By: Kian Mokhtari
Have you ever wondered why oil price is linked to precious metals?
The answer to the question begins with the Arab producers’ wish to receive gold in exchange for oil dating date back to 1933, when King Ibn Saud demanded payment in gold for oil concession in Saudi Arabia.
Oil, gold and commodities have all been priced in US dollars since 1975 when OPEC officially agreed to sell its oil exclusively for US dollars. From 1944 until 1971, US dollars were convertible into gold by central banks in order to adjust for any trade imbalances between countries. Once the US ceased gold convertibility in 1971, OPEC producers were forced to convert their excess US dollars by purchasing gold in foreign marketplaces. This resulted in price increases for both oil and gold: current oil prices stand at around $115 per barrel and gold recently reached $900-1000 per ounce.
Gold and oil are both finite commodities so what logic constituted the relationship between oil and gold prices?
Annual gold production is approximately $35 billion; annual oil production is $1.5trillion, by far the largest-trading world commodity. Oil price increase and demand for US dollar diversification, will create an ever-expanding number of petro dollars chasing a relatively small amount of gold bullion. With an ever-increasing US money supply, growing triple deficits and mounting debt at all levels, hyperinflation is sure to follow to blight many unprepared economies. This is while foreign holders of US dollar assets have already lost 33 percent of their investment since 2001.
Today with ‘Peak Oil’ and increasing demand from developing countries, the price of both gold and oil can be expected to increase and the US dollar to continue its decline. But what if oil goes up to $200 per barrel? Will the current oil/gold ratio hold at such levels?
Current logic of gold/oil relationship says it will, hence the world of Islam will be left with little choice other than to gain a credible foothold in the global gold market.
So the main question transmutes into how long would Arab oil producers be able to maintain US dollars as their reserve currency? And it would no longer be a matter of national political choice!
The most important of all for the world of Islam are current discussions among Arab nations about pricing oil in Islamic gold and silver dinars and creating a common regional currency.
If other producers like Russia seriously opt out of accepting US dollars for oil, demand for the currency will plummet, sending the dollar into a freefall while demand for gold and silver will soar: at which point holding local Islamic gold and silver standards will hedge the region against inflationary pressures caused by turmoil in the foreign markets.
We are now depleting global reserves at an annual rate of 6 percent, while demand is growing at an annual rate of 2 percent: with the growth rate expected to triple over the next 20 years. This means we must increase world reserves by 8 percent per annum simply to maintain the status quo, and we are nowhere near achieving that goal: the world consumes four barrels of oil for every one it discovers as things stand at present.
While the US accounts for only 5 percent of the world's population, it consumes 25 percent of the world's fossil fuel-based energy. It imports about 75 percent of its oil, but owns only 2 percent of world reserves. Because of this dependency, any increases in price or supply disruptions will negatively impact the US economy to a greater degree than any other nation.
Once a supply shortfall materializes, the US will be in competition with China, India, Japan and other importing countries for available oil and we must shield Islamic economies against the backlashes of the inevitable clash and competition for the remaining resources in our region.
At some point, the tangible decision to abandon the US dollar in favor of local gold standards and a single regional currency will have to arrive. If we in the Middle East hold the most precious and finite commodity, why should our customers possess control over the gold standards through which they can retain control over our markets?