J U N E 2 0 , 2 0 1 7 r u n n i n g t h r u t h e f o r e s t

The long-awaited CNY oil contract just began testing in preparation

for an expected late-July launch.

Arguably, there IS no more important develop in global capital markets, because once it goes live, it significantly accelerates China’s ability to control the international trade value of the USD through oil and gold markets. How? Simple arbitrage:

You cannot have two different oil and gold markets at two different actual or implied Gold/Oil Ratios (GORs) globally because if both oil AND gold are priced in CNY and USD, the GOR’s of CNY oil and USD oil must match, or else the currency with the higher GOR will see gold inflows while the currency with the lower GOR will see either lower oil prices or gold outflows or both until the lower GOR matches the higher GOR!!!

Critically, this math holds regardless of whether the GOR’s are actually different, or merely implied to be different (i.e. if China will settle much greater %’s of physical gold at the western USD price set by highly-levered paper markets, then the CNY “GOR” is implied to be much, MUCH higher than the USD GOR.)

Coincidentally, the GOR 50d SMA recently crossed > the 200d SMA, and the prior 2x this has happened post-SGEI launch in 3q14, the GOR has risen 138% in < 1 year on average. Will this happen again, & if it does, will it happen via higher gold or lower oil prices?

Luke Gromen, CFA FFTT, LLC 216.533.1622 Luke@FFTT-LLC.com www.FFTT-LLC.com Follow us on Twitter: @LukeGromen

The long-awaited CNY oil contract just began testing

in preparation for an expected late-July launch.

We recently received word that the long-awaited CNY oil contract would launch

in late July, and last Monday (June 12), Chinese authorities announced that a

series of tests of CNY oil futures trading would begin this past weekend:

Shanghai Int’l Energy Center to arrange 4 system exercises – 6/12/17

http://oil.fx168.com/1706/2282912.shtml

According to the Shanghai Int’l Energy Center Co., Ltd. on Monday

(June 12) issued a notice that the smooth launch of crude oil futures,

will be four times the entire market production system exercises, the

time were on June 17-18, June 24-25, July 1-2, July 8-9.

Implications? The launch of CNY oil futures is likely to place renewed and

possibly significant upward pressure on the “Gold/Oil Ratio” (GOR.)

Coincidentally, this chart shows the GOR 50d SMA recently crossed above the

200d SMA, and that the prior 2x this has happened post-SGEI launch in 3q14,

the GOR has risen 138% on average:

Critically, the prior two GOR spikes have been driven by collapses in oil prices

rather than spikes in gold prices. How might the GOR spike this time? That

remains to be seen, but one thing seems clear: Events seem to be rapidly

coming to a head.

Continued on page 2

2 • FFTT JUNE 20, 2017

Why have we been and remain so focused on the launch of the CNY oil contract? Arguably, there IS no more important

develop in global capital markets, because once it goes live, it significantly accelerates China’s ability to control the

international trade value of the USD through oil and gold markets. How? Simple arbitrage:

You cannot have two different oil and gold markets at two different actual or implied Gold/Oil Ratios (GORs)

because if both oil AND gold are priced in CNY and USD, the GOR’s of CNY oil and USD oil must match, or else

the currency with the higher GOR will see gold inflows while the currency with the lower GOR will see either

lower oil prices or gold outflows or both until the lower GOR matches the higher GOR!!!

Critically, this math holds regardless of whether the GOR’s are actually different, or merely implied to be different (i.e. if

China will settle much greater %’s of physical gold at the western USD price set by highly-levered paper markets, then the

CNY “GOR” is implied to be much, MUCH higher than the USD GOR.) This exact phenomenon was forecast back in

2011 by Daniel Oliver of Myrmikan Capital:

“As ever more retail gold exchanges open worldwide, and new wholesale gold exchanges spring into existence, such as the

Shanghai exchange where gold can now be traded directly for yuan, spatial liquidity for physical gold will increase. As physical

gold’s spatial liquidity increases, economic agents will be less willing to hold credit money such as the dollar.”

