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High Gold Prices? It's the Oil Stupid!

I'm constantly amazed at the inability of US economic and financial "expert policymakers" to understand the true reason behind gold's big move: OIL. The inflation adjusted high for gold was set in January 1980 at $2,290 an ounce. It is  not a coincidence this high was set just after the oil crisis of the 1970's. The US was lucky then: it had Paul Volker at the Federal Reserve and it had the oil reserves of Alaska and the North Sea coming online. The combination of Volker's high interest rates and new domestic oil supplies saved the day. Unfortunately, neither of these two solutions will bail America out this time. Once again, as history repeats itself, gold prices are taking off after the 2008 oil crisis which saw oil prices of $145/barrel. Why is it so hard for the Harvard B-School "experts" and the pundits on CNBC pundit to understand this very simple cause and effect?

US policymakers seem intent on devaluing the US dollar to improve the trade deficit. I'm just an engineer, but I wish one of these expert economists would explain to me how this currency devaluation "strategy" will work since:

  • oil is the biggest component of the US trade deficit
  • oil is priced in US dollars and therefore
  • the price of oil rises as the value of the dollar falls!
This is so obvious, yet the "experts" at the Federal Reserve, Treasury, and in the White House seem completely oblivious to this fundamental and inconvenient truth. Either they are oblivious, or, there are conspiracies afoot to ignore the truth about the country's dependence on foreign oil. Is this because they're in the pockets of big oil? Because they want to make the military happy by fighting foreign oil wars? Both? Your guess is as good as mine. Regardless, not solving its dependence on foreign oil is destroying the America's currency and economy. If not solved, it will eventually destroy its Democracy as well.

Brazil suffered devastating economic hardships in the 1970's as a result of its dependence on foreign oil. Their oil bill doubled within a year and set off uncontrolled inflation, which reached 110% in 1980. They saw a sharp increase in short term foreign dollar denominated debt to pay for the oil (sound familiar?). This led to 15 years of economic instability. Contrary to the US, Brazil identified the problem, attacked the problem, and solved the problem. The country adopted natural gas transportation and leveraged its ethanol capabilities. Brazil reformed it banking system and passed balanced budget policies. Today, Brazil is self sufficient with oil and will soon become a major oil exporter. The real currency is strong, and the country was one of the last in and first out of the current economic crisis. Why is it that Brazilian policymakers could identify and correct their oil problem but America, with all its Ivy League economists, cannot?

Gold is up $19 this morning, no doubt in part due to Iranian war games being held to show the extent to which they will try to protect their nuclear infrastructure. Faced with US forces on its western border (Iraq) and on its eastern border (Afghanistan), oil and natural gas rich Iran is clinging to their nuclear infrastructure in a last ditch effort to protect themselves from the fate of their neighbors. If protecting their homeland is the goal, Iran's rhetoric on the destruction of Israel was akin to shooting themselves in the foot. While Israel may or may not have the capability to take out Iranian nuclear facilities, it is clear the US must get involved if there is any hope to protect the strategic Straits of Hormuz through which much of the world's oil flows. However, it is not a given that the US can prevent Iran from bottling up the Straits. What will happen to oil and gold prices if this conflict takes place? What will be the corresponding impact on the US economy? For a country that uses 25% of the world's entire oil supply, and imports 65% of that, a war in Iran cannot be a favorable development.

Meantime, US policymakers continue to print money as fast as possible thinking they can solve a commodity problem (oil) with monetary and fiscal hijinx. It cannot be done! Officials have high sounding debates about whether or not the biggest threat is inflation or deflation. Who cares! The biggest threat is America's reliance on foreign oil! It's the oil stupid! The U.S. imported 357,000,000 barrels of oil in September, 2009 sending $24,700,000,000 overseas.  This continues...month after month, year after year. By God, when are US policymakers going to do something about this?

America is in serious trouble. Following George Bush, who I believe was the worst President in US history, we quite likely have a candidate for the 2nd worst President in Barack Obama. Bush was obviously tied at the hip to oil power and led us into the wrong-headed war in Iraq. While getting his hands on oil reserves might seem strategically logical for a country dependent on it, it took millions of barrels of oil off the market at precisely the same time that Chinese oil demand was skyrocketing. The result, in addition to supply demand problems, was an additional geopolitical risk premium being added to each barrel of oil and wah-lah! We have $145/barrel oil and record oil company profits. Too bad the rest of the American economy had to pay the price. Bush's only attempt at energy "policy" was the idiotic ethanol mandates (mostly from made from corn) while simultaneously slapping fees on imported Brazilian ethanol which is made more sanely from sugar cane. The ethanol mandates only exacerbated the country's inflation problem by causing massive dislocations in the food chain. Enter Obama and Energy Secretary Chu. Both are in love of the oxymoronic myth of "clean coal" and neither has done anything to reduce foreign oil imports. Obama has never uttered the words "natural gas transportation" and Energy Secretary Chu should give back his Nobel prize after famously being quoted as saying he is "agnostic" about natural gas transportation. How on Earth can the US solve its energy and economic problems when the two most important energy policy decision makers are "agnostic" about natural gas but are in love with the myth of "clean coal"?

Adding to US policy problems in the executive and energy departments is the worst Federal Reserve chairman in US history (Greenspan) being followed by a candidate for the 2nd worst Federal Reserve chairman (Bernanke). One can only hope that Ron Paul is successful in opening up the secrecy and publicizing just how bad Federal Reserve policy is and who is profiting the most from it. Let me give you a clue: it is NOT middle class America. Like Greenspan, Bernanke too never speaks about the need to solve the foreign oil problem in order to bolster US financial health. What kind of fiscal and monetary credibility do these officials have when they never push strongly to solve the foreign oil crisis which is at the root of US economic decline?

The only way to solve America's economic problems is to reduce foreign oil imports and rely on domestic energy sources. The only way to do this is by adopting and implementing a strategic long-term comprehensive energy policy like this one: The US consumes 70% of its oil in the transportation sector. Logically, the only way to reduce foreign oil imports is to reduce oil (gasoline) usage in the transportation sector. The only domestic fuel capable of doing that is natural gas. American's could easily be refueling NGVs in their home garages while they sleep at need with clean, cheap, and abundant natural gas. All we need are policymakers to stop ignoring the foreign oil crisis that is staring them right in the face every day. Perhaps President Obama should invite Brazilian President Lula to the White House and get a friggin clue. You'd have to live on the moon to not realize the US (and the world) is awash with abundant, clean, and cheap natural gas!

Meantime, what can Americans do to protect themselves from the foreign oil crisis and a government that has declared war on it citizens and is intent on devaluing the dollar? Buy gold and silver bullion. Buy oil stocks such as Petrobras (NYSE:PBR), Exxon Mobile (NYSE:XOM), ConocoPhilips (NYSE:COP), Chevron (NYSE:CVX), BP, and StatOil (NYSE:STO). The foreign oil companies are paying good dividends and can provide more upside due to US dollar weakness. Good luck with your investing, and if you care, contact your local Congressman or Congresswoman and implore them to support the Natural Gas Act and that you want them to adopt and support strong natural gas transportation policies. Otherwise, the American oil crisis will continue to push gold higher and higher. So hold on to your gold and don't sell it until you see the US adopt natural gas transportation. If that day every comes, sell your gold because the US economy will thrive, inflation will fall, and balanced budgets will be possible. Natural gas transportation could usher in an era of unfettered economic prosperity that few people today can even imagine.

The author owns gold and oil stocks.