Gold: The Next Reserve Currency Player

Includes: AUY, DGP, FCX, GDX, GLD, SLV
by: Greg Pinelli

The subprime crisis initiated and perfected in the United States has morphed into a full blown liquidity crush that has infected nearly every corner of the financial world. The one corner that can remain functioning in a largely rational economic way are the Persian Gulf states known as the Gulf Cooperation Council (GCC). These include Kuwait, Saudi Arabia, Bahrain, the UAE, Qatar and Oman. Not all of these oil players are of equal consequence, but they all have a common geologic inheritance and a cultural unity. All except Bahrain are ranked in the top 20 oil producing nations and Saudi Arabia alone made over 200 billion US$ in exports in 2008. They represent the great players and the only viable swing producers.

The parabolic rise last year in oil prices gave them daily billion dollar payouts. The drastic fall has still left them able to pay off substantial social committments to their populaces and have enough left over to make forays into the Sovereign Wealth Fund arena. However, there is a future to consider and oil will not be around forever. The twin conundrums the Kuwaitis and Saudis have faced in particular is how to protect themselves from the fallout of either unacceptably low or high oil prices and (critically) depreciating value of the currency they receive for their precious oil - US Dollars.

The solution to the two great concerns for the future - "What to do after oil?" and "How do we retain value from our Dollar payouts?" may rest with gold. It most certainly doesn't lie with an alternate paper currency. The EURO is rife with issues, not the least of which is reconciling drastically different nation states to a common economic vision and financial execution. The YEN is as dramatically leveraged as the US$, burdened by debt and a flagging international heft.

The answer? Initiation of a new payment regime - a 10% gold payment share between 2009 and 2012, 20% thereafter. The rest of the bill? Payable in US$. Gold has a long and very respected history in the Middle East. It is already held in very sizeable amounts by the Saudis and Kuwaitis. New gold, however, could be used to satisfy the region's concern for its following generations. It would form, literally, the foundation for mega banking centers and the stabilization of the currency they will still need to receive in mountain like proportions in the future.

The GCC states have developed some of the most lavish and technologically advanced cities in the world. They have shown the capacity to attract the most sophisticated financial and engineering work forces from around the world. They share a religious based society that values discretion and long term business relationships. Banking and gold are naturals for them, and the infrastructure and patience to realize this seismic shift in financial integrity are already in place.

Will this actually happen? The tipping point lies in the eventual landslide of liquidity, perhaps as much as the equivalent of 10 trillion US$ when various currencies are included (Euro, Yen, etc.) that will burst on the markets by Spring 2009. No matter what price gains oil delivers to the Kuwaitis and Saudis, at that point oil will be tainted by a realization it's being tallied in rapidly depreciating fiat money. My guess is they'll cautiously begin to take ever larger physical gold positions and seriously plan their strategic options. Those holding ETFs such as GLD, DGP and even silver ETF SLV could see enormous profits. Miners will doubly prosper, as they always do in strong metal uptrends. Look to GDX for diversity and individual equities like Yamana (NYSE:AUY) and Freeport-McMoRan (NYSE:FCX).

Disclosure: Long DGP, AUY, SLV.