Source: http://csinvesting.org/wp-content/uploads/2013/11/Myrmikan_Research_Report_Liquidity.pdf

Allow us to elaborate:

• Right now, USD gold is $1245/oz. while oil is $43.20/bbl., for a GOR of ~28x.

• HOWEVER – and this is critical to understand – implied in the $1245 gold price is a massive overvaluation of the international trade value of the USD. How? $1245/oz. values the US’ official gold at ~$330B, v. total Foreign-held UST’s of $6.1T, for a ratio of just 5%.

The historical context of how much $1,245/oz. gold overvalues the USD can be seen in the two charts below, showing

that $1,245/oz. effectively backs Foreign-held UST’s at ~5%, or the lowest level in at least 50 years (and more like 100+

years), and that assumes that none of the $100T+ in US Entitlement obligations are counted (right chart.)

0%

20%

40%

60%

80%

100%

120%

140%

160%

19

70

-01

-01

19

72

-12

-01

19

75

-11

-01

19

78

-10

-01

19

81

-09

-01

19

84

-08

-01

19

87

-07

-01

19

90

-06

-01

19

93

-05

-01

19

96

-04

-01

19

99

-03

-01

20

02

-02

-01

20

05

-01

-01

20

07

-12

-01

20

10

-11

-01

20

13

-10

-01

Market value of US official gold as a % of Foreign Held UST's

Source: Federal Reserve, FFTT

0%

20%

40%

60%

80%

100%

120%

140%

160%

19

70

-01

-01

19

73

-07

-01

19

77

-01

-01

19

80

-07

-01

19

84

-01

-01

19

87

-07

-01

19

91

-01

-01

19

94

-07

-01

19

98

-01

-01

20

01

-07

-01

20

05

-01

-01

20

08

-07

-01

20

12

-01

-01

20

15

-07

-01

20

19

-01

-01

20

22

-07

-01

Market Value of US official gold as a % of Foreign Held UST's

(assumes $100T in Entitlement obligations in '25E)Source: Federal Reserve, FFTT

FFTT JUNE 20, 2017 • 3

We can gauge what this implies for the

valuation of gold in USD by holding

Foreign-held UST’s constant at $6.1T (a

conservative assumption given US

structural deficits coming down the pike),

and then assuming from 5% to 120%

effective gold backing of foreign held

UST’s.

Doing this exercise shows how

laughably overvalued the USD is in gold

terms v. historically.

(Note that at the last peak in gold prices

in 1980, US official gold implicitly backed

foreign held UST’s 132%.)

From the calculation in the top chart

above, we can then calculate the

“implied GOR” for each level of effective

gold-backing of foreign held UST’s…this

math is shown in the 2nd chart at right.

Compare these GOR’s to the current

GOR of 28x.

This math in the preceding 3 charts

shows that if you can get physical gold

that for the past 100+ years has been

easily worth between $2,337 - $30,851

for the bargain basement price of

$1,245/oz., you are likely going to do so.

All you have to do get that physical

gold is price your oil in CNY.

If we are right about the above, one

would expect to see this synthesis we

laid out before begin to play out (indeed,

it has already been playing out):

If both oil AND gold are priced in CNY and USD, the GOR’s of CNY oil and USD oil must match, or else the

currency with the higher GOR will see gold inflows [China] while the currency with the lower GOR will see either

lower oil prices or gold outflows or both [the US] until the lower GOR matches the higher GOR!!!

$1,169$2,337

$4,674$7,011

$9,349

$28,046

$30,851

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

5% 10% 20% 30% 40% 120% Note: 1980Gold Peakwas 132%

Price of Gold Needed For US Official Gold to Effectively Back Foreign-Held UST's by %'s Along the Bottom Axis

Sources: Fed, US Treasury, FFTT

2653

105158

210

630

693

0

100

200

300

400

500

600

700

800

5% 10% 20% 30% 40% 120% Note: 1980Gold Peakwas 132%

Gold/Oil Ratio Implied by Gold Price Needed for US Official Gold to Effectively Back Foreign-Held by the %'s

Along the Bottom AxisSources: Fed, US Treasury, FFTT

4 • FFTT JUNE 20, 2017

Furthermore, if we flip this around, as physical gold demand rises around the world in response to the implied or actual

arbitrage China began creating in 3q14 with the launch of the SGEI (& now looks set to accelerate meaningfully with CNY

oil futures, 1 of 2 things must happen): Either the price of gold MUST be allowed to rise in response to the rise in physical

gold demand, or failing that, the price of oil will collapse to achieve the elevated GOR implied by the charts above.

