DeHedging Gold Bubble?

[blazespinnaker]

http://www.miningmx.com/gold_silver/292604.htm

Probably some steam still left in this engine if you are so inclined. I'd say once contracts are around 15 million oz I'd start to liquidate my position as once the contracts are gone (or mostly gone), the price will drop very fast I think.

[Alfredo Dominguez]

Why? How will the reduction of hedging to a certain number you pulled out of the air affect supply and demand in the gold market or the place of gold as a monetary refuge in the face of rapidly inflating world currencies?

[blazespinnaker]

Well, I am making the assumption that the people who wrote the contracts had a reason for writing them other than thinking that Barricks was stupid.

They'll probably take their 2BN and go write contracts with someone else, which should put a lot of support under current prices.

When the dehedging stops, so will the support, and we can see some pressure on gold prices, which are already pretty high..

[EJ]

One of the reasons for the Kitco prices for gold, silver and platinum on the site is to show that not only gold but all PMs are up. You can't focus on only one.

Gold is far from a bubble. The vast majority potential investors believe it's overpriced and most of these are the same people who felt that way in 2001 when it was at $270. Now they think, it's REALLY overpricd. Compared to what?

[blazespinnaker]

Looks like dehedging is about to slow down. I wonder if there will be an impact on gold prices in the second half here.

http://news.morningstar.com/news/DJ/M08/D03/200608030938DOWJONESDJONLINE000813.html?Cat=AsiaPa c

[jk]

dehedging has been one source of demand for gold, but only one among many. investment demand will be the ulimate source of gold's rise-to-come. oh, gold might pull back if there is a global asset correction- with equities and commodities all hit in the context of a slowdown or recession. but at the same time central banks like the bank of england have ceased their stupid sales of gold [they picked the bottom pretty much exactly], while there are noises about e.g. the pboc or boj or cb of korea looking to "diversify."

it is dawning on more and more people that paper currency is first and foremost paper. i think inflation/stagflation is our most likely scenario going forward, and so you'll likely be glad if you buy and HOLD gold for some time, perhaps a decade or more.

one more thing - a thought i've seen articulated by richard russell. bull markets in gold are propelled in their early and especially mid-stages by greed, like all asset ramps. but in the last stage, the vertical ascent to come likely years from now, gold will be propelled by fear. fear of losing all purchasing power if you hold onto paper. this is what makes a gold bull market unique.

[blazespinnaker]

it is dawning on more and more people that paper currency is first and foremost paper.


I'm not sure I buy this. The value of gold is just as arbitrary as the value of currency backed by the US government.

Gold is a yellow metal that you can not eat or shelter your family in.

Now, real estate, I guess, has some fundamental value. In fact, until we get to space, it will be the only thing with fundamental value.

[jk]

I'm not sure I buy this. The value of gold is just as arbitrary as the value of currency backed by the US government.

Gold is a yellow metal that you can not eat or shelter your family in.

Now, real estate, I guess, has some fundamental value. In fact, until we get to space, it will be the only thing with fundamental value.
i agree that there is an arbitrariness to people's attraction to gold. the only thing that makes it worth anything at all is that people want it, not that it has important use. but for some reason people do indeed want it, and have wanted it for thousands of years. [even nomads who don't want real estate want gold.]

so i buy gld thinking that were we a more more evolved species, at least in our culture if not in our dna, we would have outgrown our attraction to this stuff and the shiny trinkets it can produce. [that also goes for the value of sparkly glass-like gem stones, where little pieces of rock are valued at millions of dollars. it's really bizarre.] but, primitive as it is, people want it, so it's worth something- that's the intrinsic definition of a market. and it has continued to be worth something while every fiat currency in history has eventually turned to waste paper. so at this particular juncture in history, i'd rather trust the consistant, if irrational, desire people have for gold, than the arbitrary and historically transitory trust they put in specially colored and decorated pieces of paper.

[Finster]

DeHedging Gold Bubble?

Gold bubble???

Not yet! Gold is just getting back to its average inflation-adjusted price for the past three or four decades. Bubble territory is at least a few years away yet. Carry forward the average price for the first quarter of 1980 (when there actually was a gold bubble) and you get around $2200 per ounce in 2006 dollars. On top of that, by the time we get there, the dollar will have depreciated even further, so $3000-$6000 an ounce is easily doable before this is over. Only when we've advanced past the $2000 mark will be time to even start worrying about a gold bubble.

