Gold, Oil, the US$ and Silver

February 4, 2004

I recently had cause to recall the fact that my Professor of International Finance gave me a "courtesy" pass mark for his course (in 1970/1) because I was stupid/arrogant enough to argue that the gold price would rise above $35/ounce, which was contrary to the then conventional wisdom of the day. (The leading Economists of the day were Paul Samuelson and Milton Friedman - both of whom had won or would win Nobel prizes, and both were arguing that gold was a relic of the past).

What prompted this recollection was a book entitled "The Gold War" (Authors: Weil and Davidson; Publishers: Secker & Warburg, 1970) - which sought to explain the rationale for Central Bank machinations in the 1950s and 1960s, and which I re-read during my annual vacation in early January 2004.

In it I found several addition pieces of a jigsaw puzzle that I have been slowly putting together since the late 1960s. I guess I must have known these facts at that time, but my professor was probably correct: I was young and arrogant; and I probably didn't really understand their implications then.

In the ensuing years, I came to understand that International Finance is all about power politics and confidence in the system, and has very little to do with rational Economics. It was for this reason that the three erudite Professors of Economics and Finance turned out to have been wrong regarding the gold price; and this raises the question: "What is the state of play today in the political field, and how robust is the current level of confidence in the International Financial System?" Men like George Soros and Sir John Templeton are clearly lying awake at night worrying about these very questions.

One important piece of the jigsaw puzzle (at page 65 of The Gold War) was the reference to President John Kennedy's speech on July 4th 1962, wherein he called for a "declaration of interdependence" of nations on both sides of the Atlantic. (Europe and the Americas)

To me, this verbalisation of the concept of "interdependence" was the first step in a long journey which was to eventually emerge and become known as "globalization" and I FINALLY understood the fact that if all nations in the world are interdependent, then Fiat Currencies might be expected to work for the very reason that the debtor and creditor nations would be symbiotically interdependent.

By way of explanation: If my biggest asset is the loan you owe me (AND I am chronically in surplus), and your biggest liability is the loan you owe me (AND you are chronically in deficit) then it is not in either of our interests for me to call in my loan. First, I will probably land up having to write off the debt, and secondly, if I do that, trade between us - which is what drives my economy - is likely to dry up. Clearly, if I moved to crystallise the bad debt, I would not thereafter be able to justify a continuation of supply except on a COD basis (which you would not be able to afford given your chronic deficit). No, it would be better for me to just accept that ensuring a maintenance of my ongoing standard of living is far more sensible than obdurately moving to "white ant" it.

It seems to me, therefore, that the ultimate objective of globalization is to make ALL nations of the world interdependent and, under these circumstances, Fiat Currencies will work because International (Sovereign) debts will never be called in - except for the purposes of disciplining recalcitrant debtors who go "feral" and who need to be disciplined by all the others acting in concert. If ALL nations of the world were in fact interdependent, then all the hullabaloo about the sustainability of International debt levels would represent nothing more than "background noise". Quite simply, Sovereign Debts would never be repaid. This argument is similar to that relating to domestic real estate. What does it matter that my house has risen five-fold in value? I can't sell it and benefit from the capital profit, because the price any replacement home I might buy will have ALSO risen five-fold. Only a minute proportion of existing homes will be sold for the purpose of realising capital profit; just as only a minute proportion of existing sovereign debts will be called in for purposes of credit management.

There are two weaknesses in the above argument:

  1. What if some nations balk at the concept of globalization and elect not to join in the game?
  2. What if the USA (the host of the "anchor" currency) goes feral?

If we now focus on the greatest "political" risks to globalization, we come to understand (which is what the Neo Conservatives appear to be focussing on) that the concept was (until recently) incapable of being fully realised because there are some nations which are consciously unwilling to play the game given that they have (had) no incentive to become interdependent.

These nations - most of which are either in the Middle East or Africa - have no real need for what the industrialised nations have to offer. They are run by an Elite few (eg the Oil Sheiks) and there is typically no "Middle Class" to which the Elite Few are accountable; and their peasants are "ruled" with iron fists.

From the perspective of the globalizers and the proponents of Fiat Currency, there are dictatorships (some are nominally called theocracies) which control rare storehouses of "primary" products (no value add) that the Industrialised nations absolutely cannot live without, and which do not care whether the main debtor nation (the USA) goes under because they do not care if the oil or chrome or whatever stays in the ground.

