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It is NOT about the OIL after all
Old 05-19-2006, 09:16 AM   #1
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It is NOT about the OIL after all

Two interesting articles from recent issues of the Wall Street Journal here. The basic point is that high oil prices are just symptomatic of higher commodities prices overall due to the general lack of confidence in our government's ability to pay back its obligations in dollars that are worth a dollar. In fact, Oil is not far off from where it should be relative to precious metals prices. Thoughts?

In Gold We Trust

By DAVID RANSON and PENNY RUSSELL
May 18, 2006;

Widespread fear of another global energy crisis is rife, especially in light of the confrontation with Iran. But the second of Murphy's Laws cautions that what actually goes wrong is seldom what we anticipate. While the markets are clearly indicating something ominous, the current situation is mischaracterized as an energy crisis -- even if the price of a gallon of gas goes past $3 and stays there. Energy prices are simply keeping pace with the rising prices of gold and other commodities. What we are facing is a money crisis: an alarming outbreak of inflation and all its consequences.

It's silly to blame the rise in commodity prices on foreigners; no country, not even China or Saudi Arabia, has the market power to set off the kind of across-the-board acceleration in prices that we have been witnessing. Nor can prices rising this consistently and at this speed be attributed to an excess of global demand over supply, or fears about the political situation in Iraq or Iran. Speculators, another convenient scapegoat, also lack the power to drive world commodity markets, in spite of their rapacious reputation. The real culprit is the precipitous decline in the world's mightiest currency, the dollar, which has lost more than 60% of its gold value in just four years.


The run on the dollar is largely being ignored by Washington and Wall Street, and most of the financial press is only beginning to take note. When analysts do comment on the strength or weakness in the dollar, they are most often referring to its value in terms of foreign exchange; little attention is given to the value of the dollar in terms of gold. When headlines do herald that the price of gold is rising, there is little recognition that, since gold is quoted in dollars, it is just as true that the dollar is falling. It is gold that is a benchmark for the value of the dollar -- not the other way around. When the dollar price of gold is on the rise, the dollar prices of oil and other commodities have historically kept pace.

It is only the nominal price of oil that has reached record levels; in real terms, we are still on the road to recovery from the genuine energy crisis that culminated with Hurricane Katrina. Although it is the accepted convention to calculate the real price of an asset from official government measures of inflation such as the CPI, this would be a mistake in the case of energy. Since oil is traded in fast-moving markets worldwide, its real price can only be assessed by comparison with other internationally traded commodities; for this purpose the U.S. cost of living index is irrelevant. We suggest instead using an index of precious-metals prices.

The adjacent chart shows the divergent picture of the oil market that emerges when representative oil prices (West Texas Crude) are expressed in real terms. The solid line charts changes in the ratio of the price of oil to a price index for precious metals over the past half century. While the chart shows abundant variations in the real price of oil over time, it also shows the real price gravitating around a slowly rising trend. The dotted line represents the equilibrium real price of oil. We believe that its gradual upward slope reflects the fact that oil is gradually becoming scarcer with the passage of time.

The chart confirms that the real price of oil peaked out late last year and has been on the decline since. In other words, the dollar has been falling relative to its precious-metals benchmark faster than oil has been rising relative to the dollar. That's why we believe that the current rise in the dollar price of oil is merely the process by which this price converges toward equilibrium. Far from entering into a new crisis phase, the oil market is still cooling off from the last one.

We estimate from nearly a half century of history that the equilibrium price of oil, converted back to current dollars, was about $61 a barrel in April. In other words, the long-term history of the ratio between oil and precious-metals prices, given the prices that these metals have now reached, implies that the oil market would be in balance at $61. The actual price in April was $70. Reading from the graph, we see that the real price of oil has moved two-thirds of the way back to equilibrium since Hurricane Katrina.

It's not the time, however, to breathe a collective sigh of relief. It is just as foolish to fail to recognize a true crisis in the making as to conjure one up. As of this writing, gold is fluctuating around the $700 mark, with silver and platinum up at least as much. The gold value of the dollar appears to be going into free fall, and the further it declines the more dire the consequences, including still higher nominal prices for energy, even without any further change in the real price. Absent some miraculous reversal, $3-a-gallon gasoline may be here to stay.

If none of the usual suspects is responsible for gold's sharp rise, what is? We believe it represents an equally sharp decline in the confidence of investors -- large and small -- in the likelihood that Washington will pay back its mounting obligations in undepreciated money. Throughout history, and especially in wartime, governments have escaped from fiscal over-commitments by letting their currencies depreciate. Ambitious spending initiatives, threats of international conflict and even Washington's political unpopularity all contribute to the fear that this is happening again now.

