Wednesday, December 31, 2008

My Yearly Commodity Returns Since 2005

Well it's time to close the books on the 2008 investing year. One that started off with so much promise for commodities, and ended up being the crappiest year in about 50 years for our beloved commodities.

As for me personally, I started great, and lost all of my gains plus some since March. No sense dragging out the gory details - you can peruse my previous Weekly Update posts throughout the year for those.

All-in-all, it was my first down year since I started investing in commodities in 2005. But it certainly could have been worse - I'll live to see 2009, and that's all you can ever ask for I think.

2007's Yearly Returns Post

My yearly returns investing in Commodities - as of Dec 31, 2008:
  • 2005: 802%*
  • 2006: 60%
  • 2007: 175%
  • 2008: -8%
*Account opened with $2,000 on 4/28/05. This number is especially gaudy because I loaded up on a couple of sugar contracts (more leverage than I should have used) and rode sugar from 9 cents up to 14 cents. Nice trade but lucky timing, which I am grateful for.

Happy New Year!

Jim Rogers' Outlook for 2009

Some great coverage of Jim Rogers' investing outlook for 2009 by

A brief excerpt of the summary provided by

The facts are, during this period in time the only thing to have its fundamentals unimpaired is commodities.
  • Farmers can’t even get loans for fertilizer now.
  • The supply of things is going to be in even worse shape coming out of this.
  • The IEA recently came out with a study showing that the worlds reserves of oil are declining at the rate of 7% per year.
  • you can do the arithmetic, the supply of everything is going down; oil and everything else;
  • we’re going to have serious supply problems before too much longer.

Tuesday, December 30, 2008

Bargain Basement Deals on Spain's Coastal Real Estate

Here's an educational and entertaining article by the folks at Casey Research detailing the popping of the Spanish real estate bubble. Here in the US, we're not the only ones who can inflate wild real estate bubbles. There are some upcoming opportunities for potential real estate profits in Spain when the bubble completely pops - and over corrects to the downside - as bubbles have a habit of doing.

Spanish Coastal Property - "The Russians are Not Coming. The Russians are Not Coming!"

By the editors of Without Borders, Casey Research

If you’ve made your way over to Europe in the last few years, you may recall being inundated with flyers, billboard messages and seminar advertisements for Spanish property, particularly if you were in the UK. British buyers were scooping up ”cheap” homes in Spain at a blistering rate, reenacting the turn-of-millennium Florida boom. Builders followed the trend, doing what comes naturally to them, until there seemed to be an off-plan Spanish condo for every man, woman and child in Great Britain. The nice thing about real estate is that demographics can be counted on to resolve any supply and demand anomaly, even if painfully.

The pain in Spain is mainly on the coast; 2007 was a tough year, and in hindsight, 2008 will likely have been tougher. The price appreciation of real estate in Andalusia was at its peak in 2003, with 18.5%. By 2006, it had whittled down to 9.1% growth, and in 2007 turned negative; in fact, the market has since gone “no bid” in many places.

This is bad news for the coastal communities because, other than real estate, tourism, and the container port in Algeciras, there is no real economy in southern Spain. Mainly they sell sun, homes, and stuff to fill homes. And judging by the vacancies, more people are choosing sun over shade. This is worse than Miami, the other bubble-busting, sun-drenched prairie of empty homes. At least southern Florida has an attractive tax regime and modern infrastructure that lure new businesses and jobs. Not so southern Spain, where the tax code and infrastructure were both conceived in an era of donkey riding and windmill charging.

How Did This Happen?

Everywhere you wander from Malaga to Cadiz, you’ll find empty apartments and apartment projects left half-built. As Simon would say, “The only person making money in this real estate market is the guy who paints the ‘Price Reduced’ signs.” It seems like there’s an idle “overseas property specialist” on every street corner.

Most of the real estate agents are British because, for the last twenty years, most of the buyers in coastal Spain were British, with a smattering of Germans and other northern, sun-starved Europeans. About four years ago, the buyers became a bit more eclectic. Or did they?

What really happened was the builders became more eclectic. In particular, Russians converted their commodity wealth from U.S. dollars to Spanish property… as developers. In what could be a Monty Python comedy, the British property promoters turned this into, “The Russian BUYERS are coming. They are going to buy only the best. And they don’t care about the price.” The story wasn’t a huge leap for the average Brit, since Russian billionaires and their newly affluent nephews are a force to be reckoned with in London. Known for their conspicuous consumption, the Russians are seen as the flashiest and most gauche of the nouveaux riche.

After a decade of skyrocketing property appreciation, the thought of price-agnostic Russkies fleeing from the cold winters of Moscow warmed the hearts of speculators from Birmingham to Bristol -- many of whom had already made small fortunes flipping Costa del Condos. The promoters brought in a slew of new “investors” to build the inventory the Russians were supposed to buy. This birthed a creative scheme that would make Carlton Sheets, and the rest of the late-night, no-money-down TV gurus, salivate if not hyperventilate.

