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The U.S. Dollar-Oil-Gold Relationship

Rare Coin News

August 12, 2008 Rare Coin News Monaco Rare Coins

by Adam Crum

The U.S. dollar has become the whipping boy of world currencies and the price of oil has been the big topic of discussion for some time now. Why is oil so expensive? Are we running out of it or is someone disrupting the supply? Is there some sort of conspiracy against the United States? Some blame supply and demand; others say speculation and politicians tell us it is oil company greed. Saudi Oil Minister Ali al-Naimi has stated, “There is no justification for the current rise in prices.”

When the U.S. dollar is losing value, it is believed to be a function of low interest rates, an expanding budget and current account deficits. Oil price increases are viewed as a result of growing demand, geopolitical tensions, supply issues, speculation…AND a weak U.S. dollar.

Today, the two main reasons for the high price of oil are 1) the weak U.S. dollar and 2) the liquidity the Federal Reserve is pumping into the economy, which, in fact, helps to weaken the dollar. Pessimism on the part of the citizenry towards the dollar (even if it is only psychological) can cause the dollar to plummet even lower, which is where some experts believe the dollar is headed. And yet, the dollar bulls believe the dollar is poised to go up.

Dollar jumps, oil sinks, bond market pays the price

Because the situation is so dismal at the moment, some suggest that the only direction for the U.S. dollar is up. A few of the reasons for this belief include…

  • The dollar is undervalued. It was just before the dollar bull market in 1982 that the dollar was this undervalued compared to other world currencies.
  • The last two major U.S. dollar bear markets each lasted exactly seven years and this is the seventh year of the present dollar bear market. Starting in 1971 when President Nixon nixed the gold standard, those who believe the dollar is poised to ascend will propose the following three major dollar bear markets as proof that this will be the last year for the present cycle.
  • 1971 — 1978
    • Fed Chairman Volcker squeezes inflation.
    • Gold rises
  • 1985 — 1992
    • Tech boom begins
  • 2001 — 2008
    • Tech bubble pops
    • Credit crunch
  • Stabilized interest rates would provide support for the greenback. Treasury Secretary Henry Paulson, Jr. and Federal Reserve Chairman Bernanke have zeroed in on the dollar as a way to reduce oil prices. Stabilized interest rates would lend support to the dollar. And, rising bond yields strengthen the dollar’s position since they make bonds more attractive to investors. [Of course, rising bond yields will put pressure on mortgage rates too, which is about the last thing the struggling housing market needs at the moment.]

The dollar could remain weak or falter even more

Unfortunately there are quite a few reasons why the dollar could weaken even more.

  • First, interest rates are still out of kilter. The yield differential for the dollar against the euro is negative. In fact, when one compares the real interest rates of all the major currencies, the U.S. dollar comes in last. While the Fed may not cut interest rates any further, that doesn’t mean the interest rate differentials that currently favor other major currencies will change right away.
  • Second, the credit crunch may not be over. Because of its position among the world’s currencies, the U.S. dollar gets hit the hardest when risk increases in the global economy, so it’s too soon to say the U.S. economy is safe from the effects of the credit crunch.
  • Third, there’s the U.S. housing and mortgage crisis. U.S. Treasury Secretary Paulson stated in July that 1.5 million home foreclosures were initiated in 2007, and some economists estimate there will be about 2.5 million foreclosures initiated this year. Fannie Mae and Freddie Mac, the only two institutions thought to be big enough to save the market from further collapse now need to be propped up at a cost estimated as high as $25 billion.
  • Fourth, the United States is running a massive current account deficit funded by the rest of the world. The U.S. has been able to borrow at low rates, but there is a limit. Increasing budget and trade deficits have thrust the U.S. current account deficit to over $60 billion a month!
  • Fifth, and perhaps the most critical of all, there are big differences between previous oil crises and the oil crisis we are now experiencing. In 1973, when OPEC placed an embargo on oil to the United States for supporting Israel in the Yom Kippur War with Egypt, the reason was political. It had nothing to do with supply and demand. Ironically, the embargo prompted conservation, so that when the supply of oil was cut off a second time, it wasn’t nearly as painful for the U.S. as the time. This time OPEC took it on the jaw, because the U.S. didn’t need as much and without American demand oil prices fell.

