Grant Williams pieced together
some of the same things I did in my Russia piece which you
ran last April, about why the Russians are buying gold (when
economists are advising them to sell it) and why Russia’s
balance sheet is in great shape compared to those of Western
nations. The ruble’s recovery still confounds the mainstream!
But Grant takes the analysis a step further to show that
oil may be trading in gold terms again, tying its price
action to the proposed Shanghai crude oil futures contract
(which has been delayed) and the Shanghai gold market. When
that oil futures contract goes live, basically the countries
that have been cut out of the USD-based financial system
by sanctions will be able to sell oil for gold in Shanghai.
This will be a very big deal, and few mainstream economists
will understand why! No one knows the timing, of course,
but it’s certainly worth watching because it’s an important
piece of the geopolitical and financial puzzle.
From Zero Hedge:
In December, Grant Williams, author of “Things
That Make You Go Hmm…” offered the most comprehensive analysis
yet of the rise and inevitable fall of the petrodollar (and
implicitly US hegemony). In the following presentation,
from Mines & Money Conference in London in December
2016, Williams focuses on gold’s performance in 2016, the
reaction to Donald Trump’s election and joins a series of
dots that may lead to the end of the petrodollar system
and a new place for gold in the global monetary system.
Why are the most advertised Gold and Silver
coins NOT the best way to invest?
Grab a glass fo wine – turn off Trump’s
twitter feed for 30 minutes and enjoy. Here is the full
presentation – “Get It. Got It. Good”
The story begins in the 1970s when Henry
Kissinger and Richard Nixon struck a deal with the House
of Saud — a deal which gave birth to the petrodollar system.
The terms were simple The Saudis agreed
to ONLY accept U.S. Dollars in return for their oil and
that they would reinvest their surplus dollars into U.S.
In return, the U.S. would provide arms and
a security guarantee to the Saudis who, it has to be said,
were living in a pretty rough neighbourhood. As you can
see, things went swimmingly (chart below)
Saudi purchases of treasuries grew along
with the oil price and everyone was happy. (We’ll come back
to that blue box on the right shortly)
The inverse correlation between the dollar
and crude is just about as perfect as one could expect (until
recently that is… but again, we’ll be back to that).
And, as you can see here, beginning when
Nixon slammed the gold window shut on French fingers and
picking up speed once the petrodollar system was ensconced,
foreign buyers of U.S. debt grew exponentially.
Having the world’s most vital commodity
exclusively priced in U.S. dollars meant everybody needed
to hold large dollar reserves to pay for it and that meant
a yuuuge bid for treasuries. It’s good to be the king.
By 2015, as the chart on the next page shows
quite clearly, there were treasuries to the value of around
6 years of total global oil supply in the hands of foreigners
(if we assume a constant 97 million bpd supply which I think
is a pretty reasonable estimate).
Now… with that brief background on the petrodollar
system, here’s where I need you to stick with me. I promise
you it’ll be worth the mental effort
Ready? Here we go.
Now, back in 2010, then-World Bank President
Robert Zoellick caused something of a commotion when he
suggested that an entirely new global monetary system maybe
wasn’t such a bad idea.
The system he had in mind involved a freely-convertible
Yuan and, controversially was constructed around gold as
its central reference point:
(Robert Zoellick, November
8, 2010): …the G20 should complement this growth recovery
programme with a plan to build a co-operative monetary system
that reflects emerging economic conditions. This new system
is likely to need to involve the dollar, the euro, the yen,
the pound and a renminbi that moves towards internationalisation
and then an open capital account.
The system should also consider employing gold as an
international reference point of market expectations about
inflation, deflation and future currency values. Although
textbooks may view gold as the old money, markets are
using gold as an alternative monetary asset today.
In seemingly unrelated news, two years later,
Iran began accepting Yuan in payment for its oil amid US
sanctions. The transactions were conducted through Russian
(Financial Times, May 2012): Iran is accepting
renminbi for some of the crude oil it supplies to China…
…Tehran is spending the currency, which
is not freely convertible, on goods and services imported
The trade is worth as much as $20bn-$30bn
annually according to industry estimates…
The renminbi purchases began some months
ago…much of the money is transferred to Tehran through
Russian banks, which take large commissions on the transactions…
Beijing has been trying to get its trading
partners to use the renminbi, in effect transferring the
exchange rate risk to its counterparties, since the price
of crude is set in US dollars. It also frees Beijing of
the need to hold as many dollars in its reserves.
