Oil, Gold, and the Illusion of Paper Wealth

February 7, 2000

I had planned to send this on February 3, but a computer virus shut down my secretary’s computer.  She could not post it.  Given what has happened to gold since I write this, I think it will make a lot more sense.  I am very sorry that it’s late.

Digits are the basis of the modern economy.  Digits represent wealth, but they also represent debt.  Today’s prices are based on expected future returns, discounted by the interest rate.  They are also based on men’s belief that a greater fool will buy an asset that cannot rationally be priced as high as it is priced today.

Numbers represent the real world.  They also shape the real world.  There is feedback back and forth.  But when numbers in free markets depart from what appear to be the objective facts of the real world, then there has to be an explanation.  Maybe the facts are wrong.  Maybe the buyers and sellers are caught up in a mania.  Maybe the market is rigged.


The world, we are told, runs on information.  So it is.  But information doesn’t warm the house or power the car.  Energy does.

The increase in the price of oil in the second half of 1999 was spectacular.  Yet an increase to about $30 was predicted in a July report by  Dr. Colin Campbell, who spoke to an All-Party Committee of Britain’s House of Commons.  He said it would take place in 2001 or earlier. Much earlier, as it turned out.

This report appears, appropriately, on www.hubbertpeak.com.


Hubbert is not a familiar name to most people.  M. King Hubbert was a man who believed in charts.  He once produced a chart on the increase in the number of professional journals over the last two centuries.  The curve in 1960 was becoming exponential.  I cited that chart decades ago, although I can’t recall where.

But his more intriguing charts had to do with oil depletion.  In 1956, he predicted that oil production in the U.S. would peak sometime around 1970.  He was not taken seriously in 1956 or even 1970.  I recall an economist’s book on oil production issued by a university press in 1970 or 1971 that forecast $1 oil.  This forecast sank into the academic tar pit in 1973.  The OPEC price hike buried it.

In 1974, he predicted that world petroleum output would peak around 1995.  His forecast here was not quite so accurate, although it has been reasonably close.

I am no fan of his monetary theory, interest rate theory, and his theory of the ever-declining work week. But I do not argue with his forecasts on oil production.

Neither does Dr. Campbell.  In his presentation to the Commons committee, he outlined a theory of oil reserves. He thinks that they are basically fixed — a matter of geology.  Oilfields were produced under rare circumstances. Modern technology has advance considerably, letting us identify these fields.   “The world has now been very thoroughly explored with the benefits of this new understanding and the high resolution seismic surveys. About 90% of the world’s oil endowment lies in just 30 major petroleum systems. . . . All the promising areas have been thoroughly explored.”

He argues that when an oil discovery curve for an oilfield region becomes flat, the exploration will end. The same is true for oil companies.  He provides charts for Shell and Amoco.  “The point is that all discovery curves are flattening. . . . Discovery peaked in the 1960s with a 60 G [Giga = billion] b[arrel] surplus.  But that has given was to a deficit of almost 20 Gb.  We now find one barrel for every four we consume.”

Yet the public is unconcerned.  “The general situation seems so obvious.  Surely everyone can see it staring them in the face.  How can any thinking person not be aware of it?  How can governments be obvious of the realities of discovery and their implications?”

But aren’t there stable or increasing oil reserves today?  No.  There is statistical deception going on. Companies usually under-report reserves when a new field is discovered.  So do OPEC countries, whose quotas are tied to oil reserves.  These reserve figures should be backdated. If they were, this would have major implications on the discovery charts.  They would be flattening.

Prudhoe Bay’s depletion curve has been flat since 1991.  It will barely make the original 1977 estimate of 12.5 Gb, which was downgraded officially to 9 Gb.

What we have experienced is a growth of reporting, not a growth in oil reserves.

Today, half of the world’s known oil reserves are in five Middle East countries.  They hold the hammer.  He thinks they will be using it soon.

There is a discovery/production relationship for newly discovered fields.  Production peaks at the halfway point. In the U.S.A.’s lower 48 states, discovery peaked in the 1930’s and production peaked in 1971.  In the North Sea, discovery peaked in 1980 and peak production seems to have been reached.