Between 1979 and 1981, when the oil industry in Iran collapsed in the wake of revolution and the loss in output contributed to the worst worldwide recession, especially in the U.S., since the 1930s, new oil sources such as Alaska, the North Sea, Mexico and Angola were about to kick in. By the mid-1980s, oil was selling for less than $15 per barrel and because everyone believed the supply was plentiful, the price remained relatively stable. This era of cheap oil, however, created the illusion that oil would be cheap forever or at least for a long, long time.

Today, the import/domestic production ratio has reversed and the United States imports about two-thirds of its oil. Along with supply and demand, there are some other serious reasons why the U.S. is in uncharted territory.

    • Accelerating decline in net oil exports. Jeffrey Brown and others associated with TheOilDrum.com have proposed a theory called the “Export Land Model” or ELM. The ELM proposes that once a country’s oil production peaks, it will decline at a 5% annual rate at the same time that local consumption increases by 2.5%. Nine years after peak production is hit, a country’s net exports will reach zero and the one-time exporter becomes an importer. The model has proven accurate in the cases of the United States, China, Great Britain and Indonesia. For example, China has gone from being a net exporter in 1993 to importing four million barrels a day today, with those imports projected to rise another 50% over the next 10 years. Recently, the U.S. Department of Energy said the amount of petroleum products shipped by the world’s top oil exporters fell 2.5% last year, despite a 57% increase in prices. And that only means one thing: prices going much higher.

All oil reserves follow Hubbert’s Curve

A leading geophysicist in the early 1950s, M. King Hubbert, developed a predictive model called Hubbert’s Curve. The model demonstrated that all oil reserves follow a pattern spanning discovery to depletion. Production initially increases as more wells are drilled in any given oil field and newer and better technology comes online. Eventually peak output is reached and oil production not only begins to decline, it also becomes less cost effective. In fact, at some point the energy it takes to extract, transport and refine a barrel of oil exceeds the energy contained in that barrel of oil. At that point in time, drilling is no longer viable and the reserve is abandoned.

Met with great skepticism in 1956, Hubbert predicted that U.S. crude oil production would peak in the early 1970s and then decline. The prediction, in fact, was accurate. Oil production in the U.S. peaked in 1970 and has been declining ever since.

We are now depleting global reserves at an annual rate of 6 percent, while demand is growing at an annual rate of 2 percent. That growth rate is expected to triple over the next 20 years. This means that world reserves must increase by 8 percent per annum simply to maintain the status quo. We are nowhere near achieving that goal. According to Dr. Colin Campbell, one of the world’s leading geologists, the world consumes four barrels of oil for every one it discovers. Based on Hubbert’s work, oil and gas experts now project that world oil production will peak sometime in the latter half of this decade.

  • Catastrophic decline in Mexico. In April, Mexico’s oil production fell to a nine-year low of 2.8 million barrels a day, mostly because of a decline in its giant Cantarell field. According to Mexico’s Energy Ministry, at the current rate of decline, Mexico will become a net oil importer by 2016, and perhaps sooner. Mexico’s state-run oil company, Pemex, has reported its oil exports will drop about 15% below last year’s level. Mexico is America’s #3 supplier of imported oil. This is not only a crisis for Mexico; it’s a crisis for the United States.
  • Resource Nationalism on the rise. More and more countries are realizing their oil is a national treasure, and they’re starting to sell as little of it as possible at the highest prices possible. In Venezuela, President Hugo Chavez’s nationalization crusade has forced out two of the world’s largest energy companies and OPEC is preparing a “windfall” oil tax to boost its share of profits from its fields. In Russia, Vladimir Putin has brought more than half of that country’s oil industry under state control by taking properties and projects from large foreign oil companies.

