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China’s Oil Plans Mean You Should Own Gold

There has been no lack of stories generating big headlines in recent weeks, starting with North Korea’s game of chicken with the West and followed by Hurricanes Harvey and now Irma. With respect to Korea, it remains unclear what role China is playing. The more cynical among observers – and I would count myself among them – might tend to think that China has more influence over Korea than it wants to let on and is using it as a foil to get the U.S. off the Korean Peninsula, furthering Chinese hegemony in the East. But who knows, it could be the case that China, too, is a victim of Kim Jong-un.

Through it all, geopolitical and natural storms alike, markets have held their own. Commodities, while correcting today, are doing so after having made massive gains. The same is true of the yuan, whose correction today follows what is probably the strongest rally since it began freely trading. U.S. markets have had a slight upward bias, which we think can be explained by the dramatic drop in the dollar and gains in other currencies.

But there’s one story that hasn’t made headlines in the West despite having potentially major and far-reaching implications. It was reported in the well respected Nikkei Asian Times.  As you can see from the headline “China Sees New World Order With Oil Benchmark Backed by Gold,” the gist of it is that China plans to launch an oil benchmark traded in yuan backed by gold.

If true, this is bad news for the U.S. and the dollar. If a big part of the oil market no longer is denominated in dollars, it follows that the U.S. will have to pay a lot more for the oil that it gets from the East. And if you think that doesn’t matter because we can always rely on shale, there’s even less reason to believe this to be true than before Hurricane Harvey.

I’ve always doubted that shale is the magic bullet some see it as being, since I think that on a net basis (after factoring in the energy that goes into producing oil from shale) it produces less energy than is touted. In the past week, shale production declined by close to 800,000 barrels a day, and while that’s largely explained by the effects of the storm, it’s unclear how much will come back on stream.

Returning to the story that has gotten lost amidst the turbulence, the prospect of China managing oil trading in the East with a benchmark backed by gold is a twofold blow to the US. First, it means the East almost assuredly will be the center of oil supply and demand for many years to come. Most of the developing world now lies in the East, and for the first time, the developing world is both larger than the developed world and growing much faster. These developing economies will need rising amounts of oil for many years to come. (I’m echoing here a point by Robert Rapier, editor of Energy Strategist.)

And second, the launching of an Eastern oil benchmark controlled by China and will lead not just to the ascension of the yuan but also to a massive bull market in gold. China’s plans for an Eastern oil benchmark backed by gold – and the inevitability that it points directly to soaring gold – is something I have been predicting for more than a year (as you can see from my latest interview with King World News).

I continue to believe that as these developments unfold, the counterpart to the ascension of China and the East will be very uncertain times for the U.S. and the U.S. dollar. I’m by no means predicting doom, and I think America still has time to recognize the changes occurring in the world and to adapt in ways that let us thrive side by side with China. But adapt we must.

It’s essential to recognize that China is both becoming a hegemon in the East and increasingly a co-equal with the U.S. in the world at large, which means we face a changing order. It probably means ever more trade – starting in the East and then extending beyond – will be conducted not with dollars but in a currency – not necessarily the yuan but possibly a basket of currencies – that is backed by gold. Gold has been a multi-millennial favorite of China and nothing has changed in that respect (and we don’t think it’s an accident that China’s national flag features five gold stars).

Gold has had a big run recently, and it could pull back from current levels. After all, when it comes to the development most guaranteed to propel it powerfully upward, i.e., China’s establishment of an Eastern oil benchmark, for now we have just a story in a newspaper, one that happens to accord with my longtime thinking. Until it is translated into reality, however, gold could fluctuate, likely with an upward bias.

But I do believe it’s inevitable that a gold-backed oil benchmark will serve as a steppingstone to China’s complete hegemony over trade in the East. Just today, lending further support to this outlook, was the report that a Chinese conglomerate has taken an ownership position in Russia’s largest oil company, Rosneft (MCX: ROSN). This complements recent financial dealings between China and Saudi Arabia. Noteworthy is that these transactions between China and the two largest oil producers in the East, in fact in the world, very likely were denominated in yuan.

We’re by no means saying you should sell your favorite stocks in exchange for gold. But I urge all investors to own some gold, indeed, as much as they’re comfortable acquiring. And believe me, this isn’t because I’m some kind of gold bug, i.e., someone who always believes gold is headed up. Rather this is a rational recommendation based on my best analysis of events and their underlying realities. So far this century gold, by a wide margin, has outperformed other assets. There’s every reason to expect that this dramatic out-performance not only will continue but will accelerate.

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