Developers could sell condos, townhouses and villas “off plan,” which means people would purchase property that was, at the time they plopped down their deposits, nothing more than a piece of Spanish dirt and an architectural drawing. In many cases, the banks in Britain and Spain were so eager to turn plumbers and schoolteachers into property moguls, they would give non-recourse loans for up to 90% of the sales price foretold by the developer. Yes, that means no personal guarantee by the buyer. It mattered not whether he drove a lorry in Liverpool or was a doctor in Dorsett, the property “underwrote itself off-plan,” which is banker talk for “I believe in fairies.”

The promoter and the developer, often one and the same, saw an opportunity to take this concept out for a real spin, so they started offering incentives for people to buy before construction. One of the most aggressive teasers was a €20,000 “decorator’s credit,” allowed if a buyer signed the contract and paid the deposit before the project broke ground.
Following the laws of Ponzi thermodynamics, it worked perfectly if you started in 2000 and had the mind to quit in 2004. We know a couple of hourly-wage earners who now drive Aston Martins, but for everyone who drove his Vanquish into the sunset, there are quite a few more who kept rolling those decorator’s credits and condo profits into the next deal and who are now wondering when the repo man will come knocking.

What happened? That silly supply-and-demand thing combined with the fact that the Russians never came. We met with a flashy Brit promoter who actually went to St. Petersburg and hired two very attractive young Russian women in anticipation of the wave of Russian buyers. He and his wife, a Russian-Estonian, spent tens of thousands on visas and real estate training only to have his fine Russkies sit around the office, chain smoking and talking about shopping. In Russian.

The State of the Market Today

As we mentioned above, the market is now at that uncomfortable “no bid” stage. Developers and owners are scrambling. One condo we visited came with a brand-new car and an offer to carry the first year’s mortgage payments. Another came with six months of groceries and two weeks in the Canary Islands. In our property speculating experience, the “no bid” stage is often followed by the “any bid” stage. It will be just the same here, in a massive way.

What does this mean to you? Right now, properties are still in the hands of reality-challenged people who are either not yet desperate enough to sell at a significant loss or are still hoping that “the market will pick up again this summer.” Is this possible? Not unless half of Russia comes with their checkbooks. New housing starts in 2005 were the highest since they started keeping tabs shortly after Hemingway left the ambulance service. Even if sales returned to 2005 levels, there would still be too much supply. This is how a business cycle works. This is why Las Vegas makes money. The lesson for the players at the Costa del Table will be costly, and there are no more free drinks.

What to Do? How to Profit?

Things will get worse before they get better. But incredible bargains and profits are coming from this.

Because most of the loans were non-recourse, many speculators, in effect, bought options on the property market. Their losses are limited to the cash they put into each deal. They will hang on as long as they can, but eventually there will be too much month left at the end of the money. They will walk away from their condo/townhouse/villa before it’s being repossessed. The banks will be stuck with a lot of this property, and developers will be sitting on finished or nearly finished projects they can’t afford.

The banks that will be hurt the worst are the local Spanish banks, not the British banks that kicked off the mania or even the national Spanish banks. It will be the little “Cajas,” something akin to the old savings and loans, that will be feeling the most pain. If the worldwide credit crisis becomes a full-blown monetary crisis, the bottom could fall out soon. If more banks are going under because of the goofy paper on or off their books, they will be happy to get any cash they can. When you start hearing about the local banks going bankrupt or some sort of “government solution,” hop a plane and check out the offer.

So where to start once the time is right? The high end. The highest end. In percentage terms, the very high end falls the furthest when things get ugly and rebounds the most when the cycle turns. Our recommendations are Marbella and Sotogrande. Marbella has long been the haunt of Europe’s rich and famous, and Sotogrande commands a premium because it is Sotogrande. When we think the time has come, we will be buyers.


As many pundits – and President-elect Obama – expect, “Things will get worse before they get better.” In an economic crisis like this, prudent investors are well advised to diversify their portfolio… ideally, some of it in global stocks and real estate. And, as Casey Research Chairman Doug Casey likes to say, you may prefer to expatriate and “watch the crisis on TV instead of through your living room window.”

Without Borders is your go-to guide for the soundest international investments and the most beautiful (and cheap) places to live. Get the inside scoop from two ex-CIA agents with privileged connections around the globe… learn more by clicking here.

Monday, December 29, 2008

Jim Rogers on Kudlow: We're Going to Have an Inflationary Nightmare

Here's a video of Jim Rogers on CNBC's Larry Kudlow & Co. from December 13, 2008.

They start talking commodities around the 2:20 mark.

Rogers' insights:
  • The Fed has gone too far in their money printings
  • Commodities are not down because of fundamentals - they are down because of the forced liquidation of every single asset, except the Japanese Yen
  • He bought more oil a couple weeks back, and all commodities the week of the interview
  • We're going to have an inflationary nightmare in the next five years

Sunday, December 28, 2008

Weekly Futures Positions Review - December 28, 2008

Top posts from the past week:

Our coverage of Marc Faber's recent interview on CNBC from December 1st continues to see a lot of traffic.