These nations represent the greatest risk to the international financial system because their leaders have the power to undermine the US Dollar AND they are not particularly concerned about the standards of living of the masses living in their own countries - and to whom they are not Accountable.

The Neo Conservatives' proposed solution to this problem has been to "force" democracy onto these nations for the purpose of forcing an Accountability of the leadership to the electorate. In turn, this would inexorably lead to national interdependence as the electorate in the various countries became more vocal, and demanded an improvement in living standards. In turn, this could only be facilitated through International Trade.

Human beings are differentiated from the animal and plant kingdom in two specific areas:

  1. We have the capacity for abstract thought, and
  2. We all have a gene in our make-up which gives us a propensity to think one thing and say another - in a manner which is calculated to deceive or manipulate other people's behaviour.

The political leaders of our world today are typically possessed of a disproportionate amount of both of these attributes, and so one needs to view with a great deal of circumspection and statement that comes out of the mouths of most of today's leaders.

There is a lot at stake here. If the world's economy cannot become fully interdependent (globalized), then the concept of Fiat Currencies will not work because the backbone of the system - the US Dollar - will very likely eventually be destroyed by a stubborn creditor who has no incentive to give further credit.

That creditor is unlikely to be Taiwan, or China, or Germany, or any other Industrialised Nation with a positive trading balance, and which has a symbiotic relationship with the USA; AND which has a generally high or rising standard of living within its borders. It follows that unfocussed worrying to the effect that "what if the lending nations stop lending?" is not really constructive. Logic dictates that out of a sense of self preservation, the politicians and the Central Bankers of the lending nations have an extraordinarily high propensity to keep lending.

Significantly, George W. Bush was 100% correct that Saddam Hussein possessed weapons of mass destruction - only the weapons had nothing to do with Nuclear Bombs or SCUD missiles, and had everything to do with the potential for Hussein (and others like him in the Middle East) to destroy the entire International Financial Infrastructure by undermining faith in the US Dollar. His (Hussein's) country was being boycotted, and he had worked out ways of circumventing the boycotts to get what he needed - albeit at some significant cost to the standards and/or quality of living of the long suffering Iraqi citizens. From the perspective of a Westerner, his lack of caring in this particular area was abhorrent - and this alone justified the "pre-emptive" attack. The "clear and present" danger argument was merely smoke and mirror sound bites for the "great unwashed".

Ironically, by the previous actions of these same Western Nations (USA and UK) Hussein had been placed in a position where he didn't really care whether he sold his oil for US Dollars, Euros or Gold. He could dictate his terms and he therefore represented a threat to the world's economic infrastructure. As a pre-emptive measure, he had to be neutralised.

Another piece of the jigsaw puzzle that I found in the book, the Gold War, had to do with the "ho-hum" reception given to the Special Drawing Rights or "paper gold" in the 1960s. The underlying logic for their creation was that the world was possessed of insufficient gold inventories which, in turn, (because of Dollar/Sterling/Gold convertibility) was inhibiting the expansion of the world's money supply which, in turn, was inhibiting the growth of world trade.

As far as I can deduce, it was eventually rationalised that the creation of artificial (paper) gold was tantamount to merely printing the paper money that the SDRs were supposedly backing - so why not just print the paper money and be done with it?

Also at that time, part of the rationale for the SDRs was that the Central Banks were being faced with two choices - in the context of their objective to provide the underlying capital which would facilitate the financing of increased world trade viz:

  1. Increase the inventories (volume) of gold
  2. Increase the price of gold.

They chose the former route via SDRs because it was recognised that, in an environment of convertibility, if the US$ and UK pound were allowed to depreciate dramatically in price relative to gold, then inflation within the US and UK borders would spiral heavenwards.

By way of example, if Japan (or Germany) at that time was effectively pricing its products in ounces of gold then the price in US$ payable for the same Japanese or German item would double if the price of gold rose from $35/oz to $70/oz. The US and UK would be facing Hyperinflation. Only two outcomes were possible:

  1. Hyperinflation
  2. Sever the convertibility of gold and the US$; and of the UK pound.

When the gold price started to rise significantly above $35/oz, a decoupling of gold and the US$ became inevitable.

