Moon is potential goldmine

July 16, 2009

CAPE CANAVERAL - AS THE Earth's natural resources gradually dwindle, some scientists believe the moon could prove a goldmine for future generations.

Forty years after American Neil Armstrong first walked on the moon, and as the United States prepares to return astronauts to Earth's nearest neighbor by 2020, it remains an object of fascination and curiosity.

Part of the goal of once again returning to our only satellite, and establishing bases there, is to learn more about its hidden natural resources.

'The moon still has a great deal of scientific information left to be discovered that relates directly to... our understanding of the history of the Earth and early history of other planets,' geologist Harrison Schmitt told AFP.

Schmitt landed on the moon in 1972 aboard the Apollo 17, the last manned mission to ever touch down on the lunar surface. He is among an elite group of 12 Americans who are the only people to have walked on the moon.

Among the 382 kilos of rocks and lunar soil brought back by astronauts from the moon during six Apollo missions is a rock that scientists call 'genesis,' which dates back to around 4.5 million years ago, about the time when the solar system began.

The moon, which has virtually no atmosphere, is effectively a geological blank slate for scientists because it has not had the contact with water and air that has changed the Earth's surface.

'One reason to go back to the moon is to find out whether there is anything of value to be done there... If the answer is yes, you can do economically valuable things and use local resources,' said John Logsdon, a curator at Washington's National Air and Space Museum.

America's new lunar program, dubbed Constellation, was launched in 2004 with the intention of establishing a forward operating station for astronauts as well as to seek evidence of water beneath the moon's ground ice.

President Barack Obama has appointed a commission to review the program's cost and goals, but the launch last month of two preparatory lunar modules suggests it is likely to proceed in some form. -- AFP

Gold only a safe haven at the right price

Business Times - 20 Jun 2009

If deflation is your call, stay away from gold - even if you buy it cheap. By Neil Behrmann

(London)

GOLD is a safe haven investment that retains its purchasing power over the long term. The proviso, however, is that the metal must be bought cheap.

This simple, basic fact is illustrated in The Golden Constant, a book that has just been published by the World Gold Council (WGC), which promotes gold on behalf of its producer members.

Before delving into the book's historical data, the natural question of investors is whether they should follow precious metals salespeople and buy gold now. The sales points are global economic and geopolitical uncertainty, potential inflation following considerable monetary ease and China and other central bank and sovereign wealth fund diversification from the US dollar.

Indeed, vast numbers of investors have already placed money in gold. Ironically for them, this is the biggest potential danger for a sharp downturn in prices. The investment and speculative crowd could sell if the price becomes volatile and breaks downward from its recent trading range of US$927-960 an ounce.

Their exposure is massive. Investment in gold exchange traded funds (ETFs) has soared from around 15 million ounces in 2006 to more than 45 million ounces. Hedge funds and managed futures funds held 20 million ounces of net bull futures and options positions on Comex, the New York Exchange, on June 9, while the small speculators held 37 million ounces.

Excluding coins and gold bars held with London, Swiss and other bullion banks, the total investment and speculative holdings of gold amount to around 100 million ounces or around 90 per cent of annual supplies. And this excludes large gold holdings in commodity mutual funds, pension and sovereign wealth funds.

In the meantime, jewellery demand for precious metals and diamonds has slid during the recession. Indeed, high prices and tough economic conditions have encouraged people to either sell or pawn their jewellery. Production of recycled gold scrap has soared to such an extent that it matched mine output in the first quarter of this year, according to the WGC.

This illustrates the extent that the market has become dependent on investors and fickle speculators.

Over the very long term, how has gold performed during the past few hundred years? The Golden Constant was originally written by former University of California professor Roy Jastram and published in the mid-1970s and has been updated by Jill Leyland, an economic consultant of the World Gold Council. It covers gold prices and the cost of living from as far back as 1560 to 2007. The book shows that gold prices, in real inflation-adjusted terms, unsurprisingly tended to increase its purchasing power during inflationary times. Its purchasing power tended to sag during depressions and deflation.

There have been exceptions. Gold rose by 43 per cent in purchasing power in the first four years of the Great Depression between 1930 and 1933 and then shot up when president Franklin D Roosevelt devalued the US dollar and increased the gold price to US$35 an ounce.