[blazespinnaker]

Heheh.

Gold prices, like currency, can be manipulated - just remember that.

[Finster]

Heheh.

Gold prices, like currency, can be manipulated - just remember that.

Ahhh, but there's a rub here. You can't specify the "price" of gold without using a ... currency! Wouldn't it be just as accurate - maybe even more accurate - to say the "price" of the USD is 1/650 an ounce of gold?

Which is the true unit of measure?

With that in mind, how would you know which was being "manipulated"?:eek:

[blazespinnaker]

I guess I don't believe the value of real estate or a profitable business run by someone who has a reputation of trustworthiness (like Warren Buffet) can be manipulated.

Gold or fiat currencies can be bought, sold, leveraged, whatever by the powers that be until you don't know which way is up or down.

But real estate will always be real estate. People will always be able to live and build houses on it. In the long run, you always know what you have.

Similar for a good business run by decent men with ownership mentalities. True, not as perfect as RE, but then stock picking is more of an art, that's for sure.

I believe this is why Buffet wised up anf dropped his currency hedges. He realised that he was playing a game he could not control like he could when it came to buying businesses he understood and respected.

[Finster]

I guess I don't believe the value of real estate or a profitable business run by someone who has a reputation of trustworthiness (like Warren Buffet) can be manipulated.

Gold or fiat currencies can be bought, sold, leveraged, whatever by the powers that be until you don't know which way is up or down.

But real estate will always be real estate. People will always be able to live and build houses on it. In the long run, you always know what you have.

Similar for a good business run by decent men with ownership mentalities. True, not as perfect as RE, but then stock picking is more of an art, that's for sure.

I believe this is why Buffet wised up anf dropped his currency hedges. He realised that he was playing a game he could not control like he could when it came to buying businesses he understood and respected.

Same situation with gold as with real estate. Much of the apparent change in value stems not from changes in the value of the gold or real estate itself, but of the currency you're doing the measuring with.

You're still missing the key point here. Every "buy" or "sell" transaction involves two things being exchanged There is no such thing as the price of gold or the price of a piece of real property in a vacuum. When you "buy" gold, you're exchanging some currency for gold, and when you "sell" it, vice versa. The ratio of exchange depends every bit as much on the value of the currency as it does the other commodity. There is simply no way of knowing just looking at a change in the "price of gold" whether it was the value of the gold that changed or the value of the currency.

Same with real estate, same with oil. Have oil prices skyrocketed because the value of oil has gone up, or the value of the dollar has gone down? We don't know just by looking at the "price" of oil. It - expressed in dollars per barrel - is nothing but a ratio between the value of dollars and the value of oil.

Think about it.

[SeanO]

Same situation with gold as with real estate. Much of the apparent change in value stems not from changes in the value of the gold or real estate itself, but of the currency you're doing the measuring with.

You're still missing the key point here. Every "buy" or "sell" transaction involves two things being exchanged There is no such thing as the price of gold or the price of a piece of real property in a vacuum. When you "buy" gold, you're exchanging some currency for gold, and when you "sell" it, vice versa. The ratio of exchange depends every bit as much on the value of the currency as it does the other commodity. There is simply no way of knowing just looking at a change in the "price of gold" whether it was the value of the gold that changed or the value of the currency.

Same with real estate, same with oil. Have oil prices skyrocketed because the value of oil has gone up, or the value of the dollar has gone down? We don't know just by looking at the "price" of oil. It - expressed in dollars per barrel - is nothing but a ratio between the value of dollars and the value of oil.

Think about it.

Completely agree with regards to your ratio point. Just keep in mind that real estate is purchased on the basis of payment not price. So while recent real estate appreciation may have some relationship to dollar declines, cheap credit, and resulting speculation clearly play a MUCH larger roll.

[Finster]

Completely agree with regards to your ratio point. Just keep in mind that real estate is purchased on the basis of payment not price. So while recent real estate appreciation may have some relationship to dollar declines, cheap credit, and resulting speculation clearly play a MUCH larger roll.

