Best of the Week
Most Popular
1. Dollargeddon - Gold Price to Soar Above $6,000 - P_Radomski_CFA
2.Is Gold Price On Verge Of A Bottom, See For Yourself - Chris_Vermeulen
3.Dow Stock Market Trend Forecast 2018 - Nadeem_Walayat
4.Gold Price to Plunge Below $1000 - Key Factors for Gold & Silver Investors - P_Radomski_CFA
5.Why The Uranium Price Must Go Up - Richard_Mills
6.Dow Stock Market Trend Forecast 2018 - Video - Nadeem_Walayat
7.Jim Rogers on Gold, Silver, Bitcoin and Blockchain’s “Spectacular Future” - GoldCore
8.More Signs That the Stock Market Will Rally Until 2019 - Troy_Bombardia
9.It's Time for A New Economic Strategy in Turkey - Steve_H_Hanke
10.Fiat Currency Inflation, And Collapse Insurance - Raymond_Matison
Last 7 days
Gold Exodus to Reverse - 22nd Sep 18
Bitcoin Trader SCAM WARNING - Peter Jones, Dragons Den Fake Facebook Ads - 22nd Sep 18
China Is Building the World’s Largest Innovation Economy - 21st Sep 18
How Can New Companies Succeed in the Overcrowded Online Gambling Market? - 21st Sep 18
Golden Sunsets in the Land of U.S. Dollar Hegemony - 20th Sep 18
5 Things to Keep in Mind When Buying a Luxury Car in Dubai - 20th Sep 18
Gold Price Seasonal Trend Analysis - Video - 20th Sep 18
The Stealth Reason Why the Stock Market Keeps On Rising - 20th Sep 18
Sheffield School Applications Crisis Eased by New Secondary Schools Places - 20th Sep 18
Precious Metals Sector: It’s 2013 All Over Again - 19th Sep 18
US Dollar Head & Shoulders Triggered. What's Next? - 19th Sep 18
Prepare for the Stock Market’s Volatility to Increase - 19th Sep 18
The Beginning of the End of the Dollar - 19th Sep 18
Land Rover Discovery Sport 'Approved Used' Bad Paint Job - Inchcape Chester - 19th Sep 18
Are Technology and FANG Stocks Bottoming? - 18th Sep 18
Predictive Trading Model Suggests Falling Stock Prices During US Elections - 18th Sep 18
Lehman Brothers Financial Collapse - Ten Years Later - 18th Sep 18
Financial Crisis Markets Reality Check Now in Progress - 18th Sep 18
Gold’s Ultimate Confirmation - 18th Sep 18
Omanization: a 20-year Process to Fight Volatile Oil Prices  - 18th Sep 18
Sheffield Best Secondary Schools Rankings and Trend Trajectory for Applications 2018 - 18th Sep 18
Gold / US Dollar Inverse Correlation - 17th Sep 18
The Apple Story - Trump Tariffs Penalize US Multinationals - 17th Sep 18
Wall Street Created Financial Crash Catastrophe Ten Years Later - 17th Sep 18
Trade Wars Are Going To Crash This Stock Market - 17th Sep 18
Why Is Apple Giving This Tiny Stock A $900 Million Opportunity? - 17th Sep 18
Financial Markets Macro/Micro View: Waves and Cycles - 17th Sep 18
Stock Market Bulls Prevail – for Now! - 17th Sep 18
GBPUSD Set to Explode Higher - 17th Sep 18
The China Threat - Global Crisis Hot Spots & Pressure Points - 17th Sep 18 - Jim_Willie_CB
Silver's Relationship with Gold Reaching Historical Extremes - 16th Sep 18
Emerging Markets to Follow and Those to Avoid - 16th Sep 18
Investing - Look at the Facts to Find the Truth - 16th Sep 18
Gold Stocks Forced Capitulation - 15th Sep 18
Hindenburg Omen & Consumer Confidence: More Signs of Stock Market Trouble in 2019 - 15th Sep 18
Trading The Global Future - Bad Consequences - 15th Sep 18
Central Banks Have Gone Rogue, Putting Us All at Risk - 15th Sep 18
Gold Price Seasonal Trend Analysis - 14th Sep 18
Growing Number of Small Businesses Opening – and Closing – In the UK - 14th Sep 18
Gold Price Trend Analysis - Video - 14th Sep 18
Esports Is Exploding—Here’s 3 Best Stocks to Profit From - 13th Sep 18
The Four Steel Men Behind Trump’s Trade War - 13th Sep 18
How Trump Tariffs Could Double America’s Trade Losses - 13th Sep 18
Next Financial Crisis Is Already Here! John Lewis 99% Profits CRASH - Retail Sector Collapse - 13th Sep 18
Trading Cryptocurrencies: To Win, You Must Know Where You're Wrong - 13th Sep 18
Gold, Silver, and USD Index - Three Important “Nothings” - 13th Sep 18
Precious Metals Sector On a Long-term SELL Signal - 13th Sep 18
Does Gambling Regulation Work - A Case Study - 13th Sep 18
The Ritual Burial of the US Constitution - 12th Sep 18
Stock Market Final Probe Higher ... Then the PANIC! - 12th Sep 18
Gold Nuggets And Silver Bullets - 12th Sep 18
Bitcoin Trading - SEC Strikes Again - 12th Sep 18

