Is oil the new gold, or just plastic money?

April 29, 2008 | posted by Michael Baxter in Oil | comments (3) | Print This Post

Earlier this year we reported on comments made by an Indian minister that he thought oil could hit $150 a barrel this year.  

At the time he seemed to be over-exaggerating the danger – but with oil closing in on $120 a barrel last week – that unthinkable level suddenly feels, well, thinkable.

Then along comes OPEC, with a new water level.  OPEC president Chakib Kheli was quoted in Algeria’s El Moudjahid newspaper yesterday as saying he believed oil could hit $200 a barrel.

$200 a barrel – that would be a staggering level – proof, one would have thought, that we are running out of black gold.

Yet OPEC has long maintained that there is no danger of that.  That the high price of oil is down to other factors – not least a lack of refinery capacity – and that there is no need, or indeed point, in it upping output.

So how then do you square the one view from OPEC that there is plenty of oil, and the other view that it could hit $200 a barrel?

Well, Mr Kheli provided the answer.   He said the rising price of oil was wholly down to the falling dollar.     In fact he even calculated that every 1 per cent fall in the dollar pushed oil up by $4 a barrel.

If this argument is right, then China will be left in a tight spot.   China has been put under pressure by US and EU politicians to let the yuan appreciate, but it seems that the rising price of oil in dollars provides the real reason for China to let its currency rise.

If OPEC is right, and oil will hit $200 simply because of the weak dollar, China will have no choice but to let its currency rise rapidly. This in turn will have all kinds of implications for the global economy – Chinese imports prices will rise – leading to new inflationary pressures in the West – and China will import more and export less.  This will be a new development and the implications this will have for the global economy are at this stage just speculation.   

But, returning to oil, here is something odd.  Ever since oil started to creep up in price, three years or so ago now, one report after another has claimed it will be just a temporary phenomenon.

It seems there are two schools of thought.     One school of thought says it’s all just a business cycle.  What goes up, must come down – it always does, it always will.  Others say, “No, demand for oil is reaching unprecedented heights.”  They add, “this time it is different.”

And to that, those who think oil will fall say, “Ahhhh, got you.”    It is well know that the proclamation, “this time it is different” seems to be proven wrong over and over again. In fact, some say when they hear those words, they know it is time to sell.  

It might also be argued that, sure, it has taken time for the crash to occur this time – but these things never happen on cue.    Some even recite the story of Sir Isaac Newton, who bailed out of the South Sea investment craze, but then, upon noting it was showing no signs of turning, moved back in, just before the crash, and lost a fortune.

Ergo, goes the argument, just because price hasn’t fallen yet – it doesn’t mean it won’t.    (Note the parallels here with the housing market – although ironically many commentators who support the view oil will fall in price, because it always does, also say, when talking about house prices, “this time it is different, prices will stay up.”)

Another view put forward to explain why oil has risen too high is that it has been driven up by speculators.  This morning, The Times quoted Michael Waldron, energy analyst for Lehman Brothers, as saying, “There has been an increase in financial demand as many funds have poured into oil as a hedge against inflation and the weakening US dollar. This has been the main factor in driving the price in recent months. We do not think the fundamentals justify oil at $120 and, without financial demand, we think it would be trading at $20 to $30 below that level.”

This view rather suggests oil is taking over from gold as the place of safe refuge.

Then again, speculators are only putting their money into oil because they believe the long-term fundamentals that say it will rise. 

Gold used to have an intrinsic value.  People wanted it because it looked good and because of its peculiar properties.  These days, it seems oil is the product with this real intrinsic value.

Who knows, maybe one day our paper money will feature the legend: “I promise to pay the bearer the sum of one barrel of oil.”

And, putting our tongue firmly in cheek, remember this.  There was a time when money was made of gold.  Maybe in the future money will be made of oil, or at least a substance that is made from oil.  Bear that in mind when people talk about the age of plastic money. Sure, these days we stick it on the plastic, maybe one day we will spend the plastic.

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Now the IMF runs short of money – but it has nothing to do with credit crunch – or has it?

April 8, 2008 | posted by Michael Baxter in Gold, credit crunch | comments (0) | Print This Post

There can be no shortage of people out there who think it is poetic justice. The International Monetary Fund, that once seemingly-almighty financial institution, is short of money. Even more poetically, it could be argued it is down to the arrogance of its policy moves during the last decade.

Bank mangers used to be unpopular individuals. How many failed businesses blamed their bank? How many individuals felt tempted to put a picture of their bank manger on the wall and throw darts at it? It is not to say that bank mangers were necessarily wrong, but to the individuals who were turned down for loans it must have seemed that way. But, during that era of plentifully available credit, which may or may not be coming to an end, bank managers appeared to have been replaced by salesmen. No longer were we required to go cap in hand to the banks if we wanted money, they were coming to us.