Gold is the barometer of public confidence in fiat money, and it is difficult to rebuild confidence in a currency once it has been allowed to slide. Gold has been a reliable harbinger of many economic troubles -- not just of escalating prices at the gas pumps, but of inflation, rising interest rates, stagnation and poor investment performance on the part of bonds and equities alike. Changes in the price of gold are an excellent predictor of all of these. The dollar's collapse is nothing less than a body blow to capitalism. When we downplay the significance of energy prices, we are not denying that a crisis is looming. It's just a lot more threatening than an increase in the cost of a tank of gas.

Mr. Ranson and Ms. Russell are principals of H. C. Wainwright & Co., Economics, an investment-strategy research firm.


Adam Smith Growls
May 19, 2006; Page A10

Stocks continued their weeklong plunge yesterday, selling off again at the end of the day on more inflationary fears. The way to understand this washout -- knocking 4.4% off the Dow -- is that Adam Smith is giving the U.S. financial establishment a warning.

We're using our favorite moral philosopher here as a proxy for the ruthless discipline of financial markets. They can be brutal in punishing economic mismanagement, and for several days Mr. Smith has been growling that the Federal Reserve and its easy-money cheerleaders on Wall Street and in Washington need to sober up, or there will be far worse to come. The press is calling this an "inflation scare," but for those who want to know how markets respond once a real inflation settles in, we suggest reading an economic history of the 1970s. It isn't pretty.


The 4.4%-cold shower may even prove to be beneficial if it changes the psychology in elite political and economic circles. For the last year especially, they've been ignoring signs of incipient inflation, first by trusting in Alan Greenspan's assurances, later pointing to low long-bond rates, or any other excuse to avoid facing up to a world awash in dollar liquidity and soaring gold, oil and other commodity prices. (See gold's run nearby.) This is the kind of psychology that often takes hold at this stage of an expansion, with everyone enjoying the good times and desperately afraid the Fed will spoil the fun.

But the lesson of the past 30 years is that the economic pain is far more severe the longer the Fed stays too accommodative and lets pricing pressures build. The consumer price index reading that triggered Wednesday's selloff is a lagging indicator, after all, the kind that tells you inflation is here only after it has already arrived. As Paul Volcker -- the man who finally broke the 1970s inflation -- once noted, the actual inflation data comes in months later but spot commodity prices are a real-time signal. Investors have finally begun to doubt the Fed's happy talk about a "pause" in raising interest rates or that inflationary pressures are "contained."

All of which suggests that Mr. Greenspan's successor as Fed Chairman, Ben Bernanke, is facing a rough passage. He's arrived at a Fed that has clearly made a mistake in letting inflation expectations build and has been very slow to admit it. The only questions now are the magnitude of that mistake and of the resulting financial casualties.

It's worth noting that while stocks fell yesterday, bonds rallied after comments by a couple of Fed officials that inflation may be gathering steam. "I pay a lot of attention to inflation expectations," said St. Louis Fed President William Poole, which makes us wonder what he and his colleagues have been paying attention to the last year.

The sooner Mr. Bernanke shows that he understands the problem, and has the fortitude to do something about it, the fewer casualties there will be. Sooner or later Adam Smith will take over if Mr. Bernanke doesn't.

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Re: It is NOT about the OIL after all
Old 05-19-2006, 09:27 AM   #2
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Re: It is NOT about the OIL after all

Just about any commodity you care to name is up big time over the last couple of years. Its a falling USD plus huge global demand for stuff.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 09:28 AM   #3
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Re: It is NOT about the OIL after all

Makes sense, the problem though is that america runs on cheap gasoline. And the rise over 3 dollars a gallon and people having to spend 80 a fill up instead of 25 bucks IS a big problem, heck my moving costs are up almost 600 dollars because of the extra cost for the truck.

Anyway americans have really no alternatives to getting to work, like trains the american railroads look like something out of the old USSR!!

It will get very ugly in america I am glad I have cashed out of my big mortgage and downsized.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 09:33 AM   #4
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Re: It is NOT about the OIL after all

Hey, newguy, how is the move and all that going? Found a place to land down south?
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Re: It is NOT about the OIL after all
Old 05-19-2006, 09:34 AM   #5
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Re: It is NOT about the OIL after all

I'm not picking on this OP, it just seems like I've seen this once or twice lately and thought I'd bring it up again.

Posting whole articles here will sooner or later lead to problems as some publishers can get in a snit about republishing their stuff. It's best to summarize and/or selectively quote and link to the original article.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 09:38 AM   #6
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Re: It is NOT about the OIL after all

Things are progressing I think, the buyers had their home inspection and want to close the middle of june. I still will not believe that we have a contract on the house and have it sold until I have a check in my hand.

Anyway we have found a place south of raleigh, and will need a 40,000 mortgage, heck that is a car loan. i intend to close on the new place the end of june and work sept-jan back in NJ staying at a good friends place and then be early retired on Jan 1 2007.