The crucial part of this
deal was that, by diversifying their purchases in this way,
the Chinese had found a path towards not only needing to hold
fewer U.S. dollar reserves, but to circumventing the petrodollar
By 2013, the penny had clearly dropped at the PBoC who
declared an end to the era of their accumulation of U.S.
2013): The People’s Bank of China said the country does
not benefit any more from increases in its foreign-currency
holdings, adding to signs policy makers will rein in dollar
purchases that limit the yuan’s appreciation.
“It’s no longer in China’s favor to accumulate foreign-exchange
reserves,” Yi Gang, a deputy governor at the central bank,
said in a speech organized by China Economists 50 Forum
at Tsinghua University yesterday. The monetary authority
will “basically” end normal intervention in the currency
market and broaden the yuan’s daily trading range
Yes, it was, apparently
“no longer in China’s interest” to accumulate foreign exchange
Sure enough, in 2014, global FX reserves began to decline
at the fastest rate in 80 years as you can see from this
That same year, another piece of the puzzle
was laid in place when Xu Luode, the Chairman of the newly-founded
Shanghai Gold Exchange, explained that gold would be priced
and sold in Yuan as a step towards what he called the “internationalization
of the renminbi” (for those of you confused by Yuan and
Renminbi, just think of them as the Chinese equivalent of
‘Pound’ and ‘Sterling’):
(Xu Luode, Speech to
LBMA, May 2014): Foreign investors can directly use offshore
yuan to trade gold on the SGE international board, which
is promoting the internationalization of the renminbi…
Shanghai Gold will change the current gold market “consumption
in the East priced in the West” situation.
When China will have a right to speak in the international
gold market, pricing will get revealed…
Interestingly, Luode acknowledged what he accurately
described as the “consumption in the East, priced in the
West” situation and assured the world that the ‘real’
price of gold would become apparent once China took its
rightful place at the centre of the gold market.
We can but hope he is correct.
When that day comes, the change on the world’s gold markets
will be unprecedented.
In 2015, another announcement slipped by the world when
it was revealed that Russia’s Gazprom would also begin selling
oil to the Chinese in exchange for yuan and that they were
negotiating further agreements to use rubles and yuan to
settle natural gas trading directly, without the need for
(Moscow Times, June 2015):
“Two state energy companies, gas producer Gazprom and its
oil arm Gazprom Neft, said they would use more Chinese currency
in trade, while Russia’s largest bank, Sberbank, has also
promoted the use of the yuan…
Gazprom Neft announced that it began
settling shipments of oil to China in yuan. And previously,
the head of Gazprom, Alexey Miller, said in a TV interview
that the company was negotiating with China to use yuan
and rubles for gas deliveries via a planned pipeline in
OK… hands up if you’re still
with me… great!
Oh… you’re reading this so I can’t see you but hopefully
you’re following the dots…
For those of you who aren’t, here’s a little recap of where
we are so far to help you get things into the right order
before we push on to the end:
Get it? Got it? Good.
So… here we are, in 2016 and, as it turned
out, April was a hell of a month if you were paying attention.
Firstly, the Saudis threatened to sell almost
a trillion dollars of U.S. assets—including over $300 billion
of treasury bonds—should a bill be passed by the congress
allowing the Saudis to be held responsible for the 9/11
NY Times, April 16, 2016):
Saudi Arabia has told the Obama administration and members
of Congress that it will sell off hundreds of billions of
dollars’ worth of American assets held by the kingdom if
Congress passes a bill that would allow the Saudi government
to be held responsible in American courts for any role in
the 9/11 attacks.
Adel al-Jubeir, the Saudi foreign minister,
delivered the kingdom’s message personally last month
during a trip to Washington, telling lawmakers that Saudi
would be forced to sell up to $750B in treasury securities
& other assets in the US before they could be in danger
of being frozen by American courts.
In a rare show of bipartisanship,
the bill was subsequently passed before being vetoed by President
Obama who then had to watch in ignominy as he suffered the
first veto override of his presidency.