A review of our trades and positions from the previous week:
  • Continued to hold one cocoa futures contract - up slightly on the week. Looking to add to this position on higher high's.
  • Continued to hold one mini-gold futures contract - a nice bounce on Friday for Gold also made this position a solid performer on the week. Looking to pyramid if/when gold makes a serious run at $1,000.
  • Purchased one wheat futures contract. All of the grains look like they are now breaking out - the corn and soybean charts look very similar. I think the grains are seriously oversold, and the bullish fundamentals are quite intriguing at these price points. I prefer wheat and corn over soybeans personally from a fundamental perspective.

Our wish list...everything here looks beaten down...some starting to form a bottom it appears...
  • Sugar
  • Coffee
  • Cotton
  • Natural Gas
  • Silver
  • Crude Oil
  • Corn

Open positions

Date Position Qty Month/Yr Contract Entry Price Last Price Profit/Loss
12/15/08 Long 1 MAR 09 Cocoa 2586 2616 $300.00
12/24/08 Long 1 MAR 09 Wheat 579 1/4 599 $987.50
12/15/08 Long 1 FEB 09 Mini Gold 836.6 870.6 $1,128.80
Net Profit/Loss On Open Positions $2,416.30

Account Balances

Current Cash Balance $47,916.42
Open Trade Equity $2,416.30
Total Equity $50,332.72
Long Option Value $0.00
Short Option Value $0.00
Net Liquidating Value $50,332.72

Cashed out: $20,000.00
Total value: $70,332.72
Weekly return: 4.9%
YTD return: -8.6%

***"Cash out" mostly means taxes, but lately we've also been using it for living expenses, and also to finance a cool new time management software startup that is starting to lift off - and was recently covered by the Sacramento Business Journal.

Tuesday, December 23, 2008

Why eBay is the Best Indicator of Gold's Fair Value

We've discussed before how the paper market for gold can easily be manipulated - including recently that three US banks allegedly account for the majority of all net short positioning on the COMEX.

In the following article, the editors of Big Gold, a Casey Research publication, discuss how gold prices on eBay are the best indicator of the true price of gold. And they believe current prices are a steal.

The eBay Index

The one place that shows you how much gold is really worth
By the editors of BIG GOLD

Anyone who has watched the price of gold lately must have felt that something was off. While public demand for bullion coins went through the roof and major bullion dealers ran out of coins to sell, the spot gold price was flat, teetering between the upper 700- and lower 800-dollar range.

Managing Editor Jeff Clark of BIG GOLD wrote in the November 2008 newsletter:

Many dealers are out of 1-oz. coins, and not just here in the U.S. Londoners have been queuing up in front of coin shops; German suppliers are refusing new orders; demand exceeds mint capabilities in Canada, Australia, and South Africa; and Switzerland is working around the clock. If you’re fortunate enough to locate a source of coins, expect to pay an unusually high premium over the price of spot gold -- in the U.S. perhaps 10%, 15%, or more -- triple the normal level. Even then you may have to wait eight weeks or longer for delivery.

According to the laws of supply and demand, shouldn’t the spot price have skyrocketed?

Whatever the reason that it didn’t – hypotheses bounced around on the Internet ranged from deleveraging to governmental price manipulation – the BIG GOLD editors managed to find an unexpected indicator of the true value of gold that seems to be more reliable than the spot gold market itself…

The eBay Index.

Just like The Economist with its Big Mac Index or its modern cousin, CommSec’s iPod Index, both of which explain and compare the purchasing power of currencies, online auction house eBay makes an excellent yardstick for the true value of, well, just about everything.

In recent years, politics and economics seem to have entered an unholy alliance, thus increasingly obstructing the view on causes and effects in the markets. eBay, on the other hand, is the free market at its best and simplest. In other words, a seller’s item is worth exactly what a prospective buyer is willing to pay for it.

In April of this year, when the U.S. Mint rationed one-ounce, 2008 Silver Eagles to its thirteen authorized buyers, those same Silver Eagles sold on eBay for $25 apiece… nearly 50% over the then-spot price of $16.80.

Along the same lines, a few weeks ago, when gold was at $750/oz, one-ounce Gold Eagles got bids of $1,000 on eBay… a premium of 33% over spot price.

At the time of this writing, the availability of bullion coins has slightly improved, and major bullion dealers like have resumed offering some of their standard bullion products. Even though inventories are still selling like hotcakes, at least there is an inventory – and the eBay Index has reacted accordingly. Right now, with spot gold at $852, 2008 Gold Eagles are fetching bids of $876 on average… a premium of only 2.8% over spot.

This is a Christmas gift. It means any investor concerned about the government’s out-of-control printing of dollars has a window of opportunity to buy gold bullion at reduced markup. You can, at the moment, buy gold while both it and the underlying premiums are cheap. The eBay Index demonstrates that premiums can spike any time and without notice.

And since the editors of BIG GOLD recommend keeping 33% of your portfolio in gold bullion, it is well worth watching the eBay Index to gauge how high gold prices should be at any given time. For it is almost certain that the spot market will follow the Index sooner rather than later. Buy gold now before eBay signals premiums are expensive again.


