Wednesday, August 27, 2008

The King and his Gold

In his very first post on the Kitco forum, October 5, 1997, Another wrote "gold and oil can never flow in the same direction". This was a major theme in his writings. To understand Another is to understand what is going on with the gold market now. And in that spirit I have written a short story that will hopefully help you understand this first important message from Another:

Many decades ago the Saudi King realized his barren kingdom was sitting on a gold mine. Only it wasn't gold, it was oil. From his high perch as king, he was able to see the wide and very long view of the world, way off into the future. He saw a future filled with many riches, but he also knew that those oil reserves under foot were only finite cavities of value. As a king, he knew the workings of money and fiat currencies. He knew that the Western World needed his oil treasure, but he didn't want to exchange it for only paper. He wanted to turn his virtual "gold mine" into an actual pile of gold.

Back then, the paper which paid for the oil was redeemable for gold directly from the US Treasury. So there was no problem. He would take the paper and then turn it in for gold. Later, after much inflation, the US Treasury defaulted on the promise of gold. Chaos ensued for almost 10 years. The price of both oil and gold skyrocketed and there were long lines at the gas pumps. For this kingdom was only willing to trade it's finite supply of oil for an equally finite store of value, gold. And without a secured source of gold at a stable price, the oil wells just didn't have the incentive to run at peak production.

Then in the early 1980's, the markets were brought back under control. A secret deal was cut between the King and a few very high, and very powerful leaders in the West. These leaders probably included central bank chairmen and top level leaders in the US and the UK. The Western World was on it's way to world domination, both financially and militarily, but to maintain this power it needed cheap oil. The Kingdom was a good way through it's reserves of oil, and to part with this valuable commodity, the King needed the promise of an equally scarce store of value, gold. So the deal was that oil would be shipped to the West in exchange for dollars AND gold. The dollar price of oil would be kept low as long as the much more valuable gold could be had for those same low costs. The CB's involved in the deal guaranteed this to the King by backing up the deal with their own vast stores of golden bars.

But these top bankers, like the King himself, were not as dumb as they may seem. In fact, they were the best and the brightest, for they knew that the true value of gold was probably somewhere around $50,000 per ounce in today's dollars. And that was the value of oil to the King as well. His oil reserves might only last his kingdom a mere century, but if he traded it for gold, not dollars, he would enjoy the wealth of his treasure for 1,000 years or more.

The central banks that backed this deal with their own gold NEVER intended to give the King any of their precious treasure. They knew they had a way around that. By using the open markets which traded paper contracts for gold, they could keep the price of gold down to $300 per ounce and the public would be none the wiser. Then, the King with his $30 per barrel of oil could buy future gold delivery straight out of the mines in backroom deals for a premium of perhaps 100% (which is a guess). So for 20 years, vast amounts of gold flowed from the West to the Middle East for maybe $600 per ounce (twice the spot price on COMEX at the time), and those sales were hidden from the price discovery exchanges so as not to affect the price, and the oil flowed to the west freely, at the seemingly cheap price of $30 per barrel. But in reality, the King was getting one ounce of gold for 20 barrels of oil, and if gold is really worth $50,000 an ounce, that's a price of $2,500 a barrel.

So who is paying that price? In a way, all of us are. The mines are making a profit for what they pull out of the ground. They are getting twice the cost of mining. That's a good profit. But the gold in the ground under us is flowing east, while the oil in the ground in the kingdom is flowing west. So who is getting the better part of this deal? I say the King is.

Sure, we have seen unprecedented prosperity for 30 years now. But that is about to end. On the other hand, the King has seen 50 years of amazing prosperity and is looking forward to another 950 years of extreme prosperity. You see, once the oil runs out, the kingdom does not become poor. In fact, that is when the party really begins! They have sold to the West 30 or 40 years of prosperity in exchange for a thousand years of unimaginable wealth.

Then, around 1997, some big money in the Far East became aware of this bargain on gold. But they couldn't get in on the back room deals that traded large amounts of physical without affecting the price. So they had to accumulate physical on the open market which started to drive the price up. This started the 10 year rise in the price of gold..... and oil! For now that the King has to pay more for his gold, we have to pay more for his oil.

And somewhere along the way, too much physical gold was heading east, both to the desert and to the great wall, and the mines could not cover it. This threatened a default in the paper gold price discovery markets used by the Central Banks to protect their own gold reserves. So they were faced with the option of either watching the whole monetary system crash, or parting with some of their own gold. They finally had to ship some of their precious treasure to the King. After that near disaster, they fought the markets even harder, with larger and larger short positions. But now, at this very time, they (the CB's) have maybe half the gold they once had, and they have probably the largest short positions ever too. So they are standing right on the edge of a cliff, holding the end of a rope that's trying to pull them over.

It won't take much for this deal to fall apart. And when it does, we'll see the price of gold go up to probably $5,000 an ounce and then all trading will stop. No market will exist for gold at it's true value. For those that have all the gold in their possession are only buying, not selling. Oil will skyrocket too... if it flows west at all. This is coming, and soon. Buy gold. Hold gold. It only has to meet it's true price once in a lifetime and that will be more than worth the wait. I believe this is not a once in a lifetime opportunity right now, but possibly a once in the history of the world opportunity. Silver, platinum, commodities... they may all do well. But nothing will come close to the true value of gold. $50,000 an ounce may even be low.