Just days later, the Saudis were the cause of a seemingly
surprise failure by OPEC to agree a production cut as the
oil price languished in the low-$30s:
(Wall Street Journal,
April 17, 2016): DOHA, Qatar—Oil producers that supply almost
half the world’s crude failed Sunday to negotiate a production
freeze intended to strengthen prices.
The talks collapsed after Saudi Arabia surprised the
group by reasserting a demand that Iran also agree to
cap its oil production.
Oil prices had rallied in recent weeks on speculation
that Saudi Arabia might successfully lead an initiative
between members of the Organization of the Petroleum Exporting
Countries and Russia, which joined the talks.
A deal would have marked a new level of cooperation
between non-OPEC countries and OPEC members that producers
hoped would keep prices above January lows of $26 a barrel.
Just 48 hours after that surprise, the Chinese
finally launched their twice daily gold fixing, setting
the price at 256.92 yuan per gram:
(Bloomberg, April 19,
2016): China, the world’s biggest producer and consumer
of gold, started a twice-daily price fixing on Tuesday in
an attempt to establish a regional benchmark and bolster
its influence in the global market.
The Shanghai Gold Exchange set the price at 256.92 yuan
a gram ($1,233.85 an ounce) at the 10:30 a.m. session
after members of the exchange submitted buy and sell orders
for metal of 99.99 percent purity.
“This is a very important development and will obviously
closely watched,” said Robin Bhar, an analyst at Societe
Generale SA in London. “But as long as it exists inside
a closed monetary system it will have limited global repercussions.
It could be a very important development if the new benchmark
is a precursor to greater use of gold in the Chinese monetary
system, Kenneth Hoffman…said by e-mail on Monday. It may
also boost interest in the Shanghai free-trade zone, he
As Soc Gen’s Robin Bhar correctly identified,
if the ability to trade gold for yuan exists within a closed
monetary system, its importance will be limited BUT, as
Bloomberg’s Ken Hoffman also correctly pointed out, if this
was the thin end of the wedge, things could get very interesting
indeed. Now, this chart shows the oil price going back to
before the U.S. Civil War:
Between 1865 and 1973, the price of oil
was incredibly stable against a backdrop of perhaps the
greatest simultaneous economic, demographic and technological
expansion in human history.
How was that possible?
Well simply put, because oil was effectively
priced in gold.
Once the gold window closed and the petrodollar
system was implemented, the price of oil soared 50-fold
in just 35 years.
The move on the right? With the question
mark against it? We’re getting there, I promise.
Now, you remember this next chart and the
yuuuuuge supply of treasuries which exists compared to oil
now? Well, when we add in the roughly $100 trillion in boomer
entitlements that will need to be paid for by issuing—you
guessed it, more treasuries—the chart changes somewhat:
That red circle down at the bottom of the
second chart is the spike you see on the first chart.
It’s safe to say that, relative to even
oil, and without any infrastructure spending by Donald Trump,
treasuries are going to be…. abundant in the coming years.
Conversely, if we look at the value of gold
relative to foreign-held treasuries, we see an altogether
different story unfold.
During Reagan’s presidency, US treasuries
were backed 132% by the market value of the country’s gold
Today, that number has fallen to just 4.7%
If we do the same thing and account for
the $100 trillion in entitlement promises, as you can see
from the chart on the next page, the number falls to 0.3%
So the second chart (below, right) should
come as no surprise to anybody.
Yes, the Chinese have started to do what
they promised to start doing, when they promised to start
Now, this next part of the presentation
was a rattle through a whole bunch of charts showing the
recent activity in the U.S. treasury, corporate bond, agency
bond and securities markets so you’ll have to brace yourself.
The charts will appear on the next page.
Chinese sales of US treasuries (1) have
been consistent for the last three years…
…as have their sales of US securities (2)
since 2015 after plateauing in 2013 when treasury divestiture
began Concurrently, Chinese sales of corporate bonds (3)
have accelerated over the same period…
…though agency sales (4)—despite a few periods
of consistent selling—have yet to follow suit.
But now, as tensions rise and the cross-currents
get harder to discern, guess who else has showed up as a
That’s right, the Saudis are now steady
sellers of US treasuries (5)…
…and even more aggressive sellers of U.S.