Deflation today + government responses = inflation tomorrow. This means you would be well advised to own some physical gold, as well as crisis-proof stocks of major gold producers and quality ETFs. BIG GOLD is the monthly advisory for the prudent investor, focusing on precious metals investments that are safe havens in times of crisis. Learn more about it here.

Monday, December 22, 2008

Lean Hog Prices Poised to Climb in 2009

Bloomberg reports that "In the worst year for commodities in at least five decades, hogs rose 6.6 percent, the second-biggest gains on the Reuters/Jefferies CRB Commodity Index, behind cocoa."

The article quotes fund manager Mark Greenwood: “We’re going to have 3 to 4 percent less pigs next year, and that should be very supportive to higher pork prices."

“In the middle and latter stages of recession, energy and base-metals markets tend to underperform,” Barclays Capital said in its 2009 commodity outlook report to clients on Dec. 18. “Gold, agriculture and livestock tend to outperform other commodities, and it is these sectors that could prove most robust in early 2009.”

The 2008 commodity rally petered out before rising meat prices had a chance to join the party, as we had hypothesized back in May. Our theory was that higher feed inputs (corn, soybeans) would eventually pass through and result in higher meat prices. Interestingly, the Bloomberg article mentions one producer who unfortunately is locked into $6 corn until the end of 2009.

Saturday, December 20, 2008

Weekly Futures Positions Review - December 21, 2008

Top posts from the past week:
Our coverage of Marc Faber's recent interview on CNBC from December 1st continues to see a lot of traffic.

A review of our trades from the previous week:
  • Bought a Swiss Franc position on Tuesday. Tried to pyramid with another position Wednesday night. Sold both on Friday - about even after it was all said and done. Check out this volatility:
  • Bought an Australian Dollar position on Tuesday - sold it on Friday at a loss. Again, we unsuccessfully timed the breakout here.
  • Bought a Mini-Gold position. Again, tried to buy the breakout.
  • Bought a Cocoa position. Ditto.

Our wish list...everything here looks beaten down...silve
  • Sugar
  • Coffee
  • Cotton
  • Natural Gas
  • Silver
  • Crude Oil
  • Wheat
  • Corn

Open positions

Date Position Qty Month/Yr Contract Entry Price Last Price Profit/Loss
12/15/08 Long 1 MAR 09 Cocoa 2586 2587 $10.00
12/15/08 Long 1 FEB 09 Mini Gold 836.6 837.5 $29.88
Net Profit/Loss On Open Positions $39.88

Account Balances

Current Cash Balance $47,927.72
Open Trade Equity $39.88
Total Equity $47,967.60
Long Option Value $0.00
Short Option Value $0.00
Net Liquidating Value $47,967.60

Cashed out: $20,000.00
Total value: $67,967.60
Weekly return: -3.6% --> Mostly due to the bad Aussie dollar trade
YTD return: -11.9%

***"Cash out" mostly means taxes, but lately we've also been using it for living expenses, and also to finance a cool new time management software startup that is starting to lift off - and was recently covered by the Sacramento Business Journal.

Thursday, December 18, 2008

Inflation or Deflation - Which Will Prevail?

Battle of the Flations
By Bud Conrad
Chief Economist, The Casey Report

One of the most hotly debated topics among financial talking heads these days is, “Deflation or inflation, what is it going to be?”

There is no question that we are currently experiencing asset price deflation and economic slowing. But we, the editors of The Casey Report, see this as a transitional phase. In our analysis, the truly extraordinary and historic levels of government spending and bailouts being deployed to keep the economy afloat are certain to lead to inflation in the not-too-distant future.

While our long-term view remains solidly in the inflation camp, over the past four months, the U.S.’s financial problems have caused deflation in many important asset classes. Put another way, a reduction in asset prices amounting to about $14 trillion (in housing, equities, etc.) is bigger than the government’s countervailing actions of around $3 trillion -- the total, so far, arrived at by combining the measures taken by the Fed with the federal government bailouts.

But there are important differences between a sharp collapse in asset prices and the potentially leveraged stimulus packages.

The Fed’s actions, if taken in normal times, would be multiplied throughout the banking system as banks used the new money to increase their lending and, in so doing, leveraged the funds throughout the entire economy. This time around, however, while the Fed has been extremely accommodating to the banks, even going so far as to make direct loans to them, the effect is moderated. That’s because of tighter lending standards, the need to replenish capital, and the demise of many complex structures, which were previously available for securitizing and selling loans on to others.

As a result, the banking system as a whole is not responding to the stimulus. It can be thought of as pushing on a string. Simply, as large as the stimulus has been to date, it has not yet been enough to offset the effects of the economic collapse. The resulting deflationary pressure increases concern over a downward spiral in the economy.

Another way to view this is that consumers and businesses alike are now anticipating deflation, which makes saving and survival the primary goal (in an inflation, spending becomes the primary goal, unloading the money before it can lose value). Of course, a cutback in spending and demand drives down the price of things, at least temporarily.

But the longer-term expectation is that Bernanke’s assertion – an assertion now backed up by action – that the government can and will print new money to any extent needed is the more important force.