The above example goes to the heart of why the world's Central Bankers have been fighting a rising gold price since the early 1960s, even taking into account the fact that gold, the US$ and the UK pound are no longer interchangeable.

If the gold price were to start rising heavenwards in today's economic climate, the "World" will come to fear that the International Financial System was becoming unstable, and "Confidence" would be undermined. When confidence is undermined, "velocity of money" starts to fall (as people start to worry about their futures), and when velocity of money starts to fall, the Central Banks' predisposition to print money becomes increasingly irrelevant as the potency of this extra money shrinks and the economies of the world go into Viagra withdrawal.

So now the World's Central Banks are facing a huge dilemma: If the (now desperate) need for globalization and interdependence is facing obstructionist behaviour from those few recalcitrant countries (and pockets of influential terrorists) which have the power to resist it (and consequently destroy confidence in Fiat Currencies in general) AND, if a destruction of confidence were to lead to a rocketing gold price, then the "debtor" nations (including the US - which has been the main engine of world growth for nearly three generations) - are likely to face total and uncontrollable dislocation of their domestic economies. If the US's economy is dislocated, then the primary driver of the world's economy (the US accounts for approximately one third of total world GDP) will become dysfunctional. In turn, the entire world's economy could implode.

That is essentially why men like George W Bush , Tony Blair and even John Howard have been quite prepared to stand up in public and lie through their teeth with straight faces. They were attempting to shore up an economic system which is terminally ill. They were attempting to buy time.

Now, when I am grappling with questions like these I find it instructive to imagine myself in the shoes of these men of power. What would I do if I were in their shoes? Unfortunately, the information available to me is severely limited relative to their sources of information - which is why I am typically unable to "guess" in advance, and I have to await the emergence of the relevant facts. That is also why - in the 35 years or so that I have been trying to put this puzzle together - I have always been a couple of steps behind. As I am constantly pointing out to my children: THE DEFINITION OF IGNORANCE IS THAT YOU DON'T KNOW ENOUGH TO KNOW WHAT YOU DON"T KNOW (which is one reason why George Soros and Sir John Templeton may turn out to be wrong: They don't have access to ALL the information)

Here are a couple more (possibly the "final") pieces of the puzzle, which were "handed" to me in January 2004 from sources other than the book referred to above.

Whilst I was on vacation, two apparently random snippets of information came to my attention. Individually, they seemed relatively innocuous but, on reflection, together they provide a clue regarding what the Think Tanks are considering:

  1. The Australian Government announced that it would no longer support Research and Development into ways and means of reducing greenhouse gases, because it had formed the view that the Kyoto Protocols would not be ratified. Importantly, the timing of this seemingly innocuous announcement coincided with the Australian holiday season - when very few people were paying attention.
  2. George W Bush announced that the US would be spending TRILLIONS of dollars in the coming decades on a resurrection of the "Space Program".

These two developments - when read together - have an importance that is explosive, but to appreciate their explosiveness I need to make sure that I "position" the explanation appropriately. For that reason, here is short digression:

The most effective way of communicating with an audience is to talk in language that people understand and with which they can identify. (Ultimately, that is why politicians talk in sound bites). It is important here to communicate the concept of cause and effect.

  • If you are an accountant, you will appreciate that every debit must have a corresponding credit, or your books won't balance.
  • If you are an engineer, you will understand Newton's third law of gravity which states: "Every body in the Universe is attracted to every other body in the Universe with a force that is directly proportional to its mass and inversely proportional to the square of the distance between them". In simplistic and dynamic terms, every action has an equal and opposite reaction.
  • If you are spiritually inclined you will understand the balancing effect of "Yin" and "Yang".
  • If you are a physicist you will understand that there is a relationship between Energy and Matter, and that their relative behaviour is predictable by the formula E=MC2 (Energy = Matter multiplied by the square of the speed of light)

The explosiveness of these two apparently random pieces of information can best be understood in terms of cause and effect, and of "balance", and of known relationships.

First, let's look at "Velocity of Money".

Velocity of Money slows down when people start to feel conservative or nervous about their future. They start to save instead of spend. The rising gold price has been reflecting the obverse side of the "nervous" coin. The flip side is that where there is a rising gold price, the velocity of money (as opposed to the Money Supply) can be expected to (eventually) slow.