From the end of World War II, when consumer prices stabilised and fell back slightly, gold's buying power dropped slightly. These were the times when the gold price was fixed at US$35 an ounce.

When gold, the US dollar, European currencies and the yen began to float freely from the 1970s onwards, gold's nominal and real value began to fluctuate with increasing volatility.

From 1970 to 1980 when global inflation surged and there was a precious metal boom, gold's purchasing power soared by a whopping 700 per cent in US dollars, an annual real compound rate of around 22 per cent!

But from 1980 to the end of 1999, gold's purchasing power shrank by 78 per cent, a truly ghastly period for miners and gold bugs, although there were brief rallies in the interim.

From 2001, when the nominal price bottomed at US$251 an ounce to the end of 2007, gold's buying power rose by 119 per cent, an annual compound rate of 12 per cent. From the end of 2007, when the book's statistics end, gold in nominal terms has mainly traded within a range of US$800-1000 with a peak of $1031 early 2008, so its real price has fluctuated in a 25 per cent range.

Since gold began to float in a free market it has generally been a good hedge against inflation and more recently a safe haven against banking collapse. But such has been the volatility in currency and precious metals markets that investment within the present historically high range has been a guessing game.

Japan has been the only recent test for gold's purchasing power during times of deflation. During the 1970s, gold's purchasing power soared in Yen terms. But a Japanese investor who bought gold in 1980 would have experienced purchasing power shrinkage of 84 per cent in the subsequent decades.

Despite a strong gold market in recent years, the Japanese investor's gold purchasing power would still be down by 55 per cent.

Granted, 1980 was a time when gold hit an all-time high of US$850 an ounce, but even if a Japanese investor had bought gold when the market was weak in the mid 1980s and 1990s, real prices remained depressed until 2006.

So if deflation is your call, stay away from gold - even if you buy it cheap.

China increases gold reserves by 76%

Business Times - 24 Apr 2009

China revealed on Friday that it had quietly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tonnes and confirming years of speculation it had been buying.

Hu Xiaolian, head of the State Administration of Foreign Exchange (SAFE), told Xinhua news agency in an interview that the country's reserves had risen by 454 tonnes from 600 tonnes since 2003, when China last adjusted its state gold reserves figure.

The world gold market has been buzzing with talk about China buying gold for years as the country's foreign exchange reserves have rocketed, and speculation has picked up since the global economic crisis threatened to weaken the value of those reserves.

Gold prices jumped on the news and were up 1 per cent on the day at US$910.80 an ounce at 0540 GMT. By a Reuters calculation, China's holding of gold would be worth US$30.9 billion at current prices.

China recently reported the change in its gold holdings to the International Monetary Fund and would include the latest change in central bank reports and balance of payment statistics, Mr Hu said.

China's reserves were now the fifth biggest in the world, with only six countries holding more than 1,000 tonnes, she said.

China had increased its stocks by buying on the domestic market and from domestic producers.
Gold market participants said Mr Hu's revelation was good news for the market and signalled likely further buying.

'The comments indicate that China will buy more gold as reserve to improve its foreign reserve portfolio. This is a trend,' said Yao Haiqiao, president of Longgold Asset Management.

Hou Huimin, vice general secretary of the China Gold Association, said China should build its reserves to 5,000 tonnes.

'It's not a matter of a few hundred, or 1,000 tonnes. China should hold more because of its new international status, and because of the financial crisis,' he said.

'The financial crisis means the US dollar value is changing fast, and it may retreat from being the international reserve currency. If that happens, whoever holds gold will be at an advantage.'

The European Central Bank recommends its member banks hold 15 per cent of their reserves in gold, but among Asian nations the percentage is far smaller, said Albert Cheng, World Gold Council managing director for the far east.

Gold forecast to hit US$1,000

Feb 5, 2009

SINGAPORE - INVESTMENT bank Goldman Sachs has raised its forecast for the price of gold to US$1,000 (S$1,500) an ounce in the next three months from its previous forecast of $700 due to rising investor demand for safe haven assets.

Gold was trading at US$902.70 an ounce by 0106 GMT (9.06am Singapore time) on Thursday, down US$2.15 from New York's notional close, but was within sight of a near four-month high of US$930.40 an ounce hit last Friday. Gold struck record at US$1,030.80 last March.