They're not completely separate and distinct phenomena. The factors you cite mostly just put real estate at the head of the line in the inflationary chain.

Think of it this way. In 2002 a house H has a market value of $300,000. In 2004, due to the fact that the same payment will fund a larger mortgage, the same house has a market value of $400,000.

But in the value ratio D/H, which fundamentally changed? The same house - the same shelter, same amenities - but are the dollars the same? If I had to choose between assuming the house had changed in real value and the dollars had changed, I'd have to come down on the side of the changing dollars.

The house provides no more actual real value in 2004 than in 2002. But the dollars? How much oil would they buy? Gold? Copper? If it were the house that had changed in value, then the soaring prices of all the rest are a remarkable conincidence, no?

[SeanO]

Think of it this way. In 2002 a house H has a market value of $300,000. In 2004, due to the fact that the same payment will fund a larger mortgage, the same house has a market value of $400,000.

But in the value ratio D/H, which fundamentally changed?

I agree, clearly liquidity is an underlying factor. But once you start comparing to oil and gold I don't think the correlation is as simple as you've stated it. Both house price and payment are measured in dollars yet price has more than doubled, while payments have increased slightly. Just compare a $500k interest only pay option ARM loan with a $1666 payment to a $250k 30 year fixed loan at a $1663 payment.

To the consumer there has been little perceived change, so far, in the cost of housing. Not true with oil.

[Finster]

I agree, clearly liquidity is an underlying factor. But once you start comparing to oil and gold I don't think the correlation is as simple as you've stated it. Both house price and payment are measured in dollars yet price has more than doubled, while payments have increased slightly. Just compare a $500k interest only pay option ARM loan with a $1666 payment to a $250k 30 year fixed loan at a $1663 payment.

To the consumer there has been little perceived change, so far, in the cost of housing. Not true with oil.

Not surprising if there's little perceived change in the cost of housing, because there hasn't been much real change in the cost of housing. It's the dollar has has lost value. Plot housing prices in terms of ounces of gold, pounds of copper, or barrels of oil and you don't see the same kind of ballistic motion.

[SeanO]

Not surprising if there's little perceived change in the cost of housing, because there hasn't been much real change in the cost of housing. It's the dollar has has lost value. Plot housing prices in terms of ounces of gold, pounds of copper, or barrels of oil and you don't see the same kind of ballistic motion.

Yet there has been a perceived change in the cost of oil... does that make it real and therefore invalidate your argument? You can't have it both ways.

[Finster]

Yet there has been a perceived change in the cost of oil... does that make it real and therefore invalidate your argument? You can't have it both ways.

Or so you say. You skated out onto thin ice with the perception stuff.

Let's stick with objective reality. House prices did not rise when measured in ounces of gold. They did not rise when measured in barrels of oil. They did not rise when measured in pounds of copper. Only by using as your measuring rod a currency which can be created in unlimited quantities by fiat can you eke out a huge bull market in house prices.

Why are you having such a hard time letting go of the assumption that dollars are an invariant standard of value? Perhaps it is because for your entire life they have been used as if they were? I suppose that is not so unusual, given that the average person does not start realizing currency units are variable until inflation gets well into double digits. They grow up using them as the reference against which all other values are compared. The value of a car is X dollars, the value of a loaf of bread is Y, the value of a year's salary is Z. They, like you have here, tend think that things just got more expensive. But you are on a financial web site here; shouldn't you be a cut or two more economically savvy than the average person?

Perhaps an illustration will help. When I bought my last house, I measured its size with a cotton ruler. When I got ready to sell it, I took my cotton ruler and washed and dried it at high heat, and measured it again. Presto! My house had gained 75% more square footage! Applying the exact same logic, I figured my house also must be 75% more valuable and was able to get 75% more dollars for it when I sold!

[SeanO]

Or so you say. You skated out onto thin ice with the perception stuff.

Let's stick with objective reality. House prices did not rise when measured in ounces of gold. They did not rise when measured in barrels of oil. They did not rise when measured in pounds of copper. Only by using as your measuring rod a currency which can be created in unlimited quantities by fiat can you eke out a huge bull market in house prices.