Now, in a world that has a surplus of goods and services, a slowing velocity of money has the propensity to bring on deflation with a capital "D".

And in a world that is burdened with mountains of debt in all levels of society, Deflation is the "kiss of death".

Private Enterprise - which is the engine of growth in the Capitalist world - is run by people who have the same emotional make-up as consumers. When Managers feel nervous, they stop investing and they start to focus on tighter management of costs.

In short, the engine of economic growth slows down when velocity of money slows down, and the question arises: If you have already cut interest rates to 1%, and you have already flooded the economy with cash, and the Velocity of Money slows down, what do you do?


The "Space Program" is not going to be driven by Private Enterprise. It is going to be driven by the Federal Government of the United States of America.

What George W. Bush ACTUALLY announced was tantamount to the first step in a journey that is going to give rise to a new Economic Order. The US Government will be "forcing" Trillions of dollars of "Investment" over the next two decades - and this investment will, in turn, give rise to employment and will power the economic engine.

But these trillions of dollars are going to need to be sourced somewhere. He can't just print the damned dollars, surely! We will be facing humungous inflation - which will give rise to an exploding gold price and oil price.

Well, let's look at that (charts courtesy of

The monthly chart of the Amex Oil Index (proxy for oil) certainly seems to be anticipating some sort of run up in price of oil. Look at how the PMO oscillator has recently given a strong buy signal.

Paradoxically, though, the $XAU (leveraged proxy for gold) does not seem to be reflecting a similar outcome in that it is still quite far from reaching for new highs, and the PMO is starting to look overbought.

To better understand the implications of this, we need to go off at a slight tangent. (I will bring everything together later on).

The Australian Government's announcement regarding greenhouse gas emissions was exceptionally important and there was MUCH more to that announcement than met the eye.

First, it needs to be understood that the Australian Prime Minister is "in the pocket" of the US and UK leadership cabal. When they say "jump" he asks "how high?" In my mind, the Australian announcement did not occur in a vacuum. It reflected "Western" policy.

Next, some explanation of the importance of the Kyoto Protocols will probably be helpful.

It is now generally understood that the Earth is facing a rise in temperature which may threaten all of biological life, and the process has come to be known as "global warming". One cause of global warming has been the burning of fossil fuels and the emission of Carbon Dioxide into the Earth's atmosphere. This, coupled with a decimation of the carbon dioxide absorbing forests of the world has given rise to a sort of "blanket" that has been trapping warm air close to the Earth's surface that would normally radiate into the stratosphere and beyond.

The Kyoto Protocols were predicated on the base assumption that if we "managed" future levels of Carbon Dioxide emissions (thereby incidentally also reducing our utilisation of and dependence on fossil fuels) we could arrest the global warming process.

One question I have been grappling with for some years now is this: "Given that the USA has a higher incentive than any other Nation on Earth to seek to reduce its dependence on fossil fuels, why on Earth has the USA been resisting ratification of the Kyoto Protocols?" Logic dictates that ratification would give rise to a surge of activity in development of "new" alternative energy technologies that are either not related to fossil fuels or that will reduce our dependence thereon, and this activity would "drive" the economy going forward.

The conventional answer is that industrial lobby groups would become unmanageable, and that the impact on the oil dependent economy of the USA would/could be disastrous.

I am now starting to focus on four issues:

  1. As it turns out, the necessary R&D has been happening anyway. All it needed was the "threat" of ratification to motivate this
  2. Regardless of the R&D, ratification of the Kyoto Protocols would probably not have given rise to a short term increase in the Velocity of money, because if people already own motor cars, they will not "rush" to buy fuel-cell cars, and Government expenditure on a fuel delivery infrastructure and/or a superconductor cable infrastructure is unlikely to give rise to as positive a reaction as a humungous investment in a "Space Program". Ie The Space Program approach is likely to be more economically effective in the short term, and may also provide a (very) long term solution to the Global Warming problem.
  3. The Invasion of Iraq might well have had an additional desired effect - namely that of sending a message to the other recalcitrant oil nations that they would be well advised to join the community of interdependent nations or face similar consequences. (Under circumstances of increased mutual respect, Kyoto becomes less important in the short term because the threat of oil embargos recedes.)
  4. A deal may have been "cut" with some/all of these nations to the effect that: "If you join the community, we will allow the US Dollar to deteriorate relative to (say) the Euro, but we will also allow the price of oil to rise in dollars to compensate you. We will also defer the day where we move to replace oil as our primary power source, and this will allow you time to get your own houses in order".