As long as there is evidence of serious economic collapse, it can be expected that the bailout programs will be ratcheted up. And, to the extent that the public expects deflation – and so businesses reduce prices to raise cash and reduce inventories – the wave of price inflation experienced in the spring of 2008 will be moderated. But within the seeds of that positive are the very big negatives that the government, seeing that its extraordinary money creation is not being evidenced in rising prices, will be emboldened to go even further.

This is of great importance because, unlike in the 1930s, there is no limitation on what the government can do, because there is no gold standard to enforce monetary discipline. Instead, the world is afloat on a sea of massive new government spending and credit facilities. After a lag, the stimulus will perform the expected actions of reinstating credit and debasing the currency. But never lose sight of the fact that the government is creating money out of thin air. Some call it bailouts, we would call it legal counterfeiting on an epic scale.

In the New Deal, FDR created the FDIC and guaranteed bank deposits, set minimum bank deposit rates, and brought the discount rate to almost 0%. He cut the dollar/gold exchange rate from $20.67 to $35 and confiscated gold; i.e., devalued the dollar by 40%.

While the beginning of the collapse from too much credit was parallel to the previous experience of the depression, the response today is different. The size of the monetary stimulus and the risk to the dollar from foreign holders -- who can also see the implications of the out-of-control deficits -- strongly argue for a return to inflation much sooner.

How much sooner? Impossible to say, but remember: deflationary or inflationary fears are not the independent agent that will determine whether or not we will see inflation (though, in the intervening phase, they will certainly be an important economic driver). The Federal Reserve is throwing everything it can at the financial markets to fight deflation. As you can see in the chart below, the Fed has doubled the size of its balance sheet since September.

On December 16, the Fed cut interest rates to a range of between a quarter of a point and zero. That is lower than ever in the 94 years of their existence. And they promised in the accompanying announcement to provide additional funds to “stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level… the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets.”

At this time individuals and companies alike are sensing deflation and, as a result, are raising cash… in the process deleveraging the extreme debt loads. That is causing downward pressure on asset prices and, soon, a serious contraction in the economy as more and more companies lay off workers and cancel spending. This will not be a happy holiday season. And it will be a long-term recession and maybe even a protracted depression.

But the fact of the extraordinary deficit spending is there for all to see and, over time, more and more will see it. And, more to the point, understand it. In fact, thanks to the Internet and always-there financial media, the shift in sentiment can happen almost on a dime. Slowly at first, and then faster, fears over inflation will return, but this time they will be well founded.

The economic downturn could be protracted, but that does not mean that the deflation will be protracted. Instead, once we are through this phase, we expect to see poor economic conditions, but against a backdrop of rising inflation. Stagflation is a word that remains in our vocabulary.

Inflation or deflation – whatever the current market trend, there is a way to play it. Every crisis contains opportunity as well as danger… and many of those who manage to mitigate the risk and grab the opportunity have made a fortune in times like these.

Making the trend your friend and riding the market “riptides” that can lead to exceptional returns in the double, triple or even quadruple digits is easier than you think… with a little help from experts who have been correctly predicting – and profiting from -- these riptides for years. Learn more here.

Editor's Note: You may also want to check out this article by MarketFolly about investing in inflationary vs. deflationary times.

Wednesday, December 17, 2008

Washington Post Cartoon - Financial Ponzi Scheme

Fed Out of Ammo; Dollar is Toast

Everbank's Chris Gaffney comments that the Fed is now out of ammo and into uncharted territory, trying to employ untested methods which are likely to lead to higher inflation.

So Chairman Bernanke has used up all of his remaining ammunition for the main weapon against the economic crisis, and now has to move to other less proven methods to combat the crisis. These 'quantitative' easing methods which the Fed will now use are unproven, but they are all that they have left. The Fed pulled the first new weapon out yesterday with a pledge to buy unlimited quantities of mortgage backed securities. They hope that by purchasing these securities, they will be able to force mortgage rates lower. But as Chuck points out above, it isn't the cost of credit, but the availability that is the big problem.

The problem with these new untested financial weapons is that their longer term impacts are not known. I can assure you of one thing, the new methods suggested by the FOMC will all lead to higher inflation. Most of the press surrounding the announcement suggested that inflation is no longer a problem. And the data released yesterday supports this view, as CPI fell 1.7% MOM in November, bringing the annual change in core prices to just 2%. So US policy makers have decided to concentrate on getting the US economy growing again, with no consideration of the long term inflationary effects of their policies. The Fed is pushing the printing presses to their limit, and while oil prices have kept prices down for now, inflation is still alive, and is waiting just around the corner.

It looks like the markets have figured this out already - the dollar is being taken to the woodshed.

Thanks, Ben and Co.

Editor's Note: If you're interested in diversifying some of your savings, I'd recommend checking out some of Everbank's foreign currency offerings.

Monday, December 15, 2008

Stratfor: Oil Prices Likely to Remain Low for Some Time

Strategic Forecasting logo

Falling Fortunes, Rising Hopes and the Price of Oil

December 15, 2008

Graphic for Geopolitical Intelligence Report

By Peter Zeihan

Related Links

· Mexico: Insuring Oil Exports

· Canada: Oil Sands Tax Increase

Related Special Topic Page

· Global Energy Prices

Oil prices have now dipped — albeit only briefly — below US$40 a barrel, a precipitous plunge from their highs of more than US$147 a barrel in July. Just as high oil prices reworked the international economic order, low oil prices are now doing the same. Such a sudden onset of low prices impacts the international system just as severely as recent record highs.