Why are you having such a hard time letting go of the assumption that dollars are an invariant standard of value? Perhaps it is because for your entire life they have been used as if they were? I suppose that is not so unusual, given that the average person does not start realizing currency units are variable until inflation gets well into double digits. They, like you have here, tend think that things just got more expensive. But you are on a finanial web site here; shouldn't you be a cut or two more economically savvy than the average person?

Perhaps an illustration will help. When I bought my last house, I measured its size with a cotton ruler. When I got ready to sell it, I took my cotton ruler and washed and dried it at high heat, and measured it again. Presto! My house had gained 75% more square footage! Applying the exact same logic, I figured my house also must be 75% more valuable and was able to get 75% more dollars for it when I sold!

Clearly we have a failure to communicate, I think you've missed my point completely, and erronously jumped to conclusions about my beliefs.

By saying "Same situation with gold as with real estate" and "same with Oil", I just think that you've over simplified the argument which could lead to a fallacious post hoc ergo proctor hoc conclusion that these items will remain correlated to the dollar and each other in the same fashion going forward. I was simply trying to point out that each has unique drivers as well, and they are not same-same.

For example the clear prognosis here at iTulip is Oil up, Gold up, Real Estate DOWN. And in fact real estate prices are down 5-20% while oil is up 20-30% in the last 6 months. Your "same-same" argument is quickly deteriorating.

[jk]

to date, housing has moved along with oil, gold, etc. what will separate them is the leverage at the heart of the housing sector.

[Finster]

Clearly we have a failure to communicate, I think you've missed my point completely. By saying "Same situation with gold as with real estate" and "same with Oil", I just think that you've over simplied the argument which could lead to a fallacious post hoc ergo proctor hoc conclusion that these items will remain correlated to the dollar and each other in the same fashion going forward. I was simply trying to point out that each has unique drivers as well, and they are not same-same.

For example the clear prognosis here at iTulip is Oil up, Gold up, Real Estate DOWN. And in fact real esate prices are down 5-20% while oil is up 20-30% in the last 6 months. Your "same-same" argument is quickly deterioriating.

I may indeed have over-simplified, but in service of a crucial point. It is all too often lost on casual observers how much of price changes of almost everything are ultimately due not to changes in the value of the thing being priced, but the thing in which such price is quoted.

That notwithstanding, your observation about the divergence between real estate and commodity prices is yet a further oversimplification - that the price effects of inflation move uniformly through an economy. As I pointed out above, it has been "real estate at the head of the line in the inflationary chain".

Inflation is a uneven phenomenon. When excess money is created, the price effects move through the system in waves, first affecting one set of prices, then another, then another. And before I get accused of more oversimplification, with plenty of overlap. In the 1990's the inflation went into financial assets. It happens that in this latest episode housing was near the front of the money line, as reduced rates on mortgages imbued buyers' monthly cash flow with a larger dollar amount of purchasing power. Meanwhile, the selfsame homes that had sold for lower prices a couple years earlier provided no greater amount of shelter, no greater amount of amenities, than they did at the lower prices. I am therefore justified in concluding that the reduced interest rates had their intended effect, decreased the value of the currency, and promoted the illusion of greater economic growth as people fled the currency to move into assets that would better hold their value.

Of course, the money flow did not end there. People converted "home equity" into cash, with which they purchased more consumer goods from places like China and Japan. Torrents of dollars overflowed our borders to pile up in overseas coffers. Eventually, as those economies began to spend the dollars, the prices of oil, coal, copper, aluminum, cement - all the things they used to build up their infrastructure and that served as the raw materials for the things Americans were buying - rose in price as well. And just as the run-up in home prices in the US led the prices of foreign-sourced commodities upward, it would only stand to reason that any decline in housing prices would lead them back down.

Not that it will be that neat and tidy - by the time the full effects of that phenomenon are being felt another may well have taken hold. The Fed is apt to cut rates in an attempt to engineer a "soft landing" for the housing market and who knows how that next wave of inflation will play out. But do not make the simplistic assumption that simply because all prices do not move in lockstep that it is not inflation - because it never happens that way.