A similar principle applied to the IMF. But this time, it was countries that had to get the begging bowl out, and no doubt many finance ministers were made to feel two inches tall in the process. The UK was not immune, and in 1976, under the chancellorship of Dennis Healey and Prime Minister James Callaghan, the IMF bailed out the UK, or more precisely the pound, enforcing its austere regime upon the UK, and leaving the high and mighty at the Treasury with egg all over their face. In fact, Mr Healey must have felt like even more of a silly Billy in the years that followed, after the pound surged, thanks to North Sea oil. Maybe the embarrassing IMF rescue was not, in hindsight, necessary after all.

In the late 1990s though, the IMF seemed to get it wrong. When the economies of East Asia, and then Russia, hit crisis, the IMF rode in over the horizon, and, just like John Wayne, insisted everything was done its way. So that was less government expenditure and higher interest rates. Curiously, the IMF’s remedy for East Asia and Russia was the exact opposite of the approach taken by Ben Bernanke in the US right now.

The result of the IMF policy was this. Western banks by and large got their money back, and nasty crisis in the West was avoided. But many countries of East Asia, with Malaysia heading the list, and then the following year, Russia, suffered very nasty recession as a result.

The most famous critic of the IMF policy during this period is Joseph Stiglitz, winner of the Nobel memorial prize for economics.

The IMF did not mange to endear itself to the governments and people of that region; its action created a great deal of mistrust for western financial institutions. Many blamed the IMF as being solely responsible for the economic hardship that followed in those countries – and according to Stiglitz some even refer to events in their countries as either pre- or post-IMF. That’s how strongly people in the region feel about its support during that period.

Ironically though, while a Western financial crisis was avoided – even with the failure of Long Term Capital Management, which was partially caused by the Russian crisis – it could be argued that the roots of today’s credit crunch were laid.

Certainly China and Russia have gone to great lengths to ensure they never need IMF help in the future. In Russia, Western resentment grew – which explains much of the current friction between Russia and the West, while China ensured its economic boom was fuelled by savings.

China is possibly unique in the history of economics in developing while maintaining balance of payments surpluses. Its booming economy has also helped contribute to a global glut of savings – which helped underpin the borrowing boom in the US and UK.

It is a complicated web we weave, but if you squint a bit, and take a look at the current economic crisis from a certain angle, from the angle of Chinese savings and trade surpluses, you could even make a case for saying the credit crunch is down to the IMF policy decisions of 1997 and 1998.

And that brings us back to the poetic justice. For the IMF makes its money from interest payments on its loans to countries. And ever since the debacles of 1997 and 1998, customers have been thin on the ground.

Banks have changed their spots, and shed their images of being run by bank managers in the mould of Captain Mainwaring, from Dad’s Army, to a dynamic hub of financial salesmen – maybe that has also contributed to the credit crunch too, but that is another story. The IMF, on the other hand, is perhaps suffering from decades of not being sufficiently customer focused, and is now running short of money.

The solution is simple enough, though. The IMF is selling some of its gold. In all, around $6bn of gold is going to be coming up for grabs, that’s around 12 per cent of its total holdings.

As you know, gold hit its all-time high earlier this year, and although it has fallen slightly since, it still is up on the price a year ago, which itself was up on the price a year before that. It would appear that if you are going to sell gold, now is a good time.

No doubt Gordon Brown is wishing his timing had been fortuitous. He sold gold from the UK’s vaults when the price was much lower than today – bringing in much criticism – although we are not sure he could possibly have foreseen how prices were going to rise.

Interestingly, Gordon Brown has often called for the IMF to sell its gold. But Brown wanted the proceeds to be used to write-off some Third World debt – we are not sure that the IMF, which wants to generate revenue, will see it quite like that.

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Gold glitters but does nothing

March 14, 2008 | posted by Michael Baxter in Gold | comments (1) | Print This Post

Gordon Brown wasn’t a fan of gold.    It sits in vaults doing nothing – you can’t make new medicine out of gold, you can’t grow more food with gold, or use it to fuel aircraft.     Okay, you can actually use it to build some items of IT, because its peculiar properties make it ideal as a conductor of electricity, but as a general rule of thumb gold is a dead weight.  It looks pretty, but that’s about it.

So when Gordon Brown quite literally sold the family gold a few years ago, just before it shot up in price, and cost the UK a tidy sum in the process –  he was actually doing what many economists approved of.

Today, economists are not fans of gold.  Last year, for example, Capital Economics often poured scorn on the idea that gold was set to rise in price as fears over the economy grew.

The truth is that gold’s position as a place of last refuge is illogical, in fact it’s purely down to psychology and history.