The Middle East will have to make up any deficit: the hammer.  Campbell calls this “swing share.”  Swing share rise to 38% in 1973, just before the OPEC oil embargo.  It fell to 18% in 1985 as a result of North Sea oil.  Oil prices fell.  As of mid-1999, the Middle East’s swing share was back to 30%.

“This time it is set to continue to rise because there are no new provinces ready to deliver fresh production, save perhaps the Caspian and that seems to be turning sour.”

He thinks the swing share will hit 35% in 2001.  “The Middle East countries will then have the confidence to impose much higher prices, realizsing that they have no competition.  They may even get such confidence sooner.” Norway’s production is set to halve by 2006.  Norway is the world’s second largest exporter.

“I think prices might briefly soar to very high levels. . . .”  Also, “I think demand does become elastic above about $30/b, reacting to normal market forces, so higher prices may curb demand.”

The price reached $29/b before 2000 rolled over.

“But I expect that somehow a plateau of production, however volatile, will unfold around $30 a barrel.  But the end of this plateau will soon come into sight.”  He thinks it will hit in 2008, when swing share is 50% and Middle East countries will be approaching their depletion midpoint.  Production will then drop by 3% per year.  An additional 500 Gb of reserves would delay this by only a decade.

“One indisputable fact stands out.  Discovery peaked 30 years ago.  It takes no feat of intellect to conclude that we now face the corresponding peak of production.”

The balance of power will shift to the Middle East. Western monetary authorities will not be able to halt this shift.  Maybe military forces will, but I doubt it.

Paper assets are fine if all you want in exchange is another paper asset.  The profitable exchange of paper — digits — is the basis of the financial euphoria today. But digits that do not represent underlying productivity are illusionary.  This is Warren Buffet’s message, and it is also Colin Campbell’s.  Look deeper to discover reality, says Campbell: about 10,000 feet or so.

So does John Hathaway.


As an old-time defender of gold coins and 100% reserve warehouse receipts to gold coins as an appropriate currency unit, I have watched investment gold bulls come and go — mostly go.  Today, John Hathaway is my favorite gold investor bull.  He makes a great deal of sense.

His Tocqueville Asset Management is named after one of my favorite historian/sociologists, Alexis de Tocqueville, who wrote DEMOCRACY IN AMERICA in the 1830’s.  His “brainstorm” columns are aptly named.  His January column, “Rich on Paper,” is worth reading at least twice.

He predicts higher gold prices in 2000 and beyond. His argument rests on this thesis: “Gold demand has three components.  These are fabrication for jewelry and industry, potential demand from short covering, and investment demand.”  Fabrication demand has grown steadily, counterbalancing extremely negative investment sentiment.

At 3,700 tonnes in 1999, it [fabrication demand] exceeded new mine production by over 1,000 tonnes.  Without central bank sales, producer selling, and speculative short selling to fill this deficit, the equilibrium gold price would have had to be several hundred dollars higher than where it stands.

The upward pressure on gold’s price will not come from fabrication demand.  It will come from panic short covering and rising investment demand.

The short position remains large: 5,000 to 10,000 tonnes.  (Doesn’t anyone know more precisely?)  This is two to four years of mine production.  The Washington central bank agreement of last September fixes sales at 400 tonnes per year.

The gold mining industry relies on bullion banks to market its output.  These banks operate with leverage: up to five to one in paper assets over the actual flow of physical gold.  Any reduction in output by the industry threatens these banks’ short position, i.e., their promise to deliver gold at a specified price.

He makes a significant point: “The world is not awash in gold, it is awash in dollars.  The run rate of the US trade deficit is $300 billion per year.  40% of US debt is now held by foreigners.”  (Note: a decade ago, it was about 10%.)

Gold shares are cheap today.  The market capitalization (shares times price) of the entire gold mining industry is $50 billion.  By comparison, the CHANGE in market capitalization of just one company, Qualcomm, gained and then lost $50 billion in late 1999 and early 2000.

Mining companies have sold short by promising to deliver gold in the future.  This has depressed gold’s price.  These firms are now trapped: if they bid against each other to restructure their hedge books — the source of their profits — the front-runners will bid up prices, and the late-comers will be hit with massive losses.  But if they stop hedging — if they come to their senses — this will drive up prices in the futures markets by lowering gold supplies (paper promises to deliver).