Meanwhile, taking a broader view, net foreign
purchases of treasuries, according to the TIC data, have
been in a clear downtrend since 2009 (7) and have been largely
outflows for the last three years.
If we look at the 12-month sum of sales
(8), we see an even sharper decline…
…and if we take the trailing net official
demand chart for treasuries back to 1979, the scale and
extent of the change is evident—as are the catalysts for
the acceleration (and we’re back on this page once again):
Take a long, hard look at that
last chart folks—particularly within the context of the
bond bull market and the ‘bid’ for treasuries we’ve seen
throughout 2015 and 2016…
Meanwhile, the Russians—who,
as we’ve seen are now selling oil for yuan to the Chinese,
remember?— have been picking up the pace of their accumulation
of gold reserves yet again, with the most recent monthly
data setting yet another record…
…and the pick up in pace is
evident when we look at average monthly purchas
prior to 2013 and post the
agreements put in place around that time between the various
parties. Now, the next chart (top of the following page)
is crucial to understand because a look at the market value
of Russia’s gold reserves shows just how crucial their ongoing
accumulation of bullion has been for the country’s finances
over the last two years…
…and that increase in value has cushioned
the effects of, amongst other things, the bailing out of
As you can see from the green line, Russia’s
gold reserves in Ruble terms have soared as the country’s
currency has weakened—something which confounded all the
doommongers who called Game Over for Russia amidst sharply
declining oil revenues:
(Bloomberg, April3, 2015):
Here’s why Governor Elvira Nabiullina is in no haste to
resume foreign-currency purchases after an eight-month pause:
gold’s biggest quarterly surge since 1986 has all but erased
losses the Bank of Russia suffered by mounting a rescue
of the ruble more than a year ago.
While the ruble’s 9 percent rally this
year has raised the prospects that the central bank will
start buying currency again, policy makers have instead
used 13 months of gold purchases to take reserves over
$380 billion for the first time since January 2015.
Now, crucially, being given the ability to sell oil to
the Chinese for yuan and buy gold with that same yuan directly
through the Shanghai Exchange has completely changed the
game for the Russians and those changes are being reflected
where they matter most—in the energy markets, the supply/
demand dynamics of which are quietly morphing in plain sight.
By Augu of this year, Russia had overtaken Saudi Arabia
as the largest exporter of oil into China…:
(Al Awsat, August 3, 2016): During the
first seven months of this year, China imported about
30.5 million metric tons of Saudi oil, a 0.4% decrease
than that of last year. Whereas, China imported about
29.5 million metric tons of Russian oil with 27% increase
than last year.
…and that wasn’t something the Saudis could
take lying down:
Amid this fierce competition, it is important
for Saudi Arabia to fortify its oil position in China
with more political and strategic support
On the contrary, they rededicated
their efforts to increase what they call “political and strategic
support” for China.
Now, I hope you’re all still with me because here’s where we
get to the final piece of this glorious puzzle—the piece
that ties all these seemingly unrelated threads together:
China’s own crude oil futures contract, to be priced in
Yuan and traded at the Shanghai International Energy Exchange—a
yuan contract which will be made fully convertible:
5, 2015): By the end of 2015, China, the world’s No. 1 oil
importer as of April, may start its own crude futures contract.
The idea is to establish a Chinese rival to the world’s
two most traded oil contracts: West Texas Intermediate,
housed on the New York Mercantile Exchange, and Brent
Crude Futures, owned by ICE Futures Europe in London.
The yuan-based contract will trade on the Shanghai International
Energy Exchange and will be among the first Chinese commodity
contracts available to foreign investors as China promotes
global use of its currency…
Participation will be open to all foreign investors
and the yuan will be fully convertible under the contract,
according to Song Anping, the chairman of the Shanghai
As you can see from the
date of the article, this contract has been postponed several
times— ostensibly for reasons such as stock market volatility
in China, but perhaps there is more going on behind the scenes
that is causing the delay because, once this contract is in
place, things change.
In the interim, China has supplanted the U.S to become
the world’s biggest importer of oil, which serves to increase
both its importance in the oil markets and the likelihood
of it launching its own yuan-denominated contract at some
point in time:
(Bloomberg, October 13, 2016): China is
now the world’s biggest oil importer, unseating the U.S.