But before we dive into the short-term (that is, up to 12 months) impact of the new price environment, we must state our position in the oil price debate. We have long been perplexed about the onward and upward movement of the oil markets from 2005 to 2008. Certainly, global demand was strong, but a variety of factors such as production figures and growing inventories of crude oil seemed to argue against ever-increasing prices. Some of our friends pointed to the complex world of derivatives and futures trading, which they said had created artificial demand. That may well have been true, but the bottom line is that, based on the fundamentals, the oil numbers did not make a great deal of sense.

CHART: Spot Oil Prices for December 2008

Things have clarified a great deal of late. We are now facing an environment in which the United States, Europe and Japan are in recession, while China is, at the very least, expecting to see its growth slow greatly. Demand for crude the world over is sliding sharply even as the Organization of the Petroleum Exporting Countries (OPEC) member states so far seem unable (or, in the case of Saudi Arabia, perhaps unwilling) to make the necessary deep cuts in output that might halt the price slide. The bottom line is that, while the breathtaking speed at which prices have collapsed has caught us somewhat by surprise, the direction and the depth of the plunge has not.

Prices are likely to remain low for some time. Most of the world’s storage facilities — such as the U.S. Strategic Petroleum Reserve — are full to the brim, so large cuts are needed simply to prevent massive oversupply. Yet any OPEC production cuts — the cartel meets Dec. 17 and deep cuts are expected — will take months to have a demonstrable impact, especially in a recessionary environment. And there is the simple issue of scale. The global oil market is a beast: Total demand at present is about 86 million barrels per day. This is not a market that can turn on a dime. A firm fact that flies in the face of conventional wisdom is that oil actually falls far faster than it rises when the fundamentals are out of whack. This has happened on multiple occasions, and not that long ago.

Falls occurred both in the aftermath of the 1990-1991 Persian Gulf War and as a result of the 1997-1998 Asian financial crises that were similar in percentage terms to the present drop. Until the balance between supply and demand is restruck — something not likely until a global economic recovery is well under way — there is no reason to expect a significant price recovery. The journey, of course, is not necessarily a one-way trip. Quirks in everything from weather to shipping to Nigerian riots and Russian military movements can set prices gyrating, but the fundamentals are clearly bearish. It will most likely take several months for the core features of the new reality to change much at all.

CHART: 2008 Oil Production/Consumption

(click image to enlarge)

Low oil prices create both winners and losers on the international scene. First, the winners’ list.

Far and away the biggest winner from drastically lower prices is the world’s largest consumer and importer of oil: the United States. The last two years of high prices have spawned a sustained American consumer effort to get by with less oil via a mix of conservation and a shift to better-mileage vehicles. Whether this purchase pattern in automobiles lasts is not at issue. The point is that it has already happened: Many Americans have already shifted to more fuel-efficient vehicles. Just as the 1990s obsession with sport utility vehicles artificially boosted American gasoline demand so long as those automobiles were on the road, so the new fleet of hybrids and smart cars will push demand in the opposite direction for a sustained period.

Overall U.S. oil consumption has plummeted by nearly 9 percent from its peak in August 2007 to November 2008, according to the U.S. Department of Energy. Combining this with the drop in prices since July translates into U.S. energy savings of approximately US$1.95 billion at a price of US$50 a barrel and US$2.1 billion at a price of US$40 a barrel. And that is daily cost savings. In recessionary times, that cash will go a long way to building confidence and stanching the recession.

Next on the list are the major European importers of crude: Germany, Italy and Spain. As a rule, European economies are less energy-intensive than the United States, but by dint of fuel mix and lack of domestic production these three major states are forced to rely on substantial amounts of imported oil. We exclude the other major European economies from this list as they are either major oil producers themselves (the United Kingdom and the Netherlands) or their economies are extremely oil efficient (France, Belgium and Sweden). Don’t get us wrong — the EU states are all quite pleased that oil prices have dialed back. Nevertheless, in terms of relative gain, Germany, Italy and Spain are the real winners. And with Europe facing a recession much deeper and likely longer than that in the United States, the Europeans need every advant age they can get.

India, far removed from Europe culturally and geographically, sports a somewhat similar economic structure in that it boasts (or suffers from, based on your perspective) an industrializing base that is highly dependent on oil imports. Broadly, the Indians are in the same basket as Spain in that they are voracious energy consumers who have seen their demand skyrocket in recent years. Between the Nov. 26 Mumbai attack, upcoming federal elections and the energy price pain from earlier in the year, the government is desperate to pass on the cost savings to the population to shore up its support.