'The gold price rally has been driven by surging demand for gold in all forms: physical gold, exchange-traded funds (ETFs), and futures contracts as investors seek 'a safe store of value' amid the financial distress and inflation risks,' Goldman Sachs said in a report.

'It is also important to emphasise that the recent strong demand for gold has not been irrational but rather pretty much in line with the probabilities of financial and sovereign default.' It also noted a strong relationship between the price of gold in US dollars and the exchange rate of the dollar against other currencies has begun to break down, adding that strong investment buying would offset a decline in jewellery demand.

The world's largest gold-backed exchange-traded fund, the SPDR Gold Trust , said it held a record of 859.49 tonnes of gold as of Feb 4, up 6.12 tonnes from Feb 2.

'Such strong demand for investment reasons is likely more than offsetting the declines in gold demand for jewellery use,' said Goldman Sachs.

'In fact, this recent surge in gold ETF demand would more than offset a 20 per cent decline in the fourth quarter global jewellery demand for gold,' it said.

The investment bank also raised its forecast for the price of gold to US$950 an ounce in the next six months from an initial estimate of US$785. Its 12-month gold forecast was pegged at US$825 an ounce, up from US$795 previously. -- REUTERS

Gold to outperform oil as recession brews

7 Nov 2008, NEW YORK (Reuters)

The price of gold has not fallen as sharply as the price of crude oil and other cyclical commodities during the global financial crisis, and bullion should strengthen relative to other commodities as economic troubles deepen.

Gold bullion has dropped 16 percent since October after a recent wave of fund deleveraging. But its oil purchasing power, a key gauge of economic strength, is at its highest in nearly two years and is holding up relative to equities and other asset classes.

The precious metal's unique monetary functions as an inflation hedge and safe haven have not been tainted, fund managers said.

"Right now you would rather be long gold than short oil because you are still heading into a direction where gold will continue to buy more of everything," said Greg Orrell of California-based OCM Gold Fund.

Orrell said a key difference between gold and oil is that oil is produced for consumption and will deplete one day, but gold accumulates over time.

"For a commodity such as oil, you are getting a reflection of the global slowdown, and that's why it is going down on a relative basis versus gold," Orrell said.

An ounce of gold on Friday bought 12 barrels of oil, its strongest since January 2007. When oil peaked at a record near $150 per barrel in July, the gold-to-oil ratio was 6.6. Gold's weakest point relative to oil was in 2005 at just over 6, and its long-term average was about 15.

Historically, gold tends to rise in tandem with oil. Investors use the metal as a hedge against inflation because bullion's intrinsic value is not tied to any paper assets.

Gold also has risen against major industrial commodities such as copper and nickel.

In October, Deutsche Bank said the gold-to-nickel ratio, a key indicator of economic performance, could fall into single digits in the case of a deep recession as deep as that of the early 1980s.

BUY GOLD, SELL OIL

Gold's rise against oil in the second half of this year was a result of "recession trade" by investors, said Caesar Bryan, portfolio manager of GAMCO Gold Fund in New York, who manages $250 million assets.

"As the economy slows and central banks ease, you would expect gold to rally relative to the oil. We are coming off a huge 'buy gold sell oil' signal in the summer -- it was way out of whack," Bryan said.

Data released on Friday showed U.S. employers cut payrolls by a worse-than-expected 240,000 in October. So far this year, 1.2 million U.S. jobs have been lost, bringing the unemployment rate to 6.5 percent, its highest level since 1994.

Year to date, gold was down 12 percent, while crude oil dropped 36 percent and has lost more than 50 percent since it hit a record $147.27 per barrel, and the MSCI All Country World Index index .MIWD00000PUS, which tracks the performance of the global equities market, dropped 43 percent.

"We are still in a flight to liquidity rather than a flight to safety," Orrell said.

Other fund managers expressed optimism about gold as global central banks fight a deepening economic downturn.

Brian Hicks, co-manager of the Global Resources Fund PSPFX.O at Texas-based U.S. Global Investors, which oversees $2 billion assets, said the extra money flow related to the stimulus packages could spur inflation and weaken the dollar, which would be bullish for gold.

"At some point you have to wonder how that is going to impact price levels. I think gold will return as a safe haven as we come out of this short-term deleveraging process," Hicks said.