Market Oracle FREE Newsletter

Trading Any Market

Crude Oil Asset Bubble Trouble

Commodities / Crude Oil Nov 27, 2014 - 12:43 PM GMT

By: Andrew_McKillop

Commodities

Nothing Ikonic about the Gold / Oil Ratio
Assuming for discussion that a 15-to-1 ratio between the price of I Troy ounce of gold and 1 barrel of oil is a long-term average or “ikonic ratio”, ( http://www.zealllc.com/2005/gorex2.htm) this would apply for $2 oil and $30 gold as much as $120 oil and $1800 gold. But the asset bubbles built around oil and gold would be rather different, each time. Also, coming down and off highs for the gold price, or for the oil price, there would be major bloodshed among the related overpriced and now-irrational asset values, but in the case of oil assets this will include national budgets, national FX values and even global economic growth. Deflating an oil asset bubble has a lot more ramifying impacts than coming down from a high for gold.


The major problem for both these highly symbolic, emotional and political “stores of value”, is that while we can identify probable or possible absolute minimum prices for both of them, using the shaky yardstick of the US dollar and its own changing value. We however can't identify a maximum. For gold and depending on your scenario, you can say $2500 or $5000 or $10000 an ounce, all of them being disaster scenarios for the world economy!

To be sure and not so long ago, in 2010 respected oil and commodity price commentators like Matt Simmons and T. Boone Pickens for oil, and Jim Rogers for general commodities, joined by corporate chiefs with an interest in high-priced oil like Carlos Ghosn and Richard Branson gave interviews where they argued oil could attain “at least 250 US dollars a barrel”. Very theoretically therefore, gold could or might attain north of $3750 an ounce in the same scenario. The IEA and Goldman Sachs prefer the $150 oil scenario, which GS already briefly “goosed” into the  real world in 2008.

Today we could or might divide the IEA/GS “nice price for oil” by three, and get closer to reality. With no doubt at all, however, overpriced oil will always weigh heavier on the global economy than overpriced gold. On the one hand it stokes investment, economic growth and balances the budgets of a large number of oil exporter countries. On the other hand it theoretically stokes inflation and interest rates – except that this didn't happen with oil at more than $100 for a long time in the recent past. Being heretical, I could suggest that recently at least, overpriced oil was deflationary and a brake on economic growth and investment, anywhere outside the “oil patch”.

Forget About Keynes
Keynes never got around to calling oil a barbarous fossil relic and wasn't known for worrying about “carbon residues” building up in the atmosphere, but preferred to argue that gold bullion reserves in national banks should not be allowed to build up, and should be replaced by debt. His wishes were massively exorcized although it took some time from his 1930s and '40s-era outbursts on the subject.

His adage that if I owe you $10 and can't pay I am in trouble – but if I owe you $10 million and can't pay it is you who are in trouble has become the cornerstone of IMF and central bank thinking, private banking and insurance company practice, and the entire consumer-debt economy. Oil is a side issue in this debt debate, in fact the belief that overpriced oil “helps inflation” is comforting for Neo Keynesians including every single central banking chief in the western world. Claiming there is some “prudent ratio” between a central bank's total assets and the tonnage of its gold  bullion reserves is nonsense. China's central bank for example has about 1% of its total assets in the form of bullion. The US Fed's proud claim, whether it is true or false, is about 20%. Other central banks, notably Germany's, are closer to a ratio of 20% with their real world metal bullion reserves, including the gold they lent to the US Fed, or other central banksters who “let it disappear” such as the Bank of England.

Above-ground oil reserves have no meaning. Oil is hard to store and effectively pointless to store. So-called SORs (strategic oil reserves), where they exist, need highly expensive management and cycling in-and-out, and at best could only run national armed forces and food production for a few months, assuming of course that the war-time emergency concerned a conventional or “classic” war something like World War I. The belligerants would of course run a gentlemanly war whey they did not simply take out all the NPPs (nuclear power plants) of the enemy in the first days after the war was declared – making oil use for any above-ground activity pointless and useless. SORs are a luxury item and prestige waste of time for national sentiment purposes, only. Oil prices have a clear supply-demand relationship although you might find that hard to believe!

Not so for gold. Including the gold-equivalent of SORs in the shape of central bank (and bullion bank) metal reserves, gold mining company reserves, jewelry, coins, bars and other above-ground gold, WGC and other sources suggest it is about or above 180 000 metric tons. This equals about 70 years of world total gold mine output at current rates – the world's SORs, located mostly in the OECD countries hold a small fraction of 1 year's world total of oil production. Adding to the metal reserves, paper gold “reserves” are so immense it is pointless trying to make an estimate – except to say it is minuscule compared to the world total of M1-M2-M3 money plus financial assets in circulation!