Then there are the East Asian states of South Korea, China and Japan (listed in descending order of how much each one benefits from the price drop). All import massive amounts of crude oil, but we put them at the end of the list of winners because of their financial systems. In East Asia — and particularly in China and Japan — money is not allocated on the basis of rate of return or profitability as it is in the West. Instead, the concern is maximizing employment. It does not matter much in East Asia if one’s business plan is sound; the government will provide cheap loans so long one employs hordes of people. One side effect of this strategy is that firms can get loans for anything, including raw materials they otherwise could not afford — such as oil at US$147 a barrel.

Therefore, high oil prices just do not affect East Asia as badly as they affect the West. Just as the East Asian financial system mutes the impact of high prices, the converse is true as well. In the West, energy consumers are not shielded from high prices, so lower prices immediately translate into more purchasing power, and thus more economic activity. Not so in East Asia, where the same financial shielding that blunts the impact of high prices lessens the benefits of low prices.

The order in which we listed the three Asian giants relates to how much progress they have made in reforming their financial practices. South Korea’s financial system is much closer to the Western model than the Asian model: South Korea hurts more as prices rise, and so will be more relieved as prices fall. China is in the middle in terms of financial practices, but it is also attempting to unwind its system of energy price-fixing as oil costs drop; due to subsidies being reduced, Chinese consumers actually may not be seeing much of a change in retail prices. Finally, Japan will benefit the least because its system is already highly efficient compared to the other two, so the price impact was less in the first place. One barrel of oil consumed in Japan generates approximately US$2,610 of Japanese gross domestic product (GDP), while the comparative figures for Korea and China are US$1,270 and US$1,130 respectively.

In short, the heavily industrialized Asians still benefit, but the impact isn’t as much as one might think at first glance. In fact, the biggest benefit to these states from cheaper energy is indirect — lower prices spur consumption in the West, and then the West purchases more Asian products.

And now, the losers.

Venezuela and Iran top this list by far. Both are led by politicians who have lavished vast amounts of oil income on their populations to secure their respective political positions. But that public approval has come at its own price in terms of economic dislocation (why diversify the economy if strong oil prices bring in loads of cash?), low employment (the energy sector may be capital-intensive, but it certainly is not labor-intensive), and high inflation (high government spending has led to massive consumption and spurred rampant import of foreign goods to satiate that demand).

Of the two states, Venezuela is certainly in the worse position. By some estimates, Venezuela requires oil prices in the vicinity of US$120 a barrel to maintain the social spending to which its population has become accustomed. Iran’s number may be only somewhat lower, but President Mahmoud Ahmadinejad is in the process of at least beginning to bow to economic reality. On Dec. 5, he announced massive cuts in subsidy outlays with the intent of reforging the budget based on a price of only US$30 a barrel.

It is an open question whether the Iranian government — and especially the increasingly unpopular Ahmadinejad — can survive such cuts (if they are indeed made), but at least there is a public realization of the depth of the crisis at the top level of government. In Venezuela, by contrast, the mitigation process has barely begun, and for political reasons it cannot truly be implemented until after a referendum in early 2009 on term limits that could allow Chavez to run for president indefinitely.

Next is Nigeria. In terms of seeing an increase in human misery, Nigeria should probably be at the top of the losers’ list. But the harsh reality is that Nigerians are used to corrupt government, inadequate infrastructure, spotty power supply and all-around poor conditions. Some of the perks of high energy prices undoubtedly will disappear, but none of those perks succeeded in changing Nigeria in the first place.

The real impact on Nigeria will be that the government will have drastically less money available to grease the political wheels that allow it to keep competing regional and personal interests in check. Those funds have been particularly crucial for funneling cash to the country’s oil-rich Niger Delta region, giving local bosses reason not to hire and/or arm militant groups like the Movement for the Emancipation of the Niger Delta to attack oil and natural gas sites. With Abuja having less cash, the oil regions will see a surge in extortion, kidnapping and oil bunkering (i.e., theft). We already have seen attacks ramp up against the country’s natural gas industry: Within the last few days, attacks against supply points have forced operators to take the Bonny Island liquefied natural gas export facility offline. And since Nigeria’s mil itants never really differentiate between the country’s various forms of energy export, oil disruptions are probably just around the corner.

Russia is also in the crosshairs, but not nearly to the same degree as Venezuela, Iran and Nigeria. Russia has four things going for it that the others lack. First, it exports massive amounts of natural gas and metals, giving it additional income streams. (Venezuela and Iran actually import natural gas and have no real alternative to oil income.) Second, Russia never spent its money on its population. Thus, Russians have not become used to massive government support, so there will be no sharp cuts in public spending that will be missed by the populace. Third, Russia has saved nearly every nickel it made in the past eight years, giving it cash reserves worth some US$750 billion. The financial crisis is hitting Russia hard, so at least US$200 billion of that buffer already has been spent, but Russia still remains in a far better position than m ost oil exporters. Fourth and last, the Russians can rely on Deputy Prime Minister and Finance Minister Alexei Kudrin to (somewhat forcefully) keep the books firmly in balance. At his insistence, the government is in the process of refabricating its three-year budget on the basis of oil prices of below US$35 a barrel, down from the original estimate of US$95.