As seen in the chart on the front

page, the prior 2x the GOR has risen

sharply by a collapse in oil prices

because “someone” has refused to

allow the price of gold to rise in

response to a significant acceleration

in physical gold demand since 2q13:

Once the CNY oil contract launches,

if gold prices are once again not

allowed to rise by “someone” to

reflect stronger physical gold demand

that will likely be driven by the CNY

oil contract, then oil prices will likely

once again collapse as they did in

2H14 and 2H15.

As a practical matter, this will likely be

manifested as a “breakdown of the

OPEC/NOPEC production cuts” that

have supported oil prices since Nov-16.

Why might OPEC/NOPEC production cuts breakdown? Simple: Because some members of OPEC/NOPEC will be

happy to sell oil in CNY and convert those CNY into physical gold to take advantage of the massive undervaluation of

gold/overvaluation of the USD we showed on the prior two pages.

“China imported 12.5% more oil YTD in 2017E, but imports from Saudi are up 2.5% v. up 8.1% from Russia” - 6/14/17

http://mobile.reuters.com/article/idUSKBN1950YH

This is exactly what has happened since 2H14, culminating with Russia overtaking Saudi as China’s top oil supplier last

year:

Russia beats Saudi Arabia as China's top crude oil supplier in 2016 for first time ever – 1/23/17

http://mobile.reuters.com/article/idUSKBN1570VJ

Russia overtook Saudi Arabia in 2016 to became China's biggest crude oil supplier for the first year ever, customs

data showed on Monday, boosted by robust demand from independent Chinese "teapot" refineries.

Saudi Arabia seen losing market share to Iran, Iraq on oil production cuts – 4/26/17

https://www.bloomberg.com/news/articles/2017-04-26/saudi-arabia-seen-losing-market-share-to-iran-iraq-on-oil-cuts

Aramco cuts Asia oil pricing as Saudis seen losing market share – 5/1/17

https://www.bloomberg.com/news/articles/2017-05-01/aramco-cuts-asia-oil-pricing-as-saudis-seen-losing-market-share

FFTT JUNE 20, 2017 • 5

What (if anything) can the US do to stop the launch of the CNY oil contract or hamper its effectiveness, and why does the

US care so much about oil being priced and settled only in USD anyway? There are a number of steps the US can take

to try to either prevent or interfere with the launch of the CNY oil contract. For example, the US could attempt to influence

OPEC nations with defense equipment:

US, Saudi seal weapons deal worth $110B immediately, $350B over 10 years – 5/20/17

http://www.cnbc.com/2017/05/20/us-saudi-arabia-seal-weapons-deal-worth-nearly-110-billion-as-trump-begins-visit.html

US, Qatar move towards arms deal estimated at $12B – 6/14/17

https://www.wsj.com/articles/u-s-qatar-move-toward-arms-deal-estimated-at-12-billion-1497484240

Alternatively, the US could re-implement sanctions on any energy-exporting nation either considering or likely to support

the CNY oil contract as sanctions would likely keep that oil from being able to settle easily in CNY:

US Senate votes near unanimously to impose new sanctions on Russia, Iran – 6/15/17

http://mobile.reuters.com/article/idUSKBN1962AU

US may impose oil sanctions on Venezuela – 5/8/17

https://www.bloomberg.com/news/articles/2017-05-08/venezuela-braces-for-double-whammy-if-u-s-imposes-oil-sanctions

The US could also ship US oil and gold to China to support the viability of USD oil and gold futures markets at existing

GOR’s (at least until the US runs out of gold or oil falls too low to allow US production growth):

US oil exports to China up 2,400% y/y YTD; overall US exports up 2x – 6/7/17

https://www.wsj.com/articles/u-s-oil-exports-double-reshaping-vast-global-markets-1496833200