The net result, which Keynes would likely have approved, is that gold prices can range through an immense pricing space, even if oil could (we can suggest) “only” range from about $250 to $40 per barrel under present real world economic conditions.  To be sure, neither of these extremes would be long-term sustainable, although through 1986-1999 oil rarely strayed far from $18 per barrel and gold prices were similarly “range-bound” and low as they drifted down from their 1980 panic peak.

Bubble Trouble
The last 30 – 40 years tells us that both gold and oil prices can spike and crash in a short period of time – sentiment is all. Price peaks guarantee price crashes, but here we find that oil price peaks and crashes have a much bigger economic hit, when they happen. For the same reason which led Saudi Arabia to “open the taps” in 1986 and spark a 67% oil price crash in 6 months – to punish the enemies of the day, and today, Iran and Russia (the USSR in 1986) – the Saudi agenda also included the highly theoretical concept of “driving high cost producers out of business”. Quite simply, this did not happen in 1986-99. British and Norwegian North Sea oil producers – high cost producers - soldiered on and opened their own taps, forcing oil prices even lower! The Saudi goal of driving out the high cost producers will almost certainly not happen today. Nor did the theoretical Saudi concept of “forcing quota respect among OPEC suppliers” For a large number of reasons, these oil-theory concepts are even less likely to be proved true in today;s real world-real economy circumstances where, for example, high cost US and Canadian shale and tar sand oil producers will resort to more debt before they “close the taps” and this can be a long drawn out process.

To be sure, the “cheap oil interval” of 1986-99 had a major downward impact on oil exploration and development, and oilfield services spending. For several lower-income oil exporters, both OPEC and nonOPEC producers the “recourse to debt” caused by a slump of oil revenues was a major cause of a long lost decade for the economy in these countries and deepened the Third World debt crisis by the knock-on effect of falling non-oil commodity prices. In that cheap oil interval, cheap oil was a major driver of slower global economic growth. Conversely since about 2005, and absent the short financial crisis-related oil price slump of 2009-10, overpriced oil has enabled and driven a vast spending spree spreading far out from the oil and energy sector, and this includes government spending by all the OPEC states, Russia, and other producers both small and large.

Cheap oil is surely and certainly deflationary. Wheeling back Keynes (and Krugman!) into the discussion, deflation is perceived and feared by central bankers like garlic is feared by vampires. Asset deflation is their big worry. Monetary instability is their next worry. Higher interest rates is the next phase of their paranoid fear and loathing – and by supreme irony, they will start buying gold, or buy more gold in these circumstances, and become less easygoing about IMF “gold swaps” where the metal disappears and is replaced by SDRs and other bits of paper. The Swiss referendum of November 30 is a tell-tale example of this fear.

The current and probably ongoing slide in oil prices is called a “game changer” by some, but it is happening at the end of a near-decade of overpriced oil. Oil exporter country borrowing on the back of this “can't fail asset” was comensurate and proportionate – that is disproportionate and extreme like oil corporate net worth as measured by their overblown market caps. Like the market caps for oil E&P companies and field service providers, these can only become shaky and fragile, possibly subject to dawn, midday and afternoon raids by short sellers on equity markets. Interest rates for sovereign loans of oil exporter countries can and should rise. Their national currencies (like Russia's!) can take a hammering on FX markets.

Ironic Outcomes
There is nothing ironic about an overblown oil sector fattened by overpriced oil taking a hiding but for gold the irony is that prices will have to rise. Measuring this, the “ikonic” 15-to-1 price ratio will fade from the scene for some while. The deflationary impact of cheaper oil may significantly outweigh its growth-stimulating impact on the consumer economy, for one reason because the deflationary impact will act sooner.

The deflationary impacts of cheaper oil will be joined by the also-deflationary impact of higher-priced gold will also be deflationary. Tfor as long as the net impact is deflationary this will keep central bankers “holding off” from any decision to raise interest rates, stoking the now massive potential for an inflation outburst – when the right conditions are together. For the oil sector on the production side, as already shown by present OPEC 'crisis talk and debate” the reaction to falling prices - of raising output to cover lower barrel prices - will likely win out against “quota discipline”. Adding-in the geopolitical desiderata, the playact of Saudi Arabia cutting production to help protect Russia and Iran from falling oil prices – or the opposite – can be forgotten as talk fodder for “experts” on TV news shows!

 Overall, lower oil prices will likely have their “traditional” impact on production, of raising it, before some time later, lower prices cause lower output. For gold the situation is different, and annual “fresh mine output” or new gold supply is likely falling at a considerable rate. Gold price spikes, as we know, have nothing to do with production and we can expect little warning before the next spike occurs, totally unlike oil where its overpricing had reached extremes until 3 months ago.  The real irony of cheaper oil and higher priced gold, therefore, will be higher economic growth, but in a deflationary context – even if this does not figure in a Keynesian crystal ball.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2014 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

Andrew McKillop Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules