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Gold and Oil Price Limits

James West
jwest@midasletter.com
www.midasletter.com
May 14, 2008

Now everybody’s getting crazy in the price forecasting side of things. Increasingly, in an effort to draw attention as contrarian prophets, tout sheet vendors around the world are making price calls on oil and gas that while possible, are not likely. There are very real market factors that limit the heights to which any commodity price can soar.

And whereas we are living through a period of commodity hyper-inflation, these new records across the board in pretty much everything except coffee (which may very well be next) lack one common characteristic of any such event that we ultimately and in retrospect refer to as a “bubble”.

In the cases of the last three bubbles that we’ve witnessed the implosion of this decade, all three suffered from an excess of supply in the face of diminishing demand. The internet technologies of 2000 were over-invested in to the point where broadband was selling for less than it cost to run.

The real estate bubble and the credit bubble, inextricably linked, more or less collapsed together. The excess of credit caused an excess of supply real estate-wise, the fallout from which we are still only starting to feel the pain of, rosy forecasts from the mainstream notwithstanding. When the derivative possibilities of every credit configuration imaginable had been spit shined and rolled out among dopy institutional investors, the jig was up, and internet pages with the words “food riots” have multiplied by a factor of at least a million.

Both gold and oil, in direct opposition to these “bubble” markets, though not closely linked in terms of their effect on each other’s prices, nonetheless share a common differentiator that will ensure their exclusion from the bubble club membership for the foreseeable future. Namely, supply of both of these cannot easily be increased, and so therefore we are witnessing diminished supply relative to consumption of these core commodities.

Believe what you will, if every talking head in a suit out there agrees that gold is a “safe haven” investment when currencies start to emit the scent of a most unpleasant perfume, its money. The only way we will ever see a reduction in global demand for money is if the population of human beings collapses dramatically (an inevitability, at some point in geo-time scale, considering the finite essence of all things), or we suddenly come up with a range of technologies that miraculously feed, clothe and house the whole planet to their heart’s content. Neither event likely to occur in anyone old enough to read’s lifetime.

Unlike gold, oil is consumed finally, its role as an energy carrier completed once and for all upon combustion. While we still have billions of barrels locked up in everything from shale to sand to tires, the costs of extraction to some degree negate the supply side possibilities. Gold, theoretically, is never lost, but only recycled. The exception is the minute (relatively) quantities lost to ablation – the incrementally-eroded- through- wear portion – and the dental inventory safely slumbering in the mouths of un-exhumed relatives beneath our feet in quiet neighbourhoods.

With this in mind, it is forgivable to mistakenly presume that a limited supply under pressure from growing and never ending demand might result in an terminally steep upward price trajectory, but I beg to differ.

In the case of oil, for example, one need only ask one’s self, “At what price gasoline-per-gallon do I join the 95% of the planet’s population that can’t afford to drive?”

There is a figure, no matter how rich you are, that you can arrive at. So there’s the rub: With every dollar increase in the price of gasoline, fewer drivers are starting the car, and are electing instead for the bike, horse, or feet. Therefore, there is a point in the not-too-distant-future where the diminishing demand will fall below the available supply, and that is the point (in a perfect world) where the price of oil would peak, and start to fall. Thanks to the massive Perception Management Machine, popularly known as “journalism” under contract to the governments and bankers who collude daily to fleece Joe Average, the real peak will probably arrive much later, allowing the perpetrators of (what will then become) the bubble to profit by shorts and bankruptcies all the way back down again.

That, I predict, will be the terminal point of the Petroleum Age, because co-incident with the impoverishment of the nation through unaffordable transportation, and compounded by an urban design mentality (or utter lack thereof) where a one hour commute by car is considered normal, there will be a rather prolonged period of a famine of sorts, because who will be able to afford a loaf of bread that costs $25 per kilometer just to ship?

At this point, civil unrest will prompt government to bite the bullet and jump on the alternative fuel technologies bandwagon with genuine gusto, so the benefit to humanity will be, at long last, the mass adoption of cleaner fuels and technologies so our children and theirs will hopefully be able at least to breathe.

The unfortunate, but nevertheless un-mourned victim of this will petroleum, and the price of all its by-products. Hydrocarbon-based plastics will be replaced by natural glycogens from clean energy production, and the tenaciously-trapped over-priced oil in shales beneath the Rocky Mountains will be permitted to rest in peace, their hydrocarbon content no longer of sufficient value to extract.

Thank God…necessity is indeed the mother of invention.

But getting back to gold. Now there’s a tough one to figure out. With every collapsed currency, a new generation of bankrupts appreciates profoundly the inherent value of gold. There is no conceivable replacement, because there is no substance that can stand up to the scrutiny of history and maintain its appeal as the Ultimate Store of Value.

At  what point does the price of gold thwart desire of its possession? Contrary to oil, for every dollar gold rises in value, the more precious a metal it becomes, both to brides and bankers. Is it conceivable that future generations will purchase with un-batted eyes an ounce of gold for ten thousand, twenty thousand…or even one hundred thousand dollars?

What might diminish the universal desire to possess wealth in the form of gold? To that question I can fathom no answer, except the drastic ones earlier suggested. In the context of these deliberations, $2,000 gold is an easy call.

James West
jwest@midasletter.com
www.midasletter.com
May 14, 2008