed countries is a slow process because everyone can't just run out and toss their SUV in the junk heap and buy a Prius. The price of a vehicle still dominates over the fuel cost over the life of the vehicle, so economic wise you need to run a car through its useful life before you junk it and buy something more fuel efficient.
But the most important point is that as Asia rises economically, the US becomes a smaller portion of the global economy, and economic affairs in the United States will have a decreasing influence on the global economy, and one example is oil conservation of oil.
You make a good point about resource nationalism.
Furthermore- oil demand is rapidly increasing in the major oil producing nations.
The more they use, the less they have less to export.
Mexico, for example, a major source of US oil imports, is expected to not be an exporter for much longer, and in fact is expected to become an oil IMPORTER, due to 1). declining production (exacerbated by poor management) and 2). increasing use of its oil by its own domestic consumers
I hadn't seen that, but it makes perfect sense. They acted to strengthen the dollar, to raise global confidence in the dollar, to keep people buying treasuries, and to pound 'real money' gold. Their action is pure currency manipulation, and confirms my thesis.
But follow the Swedish model? Are you smoking something?
Sweden is a small economy relative to the US and socialism is a failed experiment - one only has to look at Sweden to see this to be the case. The so called Swedish experiment took place in 1992 while the US economy (still the largest single economy in the world) was doing relatively well.
If Sweden were a state in the US it would rank among the four poorest US states in terms of per capita prosperity. Socialism i.e. nationalizing companies, may seem like a good solution but it has had painful economic repercussions over the long haul.
Great in theory for those looking for a quick fix but this is a really stupid idea and one only someone writing for the New York Times would consider seriously proposing!