The country’s crude imports climbed to a record 8.08 million
barrels a day in September, a year-on-year increase of
18 percent, customs data released Thursday showed.
So, the world’s largest
exporter of oil is now dealing with the largest importer directly
in yuan and it has the ability to convert those yuan proceeds
into physical gold through the Shanghai exchange— which the
data suggest it is doing as fast as possible.
Currently, the bilateral oil for gold trade is only available
to what the U.S. would no doubt consider a ‘basket of deplorables’
in Iran and Russia…but just think what happens once that
fully convertible oil contract is up and running…?
Suddenly, the availability to price oil in gold is available
to everybody and, given rising Saudi/U.S. tensions and the
Middle East nation’s recent rededication to providing “political
and strategic support” to China it’s easy to see why this
would be attractive to the Saudis, for example.
Whatever happens, opening that contract
creates a market-wide arbitrage opportunity which affords
anybody with oil to sell the ability to exchange said oil
for gold and anybody wanting oil to acquire it cheaply by
buying cheap gold in the West and shipping it to Shanghai
or HK where it can be sold for yuan.
Already, places like Tokyo, Seoul and Dubai
are opening physical gold markets and discussing linking
their nascent markets for bullion to the Shanghai exchange
which has rapidly become the largest physical delivery market
in the world.
Now, were this arbitrage to begin happening
in any meaningful size, with the market for oil far bigger
than that for gold, it would immediately be evident in the
ratio between the two commodities…
…which, interestingly, is precisely what
has happened since the peak of global reserves in 2014 and
the Sino-Russian agreement to essentially transact oil for
gold. With those conditions in place, the gold/oil ratio
has broken out to its highest level in 80 years (chart,
…which brings us right back to the question
mark on the second chart which we left hanging like a matzah
ball earlier in this presentation
The recent move in the oil price looks to
me suspiciously like a sign that a move has started to return
to pricing oil in gold.
That move, if indeed it is happening beneath
the surface, allied with the endless possibilities enabled
by the potential full convertibility of the yuan under the
Shanghai-based oil contract leaves oil producing nations
with a rather obvious choice for the first time in almost
half a century—a choice made perfectly clear by the two
charts on the next page:
If you are an oil producing country, do
MINIMIZE your production in order to MAXIMIZE
your holdings of one of the most abundant and easily-produced
commodities in the world—U.S. treasuries—as has been the
case for the last 40 years… knowing full well that, with
the level of entitlements due in the next decade, more will
need to be printed like crazy?
Do you MAXIMIZE production in order to gain
the largest possible market share in the biggest oil market
in the world and, through the ability to buy gold for yuan,
thereby maximize your reserves of a scarce, physical commodity
which is impossible to produce from thin air and which happens
to be not only the most undervalued asset on the planet,
but is trading at its most undervalued relative to U.S.
treasuries in living memory?
With an annual production of $170bn, gold
is by far the largest metal market by value.
However, that figure is dwarfed by the oil
market which is 10x the size of the gold market on an annual
If we throw in the average annual foreign
holdings of U.S. treasuries over the last 2 years, we see
that the ‘other’ commodity is at a different magnitude altogether.
So, which one of these commodities has any
scarcity value? Given the choice, which one would you seek
to maximize your holdings of?
U.S. treasuries which can be conjured out
of thin air by the U.S. government and which, are described
thus by The Securities Industry and Financial Markets Association:
Because these debt obligations are backed
by the “full faith and credit” of the government, and
thus by its ability to raise tax revenues and print currency,
U.S. Treasury securities – or “Treasuries” – are generally
considered the safest of all investments. They are viewed
in the market as having virtually no “credit risk,” meaning
that it is highly probable your interest and principal
will be paid fully and on time.
Or how about oil? Which the Saudis, for
example, can simply print pull out of the ground at will
at a cost of a little under $10/barrel?
Or gold? A commodity which is limited in
availability, trading at its all-time low relative to U.S.
treasury supply and is not only getting harder and more
expensive to produce, but which is also catching the eye
not only of the central banks of the world’s two largest
producers, but of the largest importer and largest exporter