[jk]

Inflation is a uneven phenomenon. When excess money is created, the price effects move through the system in waves, first affecting one set of prices, then another, then another.

yes, the low rates bloated house prices [which had been conveniently removed from the cpi], and the housing atm boosted spending and lowered savings below zero. now that the wave has passed housing, the question is: what next? certainly industrial commodities have been pumped up. now they've corrected a bit, but then what? up more if he world can keep growth going; if there is global growth we've got to expect commodities to continue to rise at least when priced in dollars. the wave leaves in its wake the foam [multiple small bubbles?] of increased debt. and it has required accelerating amounts of debt to to produce a unit of gdp. but like a wave at the beach, the wave comes in, the wave perhaps goes out? rip tide? can we torture this metaphor any further?

[SeanO]

...your observation about the divergence between real estate and commodity prices is yet a further oversimplification - that the price effects of inflation move uniformly through an economy

Actually it is one part of the oversimplification you made in your same-same argument that I originally took issue with. Seems like you clearly don't think they are same-same at least with regard to timing. Perhaps had I used timing, instead of leverage, as my original example we would have come to agreement that they aren't exactly the same sooner.

[Finster]

yes, the low rates bloated house prices [which had been conveniently removed from the cpi], and the housing atm boosted spending and lowered savings below zero. now that the wave has passed housing, the question is: what next? certainly industrial commodities have been pumped up. now they've corrected a bit, but then what? up more if he world can keep growth going; if there is global growth we've got to expect commodities to continue to rise at least when priced in dollars. the wave leaves in its wake the foam [multiple small bubbles?] of increased debt. and it has required accelerating amounts of debt to to produce a unit of gdp. but like a wave at the beach, the wave comes in, the wave perhaps goes out? rip tide? can we torture this metaphor any further?

Torture it is! :eek: The Fed is like a wind trying to blow liquidity onto the beach, with gravity trying to make it flow back out to sea. If it were not for its ability to simply create money from nothing, each wave of inflation would be followed by a corresponding wave of deflation. And the waves would be a lot smaller and non-destructive.

It turns out, however, that we can observe the waves regardless if we know where to look. If we measure prices in units that cannot be artificially inflated, we see that the deflation happens regardless. The Fed's exertions merely paper it over.

The below is a chart of global stock prices expressed in gold for the past 135 years. As you can see, prior to the founding of the Fed in 1914, stock and economic cycles were fairly brief and shallow, whereas afterwards, they became very long and very deep. We see that in the 1970's even while we had inflation in dollar terms, a deflation even deeper than that of the 1930's actually occurred. It was simply obscured by the devaluation of currency. Of more immediate import, we can also see that we are in the early stages of yet another 1970's-style paper inflation - real deflation.

http://users.zoominternet.net/~fwuthering/Posts/DJWAUX.png

[jk]

nice chart, finster. i even sent copies to some friends. the only nit i'd pick: using gold as a measure is not quite right, though it's not bad. it's not quite right because of the uneven way the gold price lurches up and down. surely we don't want a measure of "real" prices which drops "prices" [in gold] like a stone in 1979 [because gold got so high] and then raises "prices" [in gold] sharply after 1980. a house which cost $125,000 in 1980, or 156oz of gold, might have cost $600,000 in 2000, or over 2000 oz of gold. the price in dollars makes it look inflationary enough, with a 5fold rise in nominal dollar price. over a 10fold rise in gold seems extreme. so yes, over a very long period i suppose putting prices in gold tells us something, but not quite enough, especially when we want to measure processes over mere decades.

[Finster]

Actually it is one part of the oversimplification you made in your same-same argument that I originally took issue with. Seems like you clearly don't think they are same-same at least with regard to timing. Perhaps had I used timing, instead of leverage, as my original example we would have come to agreement that they aren't exactly the same sooner.

It is the same-same. The same phenomenon is behind the stock bubble, the housing bubble, soaring oil prices, and the rest.

Inflation!

