The Bonfire of the Certainties: Rethinking petrodollars and your portfolio

Tim Davies

Holon Global Investments

For more than a generation – since at least the 1950s – there have been a few geopolitical and economic certainties in the world: 

  • the US has the strongest economy, 
  • the US president is the most powerful person, 
  • the US dollar is the most valuable and is the default world currency.

But as the Greek philosopher Heraclitus said so well,

“Nothing endures but change.”

A powerful force to drive the price of gold higher

The return of inflation is set to seriously challenge that dollar domination with major implications for investors’ portfolios.

And many inflation watchers will tell you, that to protect their wealth, commodity producers such as Saudi Arabia must sell their US bond holdings and invest into inflation-protecting assets, like gold. That will spur greater demand for gold and drive its price higher, while putting further downward pressure on bonds.

The rise of petrodollars

Following the end of the US dollars for gold peg in 1971, the US entered into a security arrangement with Saudi Arabia. The world’s largest oil producer would recycle its oil revenue directly into US Treasury bonds in return for US military protection over Saudi Arabia’s oil field assets.

This movement of these US dollar reserves became known as ‘Petrodollars’ in the 1970s. The decision to shift from gold bullion investments to US bonds made sense in the early 1970s for Saudi Arabia, given the heightened political situation in neighbouring Iran and the need for military protection of its assets by the US.

A petrodollars disaster

But the petrodollar has been a disaster for Saudi Arabia and every other commodity-producing country.

We estimate the loss of investment return for Saudi Arabia was equivalent to 7 out every 10 barrels of oil exports since 1971 through purchasing US Treasury bonds that have delivered returns substantially below gold bullion. This gap in investment returns has allowed the US to fund its debt (through US treasury bond issuance) over the past 50 years at interest rates well below the rate of inflation as indicated by gold bullion.

Figure 1 below illustrates the investment return that would be achieved if Saudi Arabia invested its US$6.5 trillion of oil revenue over the past 50 years directly into US 10-year treasury bonds, gold bullion, or oil(1).

Figure 1: Actual and potential Saudi oil returns, 1971 – 2021

Source: Holon

The blue line in the chart is the actual return that Saudi Arabia would achieve if recycling its export revenue solely into 10-year US Treasury bonds over each of the past fifty years. Through most of the entire period, the shift away from gold bullion has been a poor investment decision, delivering a compound net return of 0.6%.

By comparison, the gold line in the chart above represents the net investment return, after deducting US CPI inflation, that would have been achieved if Saudi Arabia continued to invest its oil revenue into gold bullion since 1971. For all but four of the past fifty years, gold bullion has delivered positive investment returns far above that of US 10-year treasury bonds, with a net return of 71% over 50 years.

Finally, the black line in the chart above provided a comparative measure of the net investment return (again, after deducting inflation) that would be achieved if Saudi Arabia invested directly into oil. Given that Saudi Arabia is selling its oil to generate this income, this data indicates that in thirty-five of the past fifty years, Saudi Arabia would have produced higher investment returns leaving its oil in the ground over selling it and investing the funds into US Treasury bonds.

The US$4.6 trillion decision

Figure 2 below summarises the cumulative return for the entire 50-year period across the three investment asset classes discussed in the previous chart.

Here we can see that on the total Saudi Arabian export revenue of US$6.48 trillion, the net (inflation adjusted) returns for 10-yr US Treasury bonds is US$6.51 trillion (0.6% total return), for oil is $7.19 trillion (11% total return), and for gold bullion is US$11.15 trillion (72% total return).

Figure 2: Cumulative returns on Saudi oil, actual and potential, 1971 – 2021

Source: Holon

By subtracting the cumulative US$ Gold return from the US 10-yr bond return, we can estimate the total investment cost of the decision by Saudi Arabia to switch to Petrodollars in the early 1970’s. At a total loss of US$4.6 trillion, this is equivalent to 71% of Saudi Arabia’s total oil export revenue over the entire 50-year period.

The return of inflation

With expectations of a high inflationary environment in the 2020’s, global commodity producers like Saudi Arabia will be forced to act quickly and preserve its future export oil revenue and past savings by shifting away from US dollar towards inflation protecting assets like gold bullion.

Saudi Arabia’s alignment with China and Russia at the recent UN votes on the Ukraine conflict suggest Saudi Arabia is well aware of the opportunity to finally break away from the shackles of the Petrodollar after 50 years.