At the end of the losers’ list we have two states that most people would not think of: Mexico and Canada. Both have other sources of economic activity. Canada is a modern service-based economy with a heavy presence of many commodity industries, while Mexico has become a major manufacturing hub. But both are major oil exporters, and have been leading suppliers to the American economy for decades. So both are exposed, but their concerns are more about unforeseen complications rather than the “simple” quantitative impact of lower prices.

Mexico has purchased derivatives contracts that, in essence, insure the price of all its oil exports for 2009. So should prices remain low, Mexico’s actual income will be unchanged. We only include Mexico on the list of losers, therefore, because it’s quite rare in geopolitics that such planning actually works out as planned. Hurricanes and strikes happen. (Mexico also faces the problem of insufficient funds, expertise and technology to counter rapidly declining output, something that will leave it with a lack of oil to sell in the first place — but that is an issue more for 2012 than 2009.)

As for Canada, most of the oil it produces comes from Alberta province, the seat of power of the ruling Conservative Party. Right now, the Canadian government is wobbling like a slowing top. Seeing the Conservatives’ power base take a massive economic hit due to oil prices is not the sort of complication the government needs right now. In the longer term, Alberta recently increased taxes on oil sands projects. Oil sands extraction is among the more capital-intensive and technologically challenging sorts of oil production currently possible. Combine the tax changes with the nature of the subindustry and the recent price drops and there is likely to be precious little investment interest in oil dur ing — at a minimum — 2009.

Most readers will take note of the countries we have chosen not to include on the list of vulnerable states. These include the bulk of the OPEC states — specifically Angola, Iraq, Kuwait, Saudi Arabia, the United Arab Emirates, Qatar and Libya. All of these states count oil as their only meaningful export (except the United Arab Emirates and Qatar, which also export natural gas), so why do we feel such countries are not in the danger zone?

For its part, Angola only became a major producer recently. Nearly all of Angolan oil output is from offshore projects controlled by foreigners — shutting in such production is a very tricky affair for a country that is utterly reliant on foreign technology to operate its only meaningful industry. But the primary reason Angola is not feeling the heat is that most of its income has not been spent but instead has been stashed away due to a lack of the necessary physical and personnel infrastructure needed to leverage the income.

Iraq is in a somewhat similar position as far as finances are concerned. While Iraq has been producing crude for decades, its current government is only a few years old, and its institutions simply cannot allocate the monies involved. Despite massive outlays by both Iraq and Angola, their respective governments simply lack the capacity to spend, and so have stored up cash accounts worth US$26 billion and US$54 billion respectively.

The rest of the Arab oil producers warrant a much simpler explanation: They’ve been fiscally conservative. While all have shared the wealth with their somewhat restive populations, none of them has repeated the mistakes of the 1970s, when they overspent on gaudy buildings and overcommitted themselves to expensive social programs. All have been saving vast amounts of cash, with the Saudis alone probably having more than US$1 trillion socked away. Tiny Kuwait officially has a wealth fund worth more than US$250 billion.

So while none of the Arab oil states are particularly thrilled with the direction — and in particular the speed — oil prices have gone, none of these governments faces a mortal danger at this time. What they are now missing is the ability to make a substantial impact on the world around them. At oil’s height the Gulf Arab oil producers were taking in US$2 billion a day in revenues — far more cash than they could ever hope to metabolize themselves. Bribes are powerful tools of foreign policy, and their income allowed them — particularly Saudi Arabia — to wield outsized influence in Iraq, Syria, Lebanon, and even in Beijing, London and Washington. So while none of these states faces a meltdown from falling prices, there are certainly some hangovers in store for them. It is jus t that they are more political than economic in nature, at least for now.

Tell Stratfor What You Think

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Saturday, December 13, 2008

Jim Rogers Covers His US Treasury Short Positions - For Now

A short Jim Rogers interview on Bloomberg - I believe from December 11, 2008. He says he has covered his short position in US Treasuries for the time being, because the trade was going against him.

He's waiting to short them again, and describes US Treasuries as "the last bubble left."

Other thoughts from Jim:
  • It's idiotic for Bernanke to purchase long-dated US government bonds.
  • Let the auto companies go into bankruptcy.
  • "The government has been taking the assets away from the competent people and giving them to the incompetent people...that's bad economics and bad morality."
  • These bailouts will be a "disaster for America", leading to the demise of the dollar, higher interest rates, and higher inflation.

Weekly Futures Positions Review - December 14, 2008

Top posts from the past week:

A review of my futures trades from the previous week:
Existing positions I've got:
  • None!

My wish list...and it looks like these commodities are at least starting to form a bottom, at last:
  • Sugar
  • Coffee
  • Cotton
  • Natural Gas
  • Silver
  • Crude Oil
  • Wheat
  • Corn

Account Balances
Current Cash Balance $49,196.88
Open Trade Equity $0.00
Total Equity $49,196.88
Long Option Value $0.00
Short Option Value $0.00
Net Liquidating Value $49,196.88

Cashed out: $20,000.00
Total value: $69,196.88
Weekly return: -2.7%
YTD return: -10.2%

***"Cash out" mostly means taxes, but lately I've also been using it for living expenses, and also to finance a cool new time management software startup that is starting to lift off.

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