[Finster]

nice chart, finster. i even sent copies to some friends. the only nit i'd pick: using gold as a measure is not quite right, though it's not bad. it's not quite right because of the uneven way the gold price lurches up and down. surely we don't want a measure of "real" prices which drops "prices" [in gold] like a stone in 1979 [because gold got so high] and then raises "prices" [in gold] sharply after 1980. a house which cost $125,000 in 1980, or 156oz of gold, might have cost $600,000 in 2000, or over 2000 oz of gold. the price in dollars makes it look inflationary enough, with a 5fold rise in nominal dollar price. over a 10fold rise in gold seems extreme. so yes, over a very long period i suppose putting prices in gold tells us something, but not quite enough, especially when we want to measure processes over mere decades.

Your point about gold fluctuating is valid. Gold is a commodity that has its own supply and demand dynamics.

Yet if we are looking for something that is constant in value against which to measure other values, we are hard pressed to do better. Currency only seems as constant as it does because it's our standard reference. As you point out, gold's utility as a standard of value is especially meaningful over long periods of time. In fact I have developed an index of the value of the dollar in an attempt to create a broader based unit, which is discussed more fully on my web site.

We can at least qualitatively assess, however, the extent to which our shorter term impressions based on gold are valid by looking for confirmation from the prices of other things. Housing prices have risen roughly parallel with gold over the past few years. So have oil prices. As well as many industrial materials. This strongly suggests that most of those price movements are indeed not fundamental to the individual things, but secondary to changes in the value of the measuring unit we call the US dollar. Further support for this suggestion follows from changes in the money supply in recent years.

Also recall that prior to 1933 the USD and gold were officially interchangeable. The thing that really changed in 1914 with the creation of the Fed was the ability of the Fed to artificially expand the number of claims against gold far in excess of the available gold. So we had inflation even while nominally on a gold standard. Of course, it was only once too many of those claims came to be redeemed that it became apparent. The result was FDR's repudiation of the gold standard and the government confiscation of gold in 1933.

[jk]

i suppose someday someone will develop some kind of market basket to measure price changes more uniformly than just using gold. we can call it "the cpi"!

[Finster]

i suppose someday someone will develop some kind of market basket to measure price changes more uniformly than just using gold. we can call it "the cpi"!

Been there done that. The CPI suffers from huge flaws in at least two areas. One is that it has been dumbed down over the years through the use of statistical legerdemain such as "homeowner's equivalent rent" and "quality" adjustment "hedonics". The former is especially insidious because the ratio of rent to price in real estate (the "cap rate") tends to track interest rates. So whenever the Fed lowers interest rates to goose inflation, the resultant effect on homes prices gets canceled out. Now isn't canceling out inflationary influences about the last thing you'd logically do in constructing an inflation index?

The other is that the price effects of inflation are not confined to consumer prices. In fact, consumer prices are near the end of the inflationary chain, often taking years to respond to changes in the money supply. Inflation usually shows up in asset prices first. Assets like stocks and bonds. We saw this in the 1960s and again in the 1990's. So no index of price inflation can focus only on consumer prices and be considered complete.

[jk]

Been there done that. The CPI suffers from huge flaws in at least two areas. One is that it has been dumbed down over the years through the use of statistical legerdemain such as "homeowner's equivalent rent" and "quality" adjustment "hedonics". The former is especially insidious because the ratio of rent to price in real estate (the "cap rate") tends to track interest rates. So whenever the Fed lowers interest rates to goose inflation, the resultant effect on homes prices gets canceled out. Now isn't canceling out inflationary influences about the last thing you'd logically do in constructing an inflation index?

The other is that the price effects of inflation are not confined to consumer prices. In fact, consumer prices are near the end of the inflationary chain, often taking years to respond to changes in the money supply. Inflation usually shows up in asset prices first. Assets like stocks and bonds. We saw this in the 1960s and again in the 1990's. So no index of price inflation can focus only on consumer prices and be considered complete.

finster, i should have put in an emoticon. i was being ironic, implying we don't have a genuine, useful cpi. there are other threads here discussing hedonics, owner's equivalent rent, and also geometric weighting and product substitution [if steak is too expensive we can shift to dog food]. there have also been many references to john williams' shadow stats sprinkled through the discussions. in general one of the things i like about this board is the relatively high level of knowledge among the participants, including you.

[EJ]

Oil is the underlying value of all money. Without oil, no industrialized nation has an economy. Oil is the one good that, if immediately cut off from an economy, the loss will immediately bring an economy to a standstill. You can't say that about anything else in an economy.