But where does all this leave the US$ and the Gold Price?

Like the Gold Price, the Euro is yet to challenge its old highs with any degree of enthusiasm - but it is certainly stronger. Note how the $XAU was at a level of around 95 in January relative to its previous high of around 150; whilst the Euro was around 124 relative to its previous high of around 150.

The Gold price (as reflected by proxy in the $XAU) has clearly been underperforming relative to the other (supposed) "dollar substitute" currency, viz the Euro.

But there is an anomaly in both the Euro chart and the $XAU chart:

BOTH have broken up out of formations that could tentatively be described (in the absence of corroborating volume) as "Reverse Head and Shoulders" patterns.

The break up of the Euro through the neckline of 120 gives a price destination of around 160, whereas the break-up of the $XAU through the neckline at around 90, gives a price destination of roughly 140


Does this mean that the gold price is likely to swoon?

The answer to this question is "absolutely not". What I have now come to understand is more likely to happen is that gold will remain as a commodity, but its price will be allowed to rise to "market" based on supply/demand factors. Both the charts and the fundamentals have for many months been pointing to an interim term gold price target of around $535/ounce and there is no reason to believe that this has changed. Significantly, $535/ounce will NOT represent a new historical high.

The primary reason (if you think it through) why gold cannot be expected to reach a level of thousands of dollars per ounce, is that such a price destination will UNDOUBTEDLY be accompanied by an implosion of the US economy, and a concomitant implosion of the overall World Economy of which it represents roughly a third - and which it therefore drives.

Nevertheless, based on the Net Present Value calculations that I did many months ago, the $535/ounce implies a very respectable Internal Rate of Return (which is the ultimate reason one invests) from the perspective of a US$ investor. ie there is NO reason for US$ investors at present to jettison gold shares as an investment (except perhaps if the company is severely undercapitalised), and there is still EVERY reason to hold gold as an insurance policy in the event that the Vision of globalization is not fully realised.

But it should be recognised that once globalisation has been effectively realised, the risks of a loss of confidence in Fiat Currencies will recede to become irrelevant, and gold will start to behave as a commodity only - albeit a very valuable commodity.

Which brings us, finally, to Silver.

To me, the most important factor in the silver market is that there is a serious imbalance in supply/demand having arisen from the greed (and outright stupidity) of the speculators.

In the week ended January 27th, 2004 the outstanding short positions of the traders (Commitments of Traders) was as follows:


Silver: 85,902 contracts, representing 429 million ounces ( equal to roughly NINE MONTHS of total world mine production of around 586 million ounces p.a.)

Gold: 132,970 contracts, representing 13.3 million ounces (equal to roughly only TWO MONTHS of total world mine production of around 83 million ounces p.a.)

A further factor of significance is that total world demand for silver is around 838 million ounces, of which photography represents around 200 million ounces. (


Of course, there has also been a supply of silver from above ground sources of around 250 million ounces p.a. (including, most recently, 70 million ounces from government sources which are now drying up). But what should also be focussed on is that the primary remaining source of above-ground silver is "scrap recycling" of around 180 million ounces, and the primary source of silver scrap is PHOTOGRAPHY!

The Silver Bears cannot have it both ways. If digital is going to decimate the demand for silver film, it is also going to decimate the supply of scrap from silver film.

I see silver as a hugely exciting play because - if the move to globalisation is finally consummated to make all nations interdependent, and the threat to Fiat Currencies goes away, then - both gold and silver will be treated as commodities by the authorities. Under such circumstances, both gold and silver will be allowed to rise to their natural market levels. Gold will rise to at least $535/ounce, and the silver price will rise to represent a much higher percentage of the gold price and more in line with historical levels.

Let's now look at gold and silver through the eyes of non US Dollar investors.

A gold price destination of $535 represents a 33% increase from current levels, whereas a Euro price destination of 160 represents a 29% increase from current levels.