US 1q17 gold exports to China/HK up 64% y/y in 1q17 (US 1q17 gold exports = 3x US gold mine production) – 5/30/17

https://minerals.usgs.gov/minerals/pubs/commodity/gold/

Or, if all else fails, the US could try go to war to kick off a flight to safety into USD’s and UST’s:

Russia protests US downing of Syrian jet, says will “intercept any aircraft” in Russian operating areas – 6/19/17

http://www.zerohedge.com/news/2017-06-19/russia-slams-us-downing-syrian-jet-act-aggression-and-support-terrorists

US, Russia, Iran draw new red lines in Syria – 6/19/17

http://mobile.reuters.com/article/idUSKBN19A21A

Ultimately however, as powerful as the US is, the US will not be able to stop the CNY oil market from functioning forever.

The opening of the CNY oil contract in the presence of a large, physically-settled CNY gold market in China, HK, & Dubai

means the upward pressure on the GOR will be relentless, and at some point, one of two things will happen:

1. It will cease making sense for the US to export gold to China at wildly-undervalued prices (this is EXACTLY what happened 1968-1971 when the London Gold Pool broke down and then the US closed the gold window), and/or;

2. Those OPEC nations that refuse to support the CNY oil market will not be able to withstand the loss of market share in the world’s biggest, fastest-growing oil import market (China) to those energy exporters willing to sell oil to China in CNY and support the CNY oil contract (Russia, Iran, Venezuela.)

To repeat this will happen because if both oil AND gold are priced in CNY and USD, the GOR’s of CNY oil and USD

oil must match, or else the currency with the higher GOR will see gold inflows while the currency with the lower

GOR will see either lower oil prices or gold outflows or both until the lower GOR matches the higher GOR!!!

6 • FFTT JUNE 20, 2017

That brings us to the second question we asked earlier: Why does the US care so much if oil is priced and settled in a

currency other than USD’s? The answer is simple but not well-understood by most western investors: Oil is both the

carrot and the stick used to enforce the USD’s primary reserve status.

Said differently, for 44 years, if a nation wanted to import oil, it had to have USD’s,

which in turn meant that nations were willing to stockpile far more UST’s than they

otherwise would have, which in turn meant the US government could run far

greater deficits than they otherwise could have. One can see why the US cares

so much about oil remaining priced only in USD in the chart at right:

The US can print USD for oil, so it only needs to hold FX reserves equal to 0.6%

of GDP. Up until just recently, China could not, so it held FX Reserves equal to

26% of GDP…FX reserves that were heavily USD-denominated and therefore

which financed US Federal deficits.

Here’s the key: If China gains the ability to effectively print CNY for oil going

forward, that 26% will move towards that 0.6% over time, which means the US

government is going to lose one of its biggest creditors…and in fact, China can

net sell UST’s over time. This puts the US government into near-immediate risk

of a severe Balance-of-Payments (BoP) crisis.

In other words, the CNY oil contract is by extension a HUGE step in cutting off foreign official funding of US

government deficits, and in particular US Entitlement & Defense spending. Given this, it is easy to imagine that

certain parties in Washington DC might see stopping the successful implementation of the CNY oil contract as a

matter of US national security.

On the flip side, multiple Chinese media articles in recent weeks alone suggest China also knows that it MUST implement

the CNY oil contract in order to avoid a fate suffered by many other EM’s over the past 40 years, which makes completing

the successful implementation of the CNY oil contract a matter of national security for China:

Although China has already launched commodity futures such as coke, soybean meal and rebar, crude oil futures are the first

commodity futures contracts in China that are fully open to foreign investors. If the Chinese version of the crude oil futures can

be successfully launched, it will be an epoch-making thing, because it marks the depth of China to participate in the

international market, the core game - oil pricing battle!

If there is no pricing power on important resources for a long time, then China can only become slaughtered lambs and slaves

in the industrial chain of developed countries! In order to get rid of the "cut wool" fate, China must compete for international

crude oil pricing, must be in the global oil field to make a difference, so the opening of crude oil futures is a major event that

China must do.