"As we move away from the peak of this financial crisis, we will start to see gold outperform relative to oil," he said.

James Steel, chief commodity analyst at HSBC, said bullion could still rise further but not because of rising price levels.

"We are clearly not in a period of inflation, but that doesn't mean that gold won't trade higher. It's a risky world and there is still a high degree of uncertainty in general as far as paper assets go," Steel said.

Oil & Gold Ratio

Eric Hommelberg, 5 Dec 2004.

This is chapter VII of the Gold Drivers 2005 report. It discusses the historical Gold/Oil ratio which suggest a price of Gold exceeding $700 nowadays and shines a light a light on previous oil shocks and their consequences. Furthermore it discusses PEAK-OIL and why it is about to bring a nasty Oil shock coming years.

As we will see, previous oil shocks were a perfect call for higher inflation figures and recession. Will this time be any different ? According to Alan Greenspan yes, he says that higher oil prices won't be much of a problem for the economy these days and inflation won't pop up as during the seventies. Well, energy experts such as Mathew Simmons and Colin Campbell do think otherwise. They make a powerful case for the end of cheap energy. The nasty consequence of a lack of cheap energy is the end of economic growth. Will we ever come out of a recession again for a sustained period of time ? Well, Richard Heinberg author of "The Party is over - Oil, War and the Fate of Industrial Societies" doesn't think so. Matthew Simmons (energy advisor for Dick Cheney) just uses different words, he says :

" there is not one serious economist in this world who would say that you can have significant economic growth without the availability of cheap energy." END.

Simmons rules out the possibility of cheap energy coming decades. When asked if there is a solution to the impending energy crisis he said :

"I don't think there is one. The solution is to pray. Under the best of circumstances, if all prayers are answered there will be no crisis for maybe two years. After that it's a certainty." END. We'll have to get used to oil prices far exceeding the $100/barrel mark. This leads us to the Gold/Oil ratio which is at an historic low these days. Such imbalances won't stay there for a long period of time so what gives ? Oil going down or Gold catching up ?

Let's focus on the following issues :

• Previous Oil shocks and their consequences
• Gold as a financial protection against coming Oil shock
• PEAK-OIL and the end of cheap energy

Previous Oil shocks and their consequences.

Stephen Leeb (president of Leeb Capital Management and editor of the prestigious newsletter 'The Complete Investor') wrote an excellent book this spring called ' The Oil Factor - Protect Yourself (AND PROFIT) from the coming Energy Crisis'. In this book he explains how to use the Oil indicator in order to predict upcoming stock bear markets and economic recessions.

In an interview with Jim Puplava on the Financial Sense Newshour Stephen Leeb says :

It's so easy, nothing has been a more reliable indicator for an upcoming recession as the price of Oil. Every major bear market, every major economic decline has been preceded by a large spike in oil prices. The 73-74 recession, recession of beginning 80's and the recession of 2000. Oil prices jumped 80% between 1999 and 2000. Oil prices have been the most important indicator of major economic disasters. Whenever Oil prices rises about 80% from year ago levels, a fair chance does exists that a recession/bear market will follow. END.

So any sudden increase in the price of Oil should be something to fear or at least pay serious attention to it. Furthermore Stephen Leeb warns for the rapid rise in the price of Oil in the face of a less rapid growing demand. He says :

When you are facing rising commodity prices in the face of a declining or less rapid growing demand, it tells you something. It tells you that you can't count on the supply being there when needed. It tells you that the world has changed. END.

It tells you that the world has changed. Stephen Leeb sounds serious, maybe even a bit alarming. What consequences Stephen Leeb expects from rapid rising Oil prices ?
Stephen Leeb says :
Sharply rising energy prices, similar the the 70's, will lead to double digit inflation figures over the next 10 years. It's going to turn the economy on its head.END.

But wait, the FED can fight inflation by engineering a recession (rapid increase of interest rates) as former FED chief Paul Volcker did in the early 80's right ?

Stephen Leeb says :

Today, we cannot engineer a recession. In 1980 when Paul Volcker took over the head of the FED, he was able to say : Well, inflation is at 12%, I don't care what it takes, I'm getting Inflation down and he was willing to engineer a big recession.

Today because of all that debt, that's not a policy alternative. Sure , the FED will raise interest rates a little bit here and there but not in such a dramatic way to create a recession. In the face of the giant total US debt, a recession would be a catastrophe. END.

Stephen Leep's Oil indicator has worked remarkably well over the last 30 years. If this Oil indicator is going to perform as well in the future as it did before than investors should be on high alert for possible nasty future economic events and be prepared to take appropriate measures in order to protect themselves financially.

Gold as a financial protection against coming Oil shock

So why to buy Gold when Oil prices are rising rapidly ?

The reason for this is two-fold :

• Gold as an Inflation Hedge
• Gold/Oil ratio says Gold is a screaming Buy.

Gold as an Inflation Hedge

Gold is being considered as the ultimate Inflation Hedge. The most obvious example is of course the 70's whereby Gold really took off when inflation kicked in. In 1977 when inflation began to pick up steam it reached 9% by 1978. Gold followed by breaking its previous high of $200. When Inflation hit 10% in 1979, Gold really took off skyrocketing to $500. Excitement kicked in and a Gold rush mania launched the yellow metal to its all time high of $850 in 1980. In times of Inflation you are losing money by holding paper money. A flight from paper money into real money (Gold) is just a logical result.

The Gold/Oil ratio

The Gold/Oil ratio says Gold is a screaming Buy.

Over the last 30 years Gold has been trading at an average of 16-17 barrels of Oil per ounce of Gold. At the moment Gold is dirt cheap compared to Oil and trades for about 9 barrels of Oil for an ounce of Gold. Such extremes won't last for a long period of time so what gives, lower Oil prices down the road or Gold catching up ?

According to Matthew Simmons we shouldn't count on cheap Oil anymore coming decades. Let's repeat once more what he said when asked if there is a solution to the impending energy crisis he said :

"I don't think there is one. The solution is to pray. Under the best of circumstances, if all prayers are answered there will be no crisis for maybe two years. After that it's a certainty." END.
So with these kind of statements in mind, would you bet on lower Oil prices or higher Gold prices ? (see chart below)

OK, fine you'll say, higher Oil prices should make a case for Gold indeed but how serious are those people screaming about the end of cheap Oil ? Should we take their claims seriously ? Why hasn't the mainstream media hardly picked upon it ? Why didn't we hear anything about it during the presidential debates ? I've heard that at least for the next 30 years there should be plenty of Oil, what about that ? Well, many questions which deserves serious attention.

PEAK-OIL and the End of Cheap Energy

Alarmist preaching a peak in oil production within a few years are referring to studies by Shell geophysicist Dr. Marion King Hubbert. Hubbert predicted already in 1956 that US domestic Oil production would peak around 1970. Unfortunately Hubbert wasn't taken seriously at all. But what happened ? US Oil production indeed peaked in 1970 as predicted by Hubbert but still it took many years before geologists were willing to admit that Hubbert was right and that US Oil production indeed had peeked in 1970.

So based on what theory Hubbert made his predictions and how reliable is this theory in order to predict a future peak in world wide oil production ? It goes far beyond the scope of this article in order to explain the scientific background of PEAK-OIL (Hubbert's Peak) , it'll just focus on its conclusions backed up with data available for the last 100 years.

Hubbert says more or less that oil discoveries and oil production do follow a so called Bell Curve. The production curve follows the discovery curve with a 40 year delay.

Prof. Kenneth Deffeyes who wrote the book 'Hubbert's Peak - The Impending World on Shortage' explains in detail the scientific background of Hubbert's theory. But let's focus on just two important issues here :

• Oil discoveries do follow a Bell Curve
• Oil production does follow a Bell Curve with a 40 year delay compared to the discovery curve.

OK, fine you'll say, but what does actual data regarding oil discoveries and oil production tell us so far ? Could Hubbert be right ?

Dr. Colin Campbell is most probably the dean among Hubbert's followers. He worked for Texaco and Amoco as an exploration geologist working in countries as Borneo, Trinidad, Colombia, Australia, Papua New Guinea, the US, Ecuador, the UK, Ireland and Norway. Later on he was associated with Petroconsultants in Geneva, Switserland and brought about the creation of the Association for the Study of Peak Oil (ASPO). Dr. Campbell did a tremendous amount of research regarding Peak-Oil and published his findings in his book 'The Coming Oil Crisis'. His findings indeed confirmed what Hubbert predicted so many years ago.

