The Fundamental Things Apply... As Time Goes By
By Tony Allison, July 9, 2007
With apologies to Casablanca, the markets ultimately make their way back to reflect the basic fundamentals. Geopolitical concerns, terrorism, election years, coordinated central bank actions, and even suspect government statistics can move the markets for a short period of time. But as time goes by, the basics of supply and demand eventually form the proverbial bottom line for the long term trends.
Global Money Printing — Not slowing down
The world economy continues to grow and continues to inflate as global money printing stays in overdrive. Central bank rates of currency growth this year are astounding. Leading the charge is Russia at 51%, India 20%, China 17%, Australia 14%, the UK 14%. The US is estimated at 10-12% growth, but with M3 now unreported, who knows for sure. The Bank of England has raised interest rates 5 times in a year, noting they are concerned about inflation. If the BOE was truly concerned, they might slow the rate of currency growth to low single digits. The world’s major central banks seem to have chosen growth over fighting inflation in the future. The odds favor continued global growth, not recession, as the supply of currency grows around the clock, well in excess of global GDP growth. Global inflation may be the price we pay for continued global expansion.
An Insatiable Thirst
On any day of the week, those of us in Southern California can drive to the Port of Long Beach and see oil tankers lined up to the horizon and beyond, bringing in oil and refined products from all over the world. We as a nation will not and cannot stop using oil, and $70 per barrel is not slowing down demand. The US used to export oil to the rest of the world, but now we must import over 60% of our energy needs. That number will go higher with increasing energy demand, and with domestic supply steadily decreasing since the peak in 1970.
Even if Wall Street insists on stripping out energy and food costs from the “core” CPI data, higher energy costs are seeping into every aspect of the economy. Our insatiable thirst for oil and our increasing energy dependence will add to our inflationary burdens. Inflation takes a long time to become embedded into the system. Once inflation awareness and expectations set in among the public, it will take a long time to get rid of it.
In the years and decades to come, oil will be in ever-greater demand around the world. Supply will continue to be found, but the cost of getting the oil to market will get higher as companies and countries look to deep sea drilling, tar sands and oil shale production. All these methods are extremely expensive in terms of labor, materials and energy expended. Oil will always be available, but the cost of producing a barrel of oil, transporting it, and refining it will likely continue to rise. In addition, the supply of light, sweet crude is declining rapidly. Heavy sour crude will be the substitute, but it’s harder to extract and more expensive to refine. Many refineries are not equipped to refine heavy crude at any price. New technology will help, but labor and material costs are rising in the race to bring oil to market as quickly as possible. The demand for oil will continue unabated, given rapid Chinese and Indian industrialization, but future supply will likely arrive with a higher price tag. From an investment perspective, capital will continue to flow to this critical sector. The best companies, with good reserves in stable locations, will be enormously profitable in the years ahead.
In 2002 oil was $20 per barrel. In 2004, $50 per barrel. Now it is $72+ per barrel and demand is still increasing at 2% per year (which exceeds growth in supply). The world is adjusting to a higher cost of energy, but it is functioning like a global tax, which is beginning to bite into US consumers.
In the future, oil will be even more critical to global prosperity, as it will be more and more coveted by every nation on earth, both sellers and buyers. The arrival of Peak Oil will likely be the most critical and defining event of the 21st century. Energy and other tangible assets will form the mirror opposite of the global currency glut, as the particularly debased currencies become less and less coveted, as time goes by.
Stay Invested in Tangibles
The flood of liquidity racing around the globe has already moved into commodities, and should continue for years as past commodity cycles have lasted 15 to 20 years. During this cycle, there has been an unprecedented demand for base metals and other commodities as Asia industrializes (China and India alone represent 40% of global population). Beyond that, many “smart money” institutions, firms and wealthy individuals understand global currency debasement, and are seeking a store of value. Energy, base metals, and precious metals provide an anchor of value in a world adrift in inflating paper.
The inflation train has departed the station and will be arriving in your town one day. The powers that be will try all manner of disguises to hide inflation’s arrival, but your wallet will see through any disguises in fairly short order. For many in the middle class living on the edge, the corrosive effects of inflation are already affecting lives and futures.
Beware the Full Cycle of Inflation
Most of us read about incessant money printing and massive debt creation and shrug indifferently. It doesn’t seem to be a problem. The global economy has never been stronger, and things are humming along nicely. We have become excessively familiar with the Goldilocks metaphor. While much of this is true, the inflation cycle is also not complete. The future is impossible to foresee and history does not always repeat, but I leave you with a quote that underscores the current state of global complacency. If we are indeed still in the early stages of inflation, the final stage may not be pretty. The passage comes from Jim Puplava’s article “The Great Inflation”. In it, Jim quotes author Jens Parsson, who wrote “Dying of Money.”
“Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steeper money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits and no one pays. This is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and ineffectiveness of traditional remedies. Everyone pays and no one benefits. This is the full cycle of every inflation.”
Clearly, no economist, analyst or politician will ever know what tomorrow may bring. But the fundamental things, such as supply and demand, will continue to apply as time goes by.
The markets edged higher Monday as investors were relieved by a drop in Treasury bond yields, yet still remained cautious as second-quarter earnings season kicks off this week. Investors were looking to corporate earnings to help give the market some direction in the coming weeks. Reports had their unofficial start after the closing bell when aluminum producer Alcoa Inc. released results that matched analysts' projections.
The yield on the benchmark 10-year Treasury note dipped to 5.16 percent from 5.18 percent on Friday. There had been some concern that the steady rise in bond yields since June would slow Wall Street deal-making.
The Dow Jones Industrials rose 38.29, or 0.28 percent, to 13,649.97. The blue chip index came within about 7 points of its record close of 13,676.32 before falling back. Broader market indexes were also higher. The Standard & Poor's 500 index rose 1.41, or 0.09 percent, to 1,531.85, and the Nasdaq composite index added 3.51, or 0.13 percent, to 2,670.02.
Gold futures closed sharply higher Monday, extending their prior-session gains, boosted by softness in the dollar and general strength in the metals market.
Gold for August delivery closed up $7.70 at $662.50 an ounce on the New York Mercantile Exchange. Other metals prices also gained ground.
Crude-oil futures fell Monday, but closed above $72 a barrel, as traders locked in profit from recent gains and shrugged off a bullish report from the International Energy Agency. Crude for August delivery closed down 62 cents at $72.19 a barrel on the New York Mercantile Exchange.
"No less than the International Energy Agency has given market bulls its endorsement with its latest report, which states that world oil demand will rise faster than expected to 2012 with expected production lags, leading to a supply crunch," said Michael Fitzpatrick, analyst at Man Financial, in a research report. (emphasis added)
There are those fundamentals again. Keep them in mind.
Wishing you a good evening,
© 2007 Tony Allsion