Sure, in the past, wars were fought over gold, it funded new empires, but there is something else that characterises that period in history when gold was the only true form of money.  Economic growth was awful.   Take as an example Western Europe from 1AD to 1820.  According to Angus Maddison (the authority on these things),  GDP per capita during that period just managed to double.    Yet between 1950 and 2003 GDP per capita almost quadrupled.    

How was it that growth suddenly started to accelerate – surely a factor behind this was the way money changed.    In an economy that is seeing changes in technology, there is a danger that demand will lag behind supply – this is why major economic recessions have often followed periods of technical innovation. 

And when growth did occur, it was often facilitated by new discoveries of gold.    Karl Marx, for example, argued that the Industrial Revolution was funded by the discovery of gold in the new world.   It would appear that economic growth needs an expansion of the money supply,  or, in other words, economic success was held back simply because of the psychological power of  a yellow metal.  They say iron pyrites is fools gold – because it looks a little like it, but is in fact worthless. Well maybe the true fools gold is gold itself – and the day monetary policy was no longer determined by gold supplies was the day  economies were freed up to enjoy their potential.

In 1980, gold hit $873 an ounce, a record that had remained unsurpassed until a few months ago.    But it seemed as if gold’s day was over.  During the recessions of the early ‘80s and early ‘90s, it stayed short of the previous peak – maybe at last its importance was gone – for good.

Actually, that argument is not completely contradicted by the current high price.  Sure, gold has been hitting all-time highs with regularity, soaring past  $1,000 an ounce last night – but then again, in real terms, that’s after allowing for inflation, gold’s price in 1980 is the equivalent of $2,170 today – so maybe gold hasn’t quite regained its former glitter.

It’s not that there aren’t solid reasons for the price of gold to go up – not only does it have applications in the world of IT, it is also especially popular as a form of  jewellery in India – and so as the economy of the subcontinent grows, demand for gold goes up with it.    But then lately, there has been anecdotal evidence that at its current price, many Indian families have been cashing in on their gold, with $1,000 dollars or so proving much more attractive than an ounce of gold.

So, why then is gold suddenly so high?

In part it is rising today because it went up yesterday.    Investors are noting that gold has risen in price, and therefore they are buying more of it. This is, of course, the definition of a bubble, and can not continue indefinitely.

Others are investing in gold because they can’t think of anywhere else to put their money.  

But there are other factors at work – presumably some countries are buying gold to replace dollars in their foreign reserves.  

But finally, of course, gold is seen as a hedge against inflation, and a place of safety.

It is not logical that gold should be either of those things. It’s just the way it is perceived.

And whether it is logical or not, the fact that gold is so high shows how pessimistic speculators are.    If history is any guide – then the high price of gold today is an indication of very tough times ahead and rising inflation.

Back in 2005 we ran a series of articles predicting future rises in the price of gold. That prediction seemed safe then – but will the yellow metal continue to rise?

It does seem that markets are still underestimating the seriousness of the current economic crisis – which would suggest gold has further to rise.  But cut through that, is there a solid, rational reason for gold to be so high,  and the answer is No.

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Gold: are you glittering too much?

January 15, 2008 | posted by Michael Baxter in Gold | comments (0) | Print This Post

For some time now we have said gold has got to be a commodity with a rosy outlook. Our rationale was manifold. The inevitable fall in the dollar, we argued, would lead to greater demand for gold. Gold as an item of fashion would see rapid demand, as the economy of India, where gold is especially popular, grows. At the same time, gold has some peculiar properties making it ideal as a conductor of electricity, while at the same time it is very resistant to the surface corrosion that is commonly suffered by copper, silver, or tin/lead alloys. As a result it is commonly used for the contacts in electrical connectors.

But, even so, with the yellow metal passing $900 a troy ounce, it does seem to have enjoyed an exceptional run.

A year ago it was trading at $600, the year before that $500, and in mid-2005 it was in the low $400s.

Can the run continue? While it is true that demand from India and IT could explain rises in gold over the long-term, it is difficult to believe they can have justified the recent surge.

And yet, according to the FT, the wise men and women of the City are betting it will rise higher, with some buying contracts agreed which will only be profitable if gold passes $1500 an ounce.

If only they had read Investment and Business News two year ago, and followed our advice then, they would be rich – if only we had followed our advice then. Can it continue? Last week, Capital Economics put a seed of doubt into the mix: “The rally in gold is still essentially a play on dollar weakness, with little hard evidence of additional support for gold either as a safe haven or as an inflation hedge. As such, gold only looks attractive at these levels if the euro is heading well above $1.50. Secondly, there is plenty of anecdotal evidence (particularly from India) that prices above $800/oz are a serious constraint on fundamental demand from the jewellery market. Finally, the last time that gold prices reached these sorts of heights (in January 1980) they also soon collapsed – falling by some $200 within two weeks.

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