Let's focus first on data available regarding world wide Oil discoveries. We'll see that the peak of Oil discoveries already occurred in the 60's, see chart below :

Now please digest this carefully. If Hubbert is right then the world Oil production should peak somewhere during this decade (40 years after discovery peak). But the problem is that you can't say with certainty that Oil production indeed has peaked until several years after the fact. So the only thing we can do is to analyze the production curves of oil producing countries which had a discovery peak way earlier than the 60's. A good example is the US which saw it's discovery rate peaking during the early 30's. Hubbert concluded that the US therefore should experience a peak in Oil production somewhere during the early seventies. At the time Hubbert made that prediction in 1956 he was ridiculed by Oil experts and economists, but nevertheless Hubbert's prediction came true in 1970, see chart below :

So the US Oil production peeked in 1970 indeed and declined ever since then just as Hubbert predicted.

When examining the production curves of all Non-Opec countries combined we'll see a production curve which matches the predicted Bell Curve almost 100%. See chart below.

So what do we see so far :

• US Oil production already peaked in 1970.
• Non OPEC Oil production already peaked in the early 90's.

What does it tell us ? It tells us that the world oil production still hasn't peeked because OPEC Oil production still hasn't peaked. So in order to make predictions about world peak production one should focus on the main OPEC producers.

So when will OPEC peak ?

According to Bush energy advisor Matthew Simmons OPEC will peak when Saudi Arabia peaks.
So what about Saudi Arabia ? When will Saudi Arabia peak ?

Matthew Simmons says :

When Ghawar peaks (Ghawar is the largest oil field ever found) Saudi Arabia peaks and when Saudi Arabia peaks the whole World peaks. END.

But the problem is that Ghawar is aging rapidly. It's one of the oldest Oil fields in production and lots of water injection is needed in order to keep production going. At one moment more water injection won't be able to keep production going and Oil production will fall off a cliff meaning the Oil field dies.. According to Matthew Simmons, the end for Ghawar must be near. It goes far beyond the scope of this article to specify why Matthew Simmons does think so but interested readers can study Simmons findings themselves at :

Matthew Simmons : Saudi Arabian Oil - A Glass Half Full Or Half Emptywww.simmonsco-intl.com/files/Hudson%20Institute.pdf

So with the peak of world Oil production in sight, what kind of production curve could we expect for total World Oil production ?

Dr. Colin Campbell calculates the following production curves :

Any case whether it's the high case, base case or low case, what should be obvious is that the end of World Oil production increase is near. A World which requires ever increasing amounts of energy (eg China, India, increasing world population etc…) and facing a limit in increasing Oil production simply has to face an increase in Oil prices. It simple as that. Demand outstrips supply by a great margin coming years. Yes, people arguing that there is still Oil left for 30 years, they are right. The Earth contained approximately 2 trillion barrels of Oil. We just consumed 1 trillion barrels of Oil by now so still 1 trillion barrels of Oil to go. With current demand of 80 million barrels a day it's easy to see why people come up with an estimate of another 30 years of Oil supply. Again, it's not the problem of No Oil, but it's the End of Cheap Oil what causes economic turbulence. Matthew Simmons says that Oil prices exceeding $100 / barrel is unavoidable and that should be a wake up call for all investors out there because the end of cheap energy could lead to an unwelcome economic slowdown.

Highlights :

• Oil discoveries have peeked already 40 years ago
• According to M King Hubbert Production peaks follow Discovery peaks after approximately 40 years.
• US Oil production already peaked in 1970.
• Non OPEC Oil production already peaked in the early 90's.
• World Oil production will peak when OPEC peaks
• OPEC peaks when Saudi Arabia peaks
• Saudi Arabia peaks when Ghawar peaks
• Ghawar is aging rapidly and its life expectancy isn't rosy. Matthew Simmons says that the end is in sight.
• World Oil peak production means the End of Cheap Oil
• The End of Cheap Oil means continuing rising Oil prices which translates itself into Oil shocks.
• Previous Oil shocks were an perfect call for recession/Inflation
• Gold is the ultimate Hedge against Inflation
• Rising Oil prices brings the historical Gold/Oil average way out of balance
• Historical average of the Gold/Oil ratio suggest a price of Gold exceeding $700 nowadays.

