THE REAL COMMODITY STORY / MACLEOD FINANCE

The real commodity story

Pricing commodities in dollars is false. Changes in the dollar’s own value are not being considered. The best valuation is in gold, which as real money retains its purchasing power.

Alasdair Macleod

The chart above illustrates the point. 

Under the Bretton Woods gold standard when the US dollar was exchangeable between central banks and governments at $35 for an ounce of gold, oil prices were remarkably stable. 

Originally fixed at $2.57 per barrel and 2.8829 barrels per gold gramme in 1950, it only rose to $3.56 per barrel and declined to 2.58 barrels per gold gramme when the Bretton Woods agreement was finally abandoned and the dollar became a fiat currency.

Even that small decline measured in gold can be laid at the door of increasing dollar instability, leading to the establishment and failure of the gold pool in the 1960s which was an attempt to contain a run on the dollar.

Following the abandonment of Bretton Woods, the oil price became extremely volatile, with the price rising to over $70 today, a multiple of over 27 times the 1950 oil value. 

Meanwhile, priced in gold, oil is only 26% of its post-war value.

This matters, because the decline of the dollar’s purchasing power and its volatility is unquestionable. 

As real legal money in everyone’s common law, we know that gold retains its purchasing power over decades, centuries, and even millennia. 

This is not to deny that it will fluctuate due to natural factors, economic cycles, and government interventions.

In the big sweep of history, none of these factors matter, and gold’s purchasing power for commodities always corrects towards a long-term norm. 

In the chart above, given that priced in gold oil was remarkably stable for over 20 years until 1971 when Bretton Woods was abandoned, we are entitled to assume that this should be oil’s long-term value. 

In which case, for it to lose 74% of its long-term value by today is clearly an aberration.

Critics of this approach will argue that gold itself is volatile, as demonstrated by its dollar price rising by over 80% in the year to date. 

But this misses the point: the volatility is not in gold but the fiat currency.

The next chart shows oil priced in gold to reveal how depressed oil prices in real terms have become.

The monthly average value is 96, close to the base value of 100. 

At 26, to return to that average suggests that priced in gold oil should rise nearly 300%. 

That would be the equivalent of $200 in today’s fiat dollars.

This is not a forecast, merely an illustration of the pricing distortions over time imposed by the fiat dollar on the most important energy and petrochemicals source for mankind. 

It also assumes constant values for the dollar, which are clearly not possible. 

Other MacleodFinance articles have demonstrated why the dollar’s purchasing power is now declining at an accelerating rate relative to gold. 

That being the case, the dollar price of oil should go considerably higher than $200 per barrel, a move which might be being triggered by the conflict against Iran.

But that is a different story, merely affecting timing. 

The point is that we can expect oil prices to go much higher, measured in fiat dollars.

Oil is not alone. 

The next chart is of a basket of base metals:

This basket is valued at only 19% of its long-term value using the methodology for oil. 

And already, despite reports of ample global stocks, we have seen the price of copper rise in dollars, while it collapses measured in gold:

Similar stories can be told in other commodity baskets. 

The message from what will undoubtedly be described as a major commodity bull market or a cyclical event, is that it is neither of these. 

It is simply an unwinding of cumulative fiat currency driven distortions coinciding with further declines in their purchasing power. 

So far, no one in the mainstream financial sector expects substantially higher commodity prices, though the US war against Iran is something of a wakeup call.

When they do wake up to it, macroeconomists will revise their forecasts of inflation, most probably by not nearly enough. 

It is likely to hit the dollar and attendant currencies hard later this year.