On the other hand, a $XAU price destination of 140 represents a 47% increase from current levels. The jigsaw puzzle finally comes together! There will be a slight upside leverage to mine profits if the Gold Price in Euros rises by around 13%

The following monthly chart is by courtesy

Importantly, the Euro Price of gold appears to have hit a "double bottom" at around E250, and is now in a trading range with a slight upside bias dating back to 1976/7- ie a price destination of around E400 seems to be a reasonable aspiration within the next few years (before resistance at that level is encountered)

Silver, on the other hand, appears to have an upside "spike" potential of a maximum of around US$60/ounce before settling back to around $15/ounce, for the following reasons:

  1. The Ultra long term chart of silver in deflated dollars shows resistance at that level
  2. The shorts need to be squeezed out and, if a threat of implosion of confidence in Fiat Currencies goes away, the greedy shorts will no longer enjoy the benefit of government protection. Price will have to rise to allow a rebalancing of supply and demand, and there is therefore likely to be a significant overshoot on the upside as the short positions are unwound.
  3. The historical "support" ratio of gold:silver can be seen from the chart below ( to be around 35:1 - which implies a "maintainable" price of silver at $535/35 = $15/ounce). In the context of only a 29% anticipated increase in the Euro exchange rate, there appears to be SIGNIFICANT upside to the Euro price of silver.


  1. Predicated on the assumption that the world's Power Politicians and Central Bankers can finally effect a globalization of the World Economy - thereby making ALL economies symbiotically interdependent - Fiat Currencies or some variation thereof appear likely to remain as the basis of international exchange.
  2. If this outcome can be effected, the question of "Sovereign Debt" becomes a red herring. Sovereign Debtors (countries) will not be treated in the same way that Consumer Debtors and/or Corporate Debtors are treated by their Creditors. Under circumstances of totally integrated global interdependence of all the worlds' discrete economies, Sovereign Debts will NEVER be repaid, and will remain on the books for ever (except if used as a disciplinary device).
  3. The invasion of Iraq appears to have the potential to finally facilitate 1 above.
  4. In order to maintain the Velocity of money which, in turn, implies that "deflation" can be avoided, the US Government is likely to move to take direct responsibility for Investment via its Space Program over the coming decades. There is likely to be a subtle shift in emphasis within the concept of "capitalism" - the nature of which is yet to unfold. ie Students of economics are likely to be studying a new form "ism" in the years ahead.
  5. A shift in emphasis towards Centralised (government) investment by way of the Space Program will also shift the burden of responsibility away from the "US consumer" as the ultimate driver of the world's economy. This implies that Consumers will be given time to repay their existing debts over the next ten to twenty years without the concomitant risk of the onset of a World Depression. Standards of living within the USA can "tread water" whilst the rest of the world catches up.
  6. The long term "angle of incline" of the trend line of the Primary Bull Market in the Euro Price of gold appears to be pointing to a minimum annual increase in the Euro gold price of around 6% p.a. - with a "four year" target of around E400 per ounce being consistent with this angle of incline. This implies (amongst other things) that the conservative Central Banks are not about to totally abandon gold as financial reserve, and it may finally evolve to form some sort of hybrid solution (At least they will be keeping their options open, but THEY will remain in control from a currency perspective - whilst the market will remain in control from a commodity perspective)
  7. A 6% p.a. annual growth rate in the Euro Gold Price is likely to give rise to a slightly higher growth rate in the non US$ price of gold SHARES given the inherent upside leverage to profits; and gold shares therefore still represent a solid investment opportunity when compared with lower growth levels being anticipated by the Econometricians in respect of the world economy.
  8. Silver seems likely to significantly outperform gold as an investment in the medium term.
  9. With the Space Program in place, and given the recent drive to reduce dependence on oil (encouraged by the drafting of the Kyoto protocols which were never ratified and now look unlikely to be ratified) , it is a matter of time before new energy efficient technologies emerge to become commercially relevant (over the coming decades). In the meantime, the oil price looks likely to rise when expressed in US$ (thereby protecting the suppliers) and this will buy the oil countries time to develop their own economies.
  10. Gold should continue to be held as an insurance policy - in case something goes wrong.
  11. The jigsaw puzzle finally fits, and I can get on with my life.
Gold ETFs outflow reaches Rs 462 crore in Apr-Aug of FY'17