Historical average of the Gold/Oil ratio suggest a price of Gold exceeding $700 nowadays. Please think about that !

Eric Hommelberg

ehommelberg@planet.nl

THE GOLD, OIL AND US DOLLAR RELATIONSHIP

Nick Barisheff, 22 Apr 2005.

Of the various vulnerabilities traditional financial assets are exposed to, a rising oil price is of particular concern. In 2004, oil hit an all-time high of $56 per barrel, up 366 percent from the $12 low of 1998, and up 75 percent since January 2004.

Generally speaking, an increasing oil price results in increasing inflation, negatively impacting the global economy, particularly oil-dependent economies such as the US. Apart from increased transportation, heating and utility costs, higher oil prices are eventually reflected in virtually every finished product, as well as food and commodities in general. Furthermore, there is evidence that global oil production is peaking and the flow will soon be in permanent decline.

The US has enjoyed inexpensive oil-based energy for nearly a century, and this is one of the prime factors behind the unprecedented prosperity of its economy in the 20th century. While the US accounts for only 5 percent of the world's population, it consumes 25 percent of the world's fossil fuel-based energy. It imports about 75 percent of its oil, but owns only 2 percent of world reserves. Because of this dependency on both oil and foreign suppliers, any increases in price or supply disruptions will negatively impact the US economy to a greater degree than any other nation.

The majority of oil reserves are located in politically unstable regions, with tensions in the Middle East, Venezuela and Nigeria likely to intensify rather than to abate. Because of frequent terrorist attacks, Iraqi oil production is subject to disruption, while the risk of political problems in Saudi Arabia grows. The timing for these risks is uncertain and hard to quantify, but the implications of Peak Oil are predictable and quantifiable, and the effects will be more far-reaching than simply a rising oil price.

In the early 1950s, M. King Hubbert, one of the leading geophysicists of the time, developed a predictive model showing that all oil reserves follow a pattern called Hubbert's Curve, which runs from discovery through to depletion. In any given oil field, as more wells are drilled and as newer and better technology is installed, production initially increases. Eventually, however, regardless of new wells and new technology, a peak output is reached. After this peak is reached, oil production not only begins to decline, but also becomes less cost effective. In fact, at some point in this decline, the energy it takes to extract, transport and refine a barrel of oil exceeds the energy contained in that barrel of oil. When that point is reached, extraction of oil is no longer feasible and the reserve is abandoned. In the early years of the 20th century, in the largest oil fields, it was possible to recover 50 barrels of oil for each barrel used in the extraction, transportation and refining process. Today that 50-to-1 ratio has declined to 5-to-1 or less. And it continues to decline.

Hubbert's 1956 prediction that crude oil production in the US would peak in the early 1970s and then decline was greeted with great skepticism. After all, production in the US was increasing and technology was improving. However, there were no new major reserves being discovered, and his prediction proved to be correct. Oil production in the US did peak in 1970, and has been declining ever since.

Using analytic techniques based on Hubbert's work, oil and gas experts now project that world oil production will peak sometime in the latter half of this decade. We are now depleting global reserves at an annual rate of 6 percent, while demand is growing at an annual rate of 2 percent (and that growth rate is expected to triple over the next 20 years). This means we must increase world reserves by 8 percent per annum simply to maintain the status quo, and we are nowhere near achieving that goal. In fact, we are so far from it that, according to Dr. Colin Campbell, one of the world's leading geologists, the world consumes four barrels of oil for every one it discovers.

Once a supply shortfall materializes, the US will be in competition with China, India, Japan and other importing countries for available oil. Many experts are now predicting US$100 per barrel within the next two years. Some believe it will go even higher. Taking geopolitical factors and supply/demand fundamentals into consideration, it is impossible to predict how high the price of oil will soar. One thing seems certain - the age of cheap oil is over.

There are numerous social, economic and political implications related to world oil production peaking in the next few years, but our concern here is to examine how a rising oil price is linked to precious metals. The answer to that question begins with the historical desire of Arab producers to receive gold in exchange for their oil. This dates back to 1933 when King Ibn Saud demanded payment in gold for the original oil concession in Saudi Arabia. In addition, Islamic law forbids the use of a promise of payment, such as the US dollar, as a medium of exchange. There is growing dissention among religious fundamentalists in Saudi Arabia regarding the exchange of oil for US dollars.