Hathaway thinks that investment demand in 2000 will increase.  The Federal Reserve pumped up the money supply at the fastest rate in history in late 1999.  (This was a Y2K strategy.)  A 20-year (actually, more like 18) bull market in financial assets has banished gold to Siberia, he says.  Nobody today pays any attention to investment demand for gold.

Will the financial euphoria continue?  He thinks not. He refers to a study by Paul M. Montgomery that found that the ratio of AAA bond yields to the S&P 500 is 7.5 to 1. The only other examples in this century of such a spread was Weimar Germany (not too useful) and Japan in 1989 — the last year of the financial bubble.

Montgomery also produced a chart on the ratio of the value of mergers to Gross Domestic Product in the U.S.  In 1901, when J. P. Morgan was putting together the manufacturing trusts, it was about 10%.  This fell sharply by 1905 to barely 1%.  This figure never increased to as high as 5% until 1985.  It hit 7% in 1987 (the year of the October sell-off), fell to under 2% in 1991 (recession in 1992), and then began its climb to 1998’s staggering 19%. The line was rising exponentially.  (Click through to the article to view the chart: page 8.)

What if foreign sellers of goods find other buyers than Americans?  The recessions abroad are ending.  If foreign sellers decide not to accept as many U.S. dollar- denominated debt in exchange for their goods and services, the dollar will fall in value.  It will take high interest rates in the U.S. to keep the dollar high and U.S. prices low.  Hathaway comments:

The positive fundamentals, which formed the underpinnings of the twenty-year bull market in financial assets, have withered.  Only the façade remains.  Once market participants wake up to the change, gold will benefit to an extent that is inconceivable to those who are short.

He then makes a statement that could serve as an epitaph for an era:

Paper wealth has become a state of mind, even a fantasy, regardless of whether it is represented by shares of overvalued high tech companies or foreign holders of overvalued US dollars.  Vying for the title of the greatest fools are the central bankers who have systematically divested their gold through outright sales and lending in order to increase their holdings of higher yielding dollars and other paper currencies. Nouveau central bankers parrot the values and beliefs of the paper asset bull market.  They disdain gold and couldn’t be more negative. Their supposed prescience is one of the unfathomable myths of our time (p. 9).

I agree with him on this:

Vast quantities of present-day paper wealth, held in the form of inflated stock equities, will never be converted into lasting wealth.  For most, this imaginary wealth will die along with the prevailing market mania.  Only a few high tech millionaires will transform their dot.com and similar paper into lasting wealth.  As in all major market turns, surprise will be a major factor (p. 9).

Today, hardly anyone wants to buy gold mining shares. Surely, a wise investor does not want to buy shares in a company that has sold their future output at today’s prices.

If you are interested in a speculative play, there is a list of about half a dozen North American mining firms that have sold forward 10% or less of their output, and which have cash reserves and low debt/equity ratios.  You can receive this list by calling or faxing Douglas Dobbs:

(800) 800-9217
(509) 624-4687 (FAX)

To buy gold is to bet against central bankers and gold market manipulators.  The world’s biggest players do not want the paper-based, leveraged economy to disappear in a flight to hard assets.  People who bet against the central banks may have to wait a while for vindication.  To find out why, click here:



Here’s a suggestion for you if you’re a Christian suffering from what Rev. C. John Miller (d. 1996) called orphan’s syndrome.  Consider taking his SONSHIP course.  It includes audiotapes or videotapes and a detailed workbook. I have found it very helpful, especially the recent presentations by Rev. Bancroft.  So has my pastor, who recommended the series to me.  (I worked briefly with Rev. Miller back in 1963.  My pastor went to seminary with Rev. Bancroft.)  The SONSHIP course has proven beneficial to hundreds of pastors and Christian workers who have hit a brick wall of frustration in their ministries and lives: the “I must try harder” syndrome.  Trying harder just won’t do it.  It will only entrap you.  I speak from experience!

The course also good for anyone with marital problems or problems with their relationships with their children. Miller went through an eight-year estrangement from his adult daughter.  After the two families reconciled, he and his daughter wrote a book on their painful experience: COME BACK, BARBARA.  The SONSHIP course shows people how to deal with the kinds of problems that led to the break.

Take the OQ (orphan’s quotient) test:


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