Even our “good friends” in the Middle East—Saudi Arabia, United Arab Emirates, Iran, Kuwait, Iraq and Qatar—curbed their output by 544,000 barrels a day last year. At the same time, their domestic demand increased by 318,000 barrels a day (remember the Export Land Model) and their net exports dropped by 862,000 barrels. In fact, net exports from Saudi Arabia, the world’s largest oil producer, have actually dropped by nearly 1.2 million barrels since 2006.

Saudi oil executive Sadad Al-Husseini said last June: “There has been a paradigm shift in the energy world whereby oil producers are no longer inclined to rapidly exhaust their resource for the sake of accelerating the misuse of a precious and finite commodity. This sentiment prevails inside and outside of OPEC countries, but has yet to be appreciated among the major energy-consuming countries of the world.” Nationalized oil companies presently control 94% of the world’s conventional oil and gas reserves.

  • The U.S. is now in major competition with China, India, Japan and other countries for oil. There are 10 million new cars and trucks heading out for the highway this year in China and millions more joining traffic jams in India and other emerging markets. OPEC is starting to realize that because of this new demand, they need the United States a lot less than we need them. Asia is why global oil demand is growing stronger even though the U.S. economy is slowing down. In previous oil crises, a weakened U.S. economy dragged down the global economy and global oil demand. But the International Monetary Fund has projected that even with higher oil prices the global economy will grow at 3.7% this year and 3.8% next year. Oil supply is growing at 1% annually. And since the governments of countries like India, China, Indonesia and some Arab countries subsidize oil and gasoline prices, demand is also artificially high in these countries. Obviously, this means that the United States isn’t even competing on an even playing field.

Islamic law forbids the use of a promise of payment

Do you know that in 1933, King Ibn Saud demanded payment in gold for the original oil concession in Saudi Arabia? In fact, Islamic law forbids the use of a promise of payment as a medium of exchange. An example of that would be the post 1971 U.S. dollar. There is growing dissention among religious fundamentalists in Saudi Arabia regarding the exchange of oil for U.S. dollars. Russian premier Vladimir Putin and Venezuela’s president Hugo Chavez have both publicly announced that they may begin to price oil in euros in the near future. Even Saudi Arabia has stated that it is considering pricing its oil in euros, as well as in U.S. dollars. Will Arab nations one day require payment in Islamic gold and silver dinars?

Dollar falls, oil up, inflation up, coins up

The immediate cause of rising oil prices is the weak dollar as we have noted. Because the dollar is worth less, oil producers are requiring more dollars to purchase a barrel of oil today than a few years ago. But, there is much more to the story as we have seen.

The United States imports about 75 percent of its oil and owns only 2 percent of world reserves. President Bush recently stated that our country is addicted to oil. In fact, it would be more to the point to say that we are addicted to foreign oil and the majority of those foreign oil reserves are located in politically unstable and/or not particularly friendly locations.

Generally speaking, when the price of oil increases, the result is increasing inflation. Experts are now saying that

  • The price of heating oil could DOUBLE this winter and that means natural gas will be higher as well.
  • Our national power grid could be hit by rolling blackouts, since it runs partially on natural gas.
  • ome currently estimate U.S. food inflation at 9% and higher fuel costs are going to take food prices into the stratosphere. Food prices increased 43% in the past year worldwide, and the IMF estimates that about half of that is due to biofuels.

Higher oil prices are eventually reflected in virtually every finished product, as well as food and commodities and, ironically, even the highways upon which we drive. Plastic, which seems to be everywhere and a part of every thing, is dependent upon oil.

Today, there is less oil to go around as net oil exports from most oil-producing countries are decreasing and demand is increasing. AND, we aren’t coming up with any quick fixes. This is probably why Alexey Miller, the chief executive officer of Russia’s oil giant Gazprom, has predicted that oil would rise to $250 a barrel in the foreseeable future.

The next few years should be spectacular for gold.

The United States is now essentially a nation under economic siege. It has gone from the world’s largest creditor to its greatest debtor. The value of the dollar is sinking and domestic manufacturing is diminishing.

Middle Eastern oil producers may be forced to diversify their vast U.S. dollar holdings into precious metals and other currencies to protect themselves from further losses. As losses mount, other large, non-oil producing U.S. dollar holders like Japan, China, Korea, India and Taiwan would seek to diversify out of U.S. dollars as well. Eventually, this could result in a dollar sell-off and a corresponding increase in oil and gold prices.