Oil, gold and commodities have all been priced in US dollars since 1975 when OPEC officially agreed to sell its oil exclusively for US dollars. From 1944 until 1971, US dollars were convertible into gold by central banks in order to adjust for any trade imbalances between countries. Up to that point, the price of gold was fixed at US$35 per ounce, and the price of oil was relatively stable at about US$3.00 per barrel. Once the US ceased gold convertibility in 1971, OPEC producers were forced to convert their excess US dollars by purchasing gold in the marketplace. This resulted in price increases for both oil and gold, until eventually oil reached US$40 per barrel and gold reached US$850 per ounce.

Today, apart from geopolitical threats in oil-producing regions, supply/demand imbalances from Peak Oil and increasing demand from developing countries, the price of both gold and oil can be expected to increase as the US dollar declines. With an ever-increasing US money supply, growing triple deficits and mounting debt at all levels, the US dollar is likely to continue the decline that began in 2001. Since then, foreign holders of US dollar assets have already lost 33 percent of their investment. How long will oil exporters continue to accept declining US dollars? How long will they continue to hold US dollars as their reserve currency?

At some point, they may decide to abandon the US dollar in favour of euros. Russian premier Vladimir Putin and Venezuela's president Hugo Chavez have both publicly announced that they may begin to price oil in euros in the near future. Even Saudi Arabia has stated that it is considering pricing its oil in euros, as well as in US dollars. There have even been discussions among Arab nations about pricing oil in Islamic gold and silver dinars. If this happens, other producers may follow suit and opt out of accepting US dollars for oil. Demand for the currency will plummet, sending the dollar into a freefall while demand for euros, gold and silver soars.

In addition, Middle Eastern oil producers would be forced to diversify their vast US dollar holdings into precious metals and other currencies to protect themselves from further losses. As losses mount, other large, non-oil producing, US dollar holders such as Japan, China, Korea, India and Taiwan would seek to diversify out of US dollars. Eventually, this could result in a dollar sell-off and a corresponding increase in oil and gold prices.

Over the last 50 years or so, gold and oil have generally moved together in terms of price, with a positive price correlation of over 80 percent. During this time, the price of oil in gold ounces has averaged about 15 barrels per ounce. However, with recent soaring oil prices, the relationship has strayed far from this average. While oil prices recently set an all-time high of $56 per barrel, gold prices have not kept pace and the oil:gold ratio fell to an all-time low of 7.5:1. At US$56 per barrel oil, the gold price should be in excess of US$840 per ounce. Some experts are suggesting that, in two or three years, US$100 per barrel oil is very possible. At that price gold should be US$1500 per ounce.

The gold silver:ratio has varied from 16:1 to 100:1. Currently it is about 66:1. Gold Fields Mineral Services expects this ratio to fall to between 40:1 and 50:1 in the near future. At a 50:1 ratio and a $1,500 gold price the price of silver should be $30/ounce. At 16:1 it would be $94/ounce.

The size disparity between oil and gold markets must also be considered. While annual gold production is approximately US$35 billion, annual oil production is US$1.5 trillion, by far the largest-trading world commodity. As oil prices increase and demand for US dollar diversification increases, there will be an ever-expanding number of petro dollars and other offshore dollar holders chasing a relatively small amount of bullion ounces.

In conclusion, the price of oil is poised to rise steadily as the supply/demand imbalance increases and the dollar declines, even if there are no supply disruptions, terrorist threats or geopolitical concerns to consider. As this happens, the price of precious metals will climb until they eventually catch up to their historic ratios. Should oil producers demand euros, dinars or precious metals in payment for their product, the decline in the US dollar will accelerate while the price of precious metals explodes. If oil producers and other foreign US dollar holders begin to sell the trillions they hold and diversify into alternatives, then the price of both oil and precious metals will rise to levels that today are hard to imagine.

Nick Barisheff is the co-founder and President of Bullion Management Services Inc., which was established to create and manage The Millennium BullionFund. The fund is Canada's first and only RRSP eligible open-end Mutual Fund Trust that holds physical Gold, Silver and Platinum bullion. www.bmsinc.ca