This also comes as the US looks unwilling to tighten its belt and switch off its printing presses, meaning further currency debasement of the US dollar looks to be a certainty.

Rising food prices, up 43% since January 2021(2), are also placing additional pressure on national budgets and risk depleting the savings of nations who have not repositioned their investable assets to protect them from the risk of inflationary currency debasement.

And if Russia is successful in breaking the stranglehold that the paper gold derivatives market has on gold bullion prices, gold bullion prices should increase substantially to make up for the price suppression.

Portfolio implications

So, what can be done?

Rising global inflation risks destroying the purchasing power of all investors if they fail to generate sufficient investment returns. While this note discusses sovereign investment risk, the topic is just as relevant for individual investment portfolios.

Identifying asset classes best positioned to generate strong returns over the next decade has therefore never been more important. Fixed income, which as this note highlights has delivered poor performance after adjusting for inflation, looks set to continue to underperform as inflation pressures grow.

While equities have done well in the past few decades, if we see a repeat of the high inflation seen in the 1970’s, share prices could fall from a substantial compression of valuation multiples. The recent selloff in global technology and innovation may provide an attractive entry point for investors, given a strong pipeline of new technology platforms arriving over the next 10 years.

Given the immense uncertainty and commentary from central banks on raising interest rates, volatility will also likely be elevated, requiring more patience from investors. In this environment, adding hard assets to your portfolio, like gold and silver bullion, should provide more stability and lower portfolio risk. As Bitcoin continues to mature, investors should also consider its hard-asset qualities that should see its rarity become more appreciated by institutional investors.

Finally, maintaining a higher portion of liquid assets, such as equities and digital assets, than prior decades may be prudent given inflation is driving up the cost of living and eating into salaries and bank savings. While Holon does not believe that central banks will raise interest rates too far (see here), liquid assets provide a safety barrier that can assist investors to meet rising interest payments.

For that much, we are certain.

1  West Texas Intermediate oil price per barrel

2 FAO Food Index – (VIEW LINK) 

This article has been prepared by Holon Global Asset Management Pty Ltd ACN 629 590 585 (Holon). Holon is a corporate authorised representative (CAR number 1276082) of Atlas Funds Management Pty Ltd ACN 612 499 528 (AFS licence number 491395). The information provided in this article is general in nature and does not constitute investment advice or personal financial product advice. This information has not taken into account your investment objectives, particular needs or financial situation. Before acting on any information contained in this article, each person should obtain independent taxation, financial and legal advice relating to this information and consider it carefully before making any decision on recommendations. Any opinions or forecasts reflect the judgment and assumptions of Holon on the basis of information at the date of publication and may later change without notice. Any projections contained in this communication are estimates only and may not be realised in the future. Returns from investments may fluctuate. Past performance is not a reliable indicator of future performance. All investments carry risks, including that the value of investments may vary and that your capital is not guaranteed. Whilst all care has been taken in preparation of this article, Holon gives no representation or warranty as to the reliability, completeness or accuracy of the information contained in this article. Holon accepts no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. To the maximum extent permitted by law, Holon will not be liable in any way for any loss or damage suffered by you through use or reliance on this information. Holon’s liability for negligence, breach of contract or contravention of any law, which cannot be lawfully excluded, is limited. Holon Photon Fund: The responsible entity for the Holon Photon Fund (ARSN 633 803 497) (the Fund) is One Managed Investment Funds Limited (ACN 117 400 987) (AFSL 297042) (OMIFL). Holon is the investment manager for the Holon Photon Fund. The content of this article does not constitute an offer or solicitation to subscribe for units in the Funds or an offer to buy or sell any financial product. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. You should also consult a licensed financial adviser before making an investment decision in relation to the Fund. Any investment in OMIFL products need to be made in accordance with and after reading the Product Disclosure Statement (PDS), Additional Information Booklet (AIB) and Target Market Determination (TMD). Investors should consider the PDS, AIB and TMD before deciding whether to invest in the Fund or continue to hold units in the Fund. Applications for units in the Fund can only be made pursuant to the application form relevant to the Fund. The PDS, AIB and TMD can be obtained by visiting

Tim Davies
Director of Research
Holon Global Investments

Tim has worked at Goldman Sachs in London and New York, covering European and UK based hedge funds, and in Australia as an investment analyst and China-focused portfolio manager at Consolidated Press Holdings, Ellerston Capital and Caledonia.


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