Investment analysts have long recommended that 10% to 20% of an investment portfolio be dedicated to gold and other precious metals no matter the financial climate. In times of crisis, this is imperative.

In fact, until very recently, gold was humanity’s money of choice for some very good reasons.

  • Gold exists in a limited supply. Presently, the world’s mines produce about 2,500 tons of gold a year, while demand for gold is currently running about 4,000 tons. New demand from countries like China and India is soaring.
  • Governments can’t make more of it, so its value tends to be stable

All the conditions that led to its tripling so far in this decade are still in place.

  • The U.S. and Europe are still borrowing far more than they can ever hope to pay off and financing this debt with newly-created paper currency, unable or unwilling to grasp the inherent risks in creating paper currency in infinite quantities.
  • Oil and other commodities are still in short supply, as demand from China and India soars.
  • The financial markets are anxious about the dollar and the U.S. monetary and banking system.

If the dollar and other paper currencies continue to weaken, the world will look for alternatives, one of which will be gold. Massive amounts of global capital will start chasing a very limited supply of gold in its various forms, sending its value through the roof. We are already beginning to see this happen.

Is the nation facing an economic upheaval of frightening proportions brought on by growing federal, personal and corporate debt, too little savings, a declining dollar, high oil prices and lack of domestic manufacturing? Are we looking towards a period marked by sizeable tax hikes, loss of retirement benefits, double digit inflation?

Can we truly know what the eventual economic outcome will be? No, we can’t. However, no matter what happens, the savvy investor looks at the long term and at diversification. Long term because there will be ups and downs…often daily …wars, disasters, governmental mistakes and so on. And, because we know it is the healthiest, wisest and safest way to maintain a portfolio, diversification is essential. And, diversification means hard assets like rare gold coins.

Demand for rare coins continues to expand

There are numerous reasons why the demand for rare coins continues to expand among collectors and investors alike. They include both the aesthetic AND the financial.

  • Historical art. Since coins have commemorated heroes, great achievements and significant events throughout the history of America, an investor or collector is essentially purchasing a piece of history and a piece of art.
  • Diversification. In order to maintain diversification and overall risk, investment professionals recommend ten to twenty percent of an investment portfolio be devoted to tangible assets. And, while past performance is no guarantee of future results, it is well documented in the literature that rare U.S. coins have proven to be an excellent hedge against inflation and have generated strong long-term profits over the past thirty years.
  • Liquidity. Rare U.S. coins have become the most liquid of collectibles due to independent grading by the Professional Coin Grading Service (PCGS) and Numismatic Guaranty Corporation (NGC).
  • Tax benefits. Coins can only be taxed when profits are actually realized and there is no taxation on undistributed profits. Unlike most other investments, there is no federal income tax liability on like-kind exchanges.
  • Privacy. Rare coins can be accumulated privately and cannot be confiscated by the government during times of crisis.
  • Intrinsic value. The value of most U.S. rare coins is almost solely based on condition, demand and rarity, yet gold coins also possess the security of bullion.
  • Affordability. Despite consistent price gains over the years, quality rare coins are still affordable for the private investor.

Call one of Monaco’s account representatives toll-free today at 1-888-900-9948 to initiate or enhance the rare coin portion of your portfolio. Among other benefits, our investment professionals can:

  • Help you plan and/or review your rare coin investment strategy.
  • Ensure that your rare coin portfolio is balanced.
  • Recommend the best coins for your investment goals.
  • Keep you updated on market news, what America’s top numismatists are doing and recommending, and new offerings.

Monaco Rare Coins is a trusted leader in the rare coin collecting and precious metals investment world. We offer a unique, vast and impressive array of resources for investors and collectors alike. At Monaco, you’ll find the finest rare coins available, an experienced and knowledgeable staff of professionals ready and willing to serve your needs, and a broad range of programs and products to fit most any budget. Monaco will always make you an offer to buy your certified rare U.S. coins, even if you purchased them elsewhere.