Sources: http://zhengshangcanyue.baijia.baidu.com/article/848371, Google Translate

RMB internationalization is still going to continue to promote, but more to rely on strengthening the physical trade between

countries and the settlement of local currency settlement. In the case of China's overall financial power weaker than the West,

this is the fundamental way of internationalization of the renminbi.

if Qatar use of the RMB clearing center to facilitate the exchange of some natural gas into RMB, it is tantamount to dig the

American oil dollar ancestral graves. China will further intervene in the entire Parsi gas field as a whole into the future

planning of the Shiite pipeline output, the RMB settlement of the total amount of oil will surge, then the oil dollar valve was held

in China and Russia, and this will undoubtedly be the nightmare of the United States.

Sources: http://www.cwzg.cn/politics/201706/36398.html , Google Translate

26.1%

0.6%

0%

5%

10%

15%

20%

25%

30%

China US

FX Reserves as a % of GDP

Sources: IMF, US Treasury, FFTT

FFTT JUNE 20, 2017 • 7

SO HOW DO WE MAKE MONEY WITH THIS?

First off, given a prospective CNY oil contract official launch date of late July, we would expect increased geopolitical

tensions between now and then. This has been happening.

Secondly, we would

expect the GOR

(which has been

creeping higher in

recently weeks) to

continue moving

higher as the CNY

oil contract launch

nears.

As we showed on

the front page, this

too has been

happening:

Thirdly, we would initially expect the GOR increase to occur via falling oil prices, and that those falling oil prices will be

initially negative for US energy and industrial shares, but only modestly and temporarily so. Ultimately, we do not expect

the US energy sector or related industrial shares or EM shares to react to falling oil prices as much or as long as one

might expect. Why? Because the CNY oil contract launch will effectively accelerate a USD BoP crisis.

We have highlighted this “epic arbitrage” a number of times over the past 12-16 months:

8 • FFTT JUNE 20, 2017

As we noted earlier, once the CNY oil contract is live, either gold must be allowed to rise in response to stronger EM gold

demand (thereby devaluing the USD) or else oil prices will fall notably and accelerate US BoP problems at right around

the exact same time (3q17) that the US debt ceiling may once again pose a problem:

Falling US tax receipts pose a debt ceiling dilemma – 6/1/17

https://ftalphaville.ft.com/2017/06/01/2189479/falling-tax-receipts-pose-a-debt-ceiling-dilemma/

White House budget director Mick Mulvaney said last week that tax receipts have risen less than expected this year,

and warned the ceiling would therefore be breached in August without any policy changes.

Given this, we remain very negative on the USD, very positive on gold, and still prefer to own EM’s, energy shares,

industrial shares, etc., and would add to such positions on any weakness surrounding the launch of the CNY oil contract

next month, because as we have noted in the past, the launch of the CNY oil contract in the presence of the existing CNY

gold exchanges in Shanghai, HK, & Dubai mean the US will face a choice:

For the reasons laid out on pages 2-3 of this report, the US can have:

1. Expensive gold and a profitable domestic energy sector (higher GOR through higher gold prices), or;

2. Cheap gold (current prices) and a bankrupt domestic energy sector (higher GOR through collapsing oil prices).

Critically, our stance to continue to add to the positions denoted above is based on the assumption that while the US may

choose option #2 above initially, that will only place severe and immediate funding pressures on the US government

(whose receipts are already < expected), and as such, we would rather own the assets denoted above than traditional

“safe haven” assets like UST’s and USD’s, as these assets will likely be nominally safe but increasingly disastrous on a

real basis.

As we have noted recently, we increasingly think the outperformance of gold will be nearly binary (akin to BTC’s $1500

increase in 1 month), and therefore so may be the outperformance of industrial/energy commodities because of China,

Russia, et al’s accelerating push to “re-open the gold window through CNY”, which increasingly shifts commodities’

reference point back to gold, but also implies the USD price of commodities will not rise until the USD price of gold

rises...enormously and rapidly.

Thank you for reading this edition of RTTF. LG

FFTT JUNE 20, 2017 • 9

© Copyright 2017, FFTT LLC.

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