Oil = money.

Oil producing countries can't exchange oil directly for goods and services so they have to use an internationally recognized intermediary money, US dollars; the internationally accepted means of exchange and store of value currently used to convert oil into another form of money is currently US dollars. Putin wants it to be rubles. Some Middle Eastern nations at odds with the US, such as Syria (http://www.bloomberg.com/apps/news?pid=20601087&sid=aSA_0pchCRFY&refer), have announced plans to move some reserves to euros.

It is more accurate to say that oil producers exchange oil for dollars versus sell oil for dollars. When demand for oil is higher than supply, the Fed has to print more money for use in the exchange of dollars for oil. This is inflationary. To end the cycle, either oil demand has to decline or supply increase. Both happened 1980 - 1983. Cutting the demand for oil was acheived via interest rate hikes to 19%. The increase in supply took seven years of high prices that created an economic incentive to locate and drill for more oil, and develop new technologies to extract oil economically at higher prices.

That was then. Now we have oil near all time highs, even in inflation-adjusted terms. High enough, long enough to create an economic incentive to locate and drill for more oil, and develop new technologies to extract oil economically? Is the oil even there? Debate rages on the latter, but the jury is in on the former: sustained high prices are inducing more exploration (http://www.forbes.com/home_europe/free_forbes/2006/0724/042.html) and the means for getting it our of the ground. Likewise, high gold prices are creating the same incentives (http://www.detnews.com/apps/pbcs.dll/article?AID=/20060225/BIZ/602250366).

The wild card is the geopolitics, thus The Coming End of the US Foreign Investment Bubble (http://www.itulip.com/forums/showthread.php?t=252). Most of the oil is in countries on the other side of the geopolitical divide from the US. First, high oil prices finances and thus strengthens dictatorial regimes and weakens already weak democracies... Chavez, Putin, Ahmadinejad. If the US loses economic and political influence in these countries, they will raise the price of their oil money even more and the US will have to print more of dollars to pay for it, as happened in 1970s. OPEC V2.0 (http://itulip.com/forums/showthread.php?p=1085).

If this happens gradually, over a decade or more, and we are prepared for it, the transition need not be catastrophic, but it will nonetheless be economically quite painful as there are no economical substitutes for oil (http://www.itulip.com/energyandmoney.htm#PartII). If the US experiences a sudden military loss in the Middle East in the manner of the Vietnam War, the results will very likely be catastrophic. The amount of dollars we'll have to print will likely create near hyperinflationary conditions, and then -- yes -- gold will be a better than dollars to exchange for oil.

[jk]

there's a problem in getting the oil majors to further their exploration and investment. many [all?] of their contracts shift increasing revenues to host countries once certain total revenue break-points are hit. this is why the majors keep planning based on relatively low oil prices. if they assumed higher oil prices, they would also have to reduce their reserves. thus they assume low prices and can't justify more intense exploration. catch-22.

[bart]

Yet there has been a perceived change in the cost of oil... does that make it real and therefore invalidate your argument? You can't have it both ways.

I don't think its a matter of having it both ways - you're comparing apples and oranges with perception/sentiment vs. what actually is basically a view of real inflation.

Also, if folk bought real estate or copper or whatever as frequently as oil, the perception would be quite similar.

[Finster]

Also, if folk bought real estate or copper or whatever as frequently as oil, the perception would be quite similar.

This is an exceptionally important point worth expanding on. People seem to regard some price increases as positive, and others as negative, but net-net, for every buyer there is a seller and vice versa. Here in the USA we are more complacent when it is home prices rising, because we are as apt to be selling a home as buying one. What's more, many who own homes have effectively entered a paired trade on them versus the dollar - we borrowed (shorted) dollars and went long our real estate. By having the dollars decline relative to the houses - and not the other way around - we all expect to get rich.

Relatively few of us, however, are sellers of oil. We are mostly buyers and burners of the stuff. Therefore we are not such happy campers when our dollars decline relative to oil. Suddenly, the inflation that we relished when it was just our houses becomes our bane.

The free lunch of inflation isn't so free after all!

[hayfield]

On Barrick and its hedges:
http://safehaven.com/article-5689.htm