It seems to be ok..
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Re: It is NOT about the OIL after all
Old 05-19-2006, 09:39 AM   #7
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Re: It is NOT about the OIL after all

Quote:
Originally Posted by newguy88
Things are progressing I think, the buyers had their home inspection and want to close the middle of june. I still will not believe that we have a contract on the house and have it sold until I have a check in my hand.

Anyway we have found a place south of raleigh, and will need a 40,000 mortgage, heck that is a car loan. i intend to close on the new place the end of june and work sept-jan back in NJ staying at a good friends place and then be early retired on Jan 1 2007.

It seems to be ok..
Sounds good.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 10:03 AM   #8
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Re: It is NOT about the OIL after all

Quote:
Originally Posted by BigMoneyJim
I'm not picking on this OP, it just seems like I've seen this once or twice lately and thought I'd bring it up again.

Posting whole articles here will sooner or later lead to problems as some publishers can get in a snit about republishing their stuff. It's best to summarize and/or selectively quote and link to the original article.
Sorry about that.* I didn't know for sure if the article could be publicly linked.* If you think you need to take down the subject, that's fine.

To the extent the dialog can continue, however, the article is at variance with the view that this is simply an issue of increased global demand or market manipuation by suppliers.* It states the real culprit is the precipitous decline in the world's mightiest currency, the dollar.* Put another way, it says the price of commodities would have gone up a lot less if our financial house was in order.* To the extent you feel both factors will continue -- global demand and the need to pay back our gov't obligations in depreciated currency, does it at all change some of the views expressed here on limiting one's asset allocation toward commodities?* What are the implications for FIRE folks?
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Re: It is NOT about the OIL after all
Old 05-19-2006, 10:05 AM   #9
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Re: It is NOT about the OIL after all

It suggests that our fiscal policies are causing us to "Import inflation". As far as portfolio allocations go, just make sure you have some non-USD denominated assets (like foreign stock and bonds) in addition to some commodities.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 10:20 AM   #10
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Re: It is NOT about the OIL after all

I have zero stocks, just a nice COLA pension with med bennies for both me and the wife, about 25 grand in cash, a new house almost paid for see above and a part time job set up for jan of 2007 making 1400 a month working 6 hours 3 days a week. I will have about 50 grand a year with a 380 a month payment to live in a nice new house.

Inflation you bet, import inflation yep.


But the increase in oil prices are a FEAR ISSUE and I must say American traders are efin scared $hitless, Oh Iran, Oh a hurricane Geeze wiz where are the tough americans?
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Re: It is NOT about the OIL after all
Old 05-19-2006, 10:23 AM   #11
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Re: It is NOT about the OIL after all

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But the increase in oil prices are a FEAR ISSUE and I must say American traders are efin scared $hitless, Oh Iran, Oh a hurricane Geeze wiz where are the tough americans?
Hmmm, last I checked, oil was used all over the world.

I think that there is likely a fear premium in oil, but not that much of one. Demand has been very strong and supply is relatively inflexible. Lots more demand plus not much more supply = higher prices. Simple as that.

As for whether hurricanes are a justified worry, well, there was a very real possibility that there would be enough gas to go around at one point last year. As it turned out, things were OK once a ton of refined products were shipped in and there were no refineries that were actually destroyed. But I think that it was a close thing for a while there.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 10:33 AM   #12
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Re: It is NOT about the OIL after all

Fear premium, I believe is alive and well.

Now how can we get americans into 35+ mpg vehicles??
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Re: It is NOT about the OIL after all
Old 05-19-2006, 10:34 AM   #13
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Re: It is NOT about the OIL after all

Quote:
Originally Posted by brewer12345
I think that there is likely a fear premium in oil, but not that much of one.* Demand has been very strong and supply is relatively inflexible.* Lots more demand plus not much more supply = higher prices.* Simple as that.
So, you're saying that the supply/demand picture has changed by a factor of 3x in 3 years?

I've heard that oil should be about $40 based on supply/demand. The rest is speculative noise.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 10:39 AM   #14
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Re: It is NOT about the OIL after all

wab....

Generally agree except for this detail. Isn't demand created by speculative purchasing just a subset of total demand. I mean the market price is still determined by supply and demand, right?
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Re: It is NOT about the OIL after all
Old 05-19-2006, 11:04 AM   #15
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Re: It is NOT about the OIL after all

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So, you're saying that the supply/demand picture has changed by a factor of 3x in 3 years?

I've heard that oil should be about $40 based on supply/demand.* *The rest is speculative noise.
Nobody really knows. Its not that demand has to triple, it is the interplay between supply and demand. When there is lots of slack between the two, prices don't move around that much. When things are tight, get out of the way...
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Re: It is NOT about the OIL after all
Old 05-19-2006, 11:24 AM   #16
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Re: It is NOT about the OIL after all

Quote:
Gold is the barometer of public confidence in fiat money ...
Anyone who uses the phrase "fiat money" immediately and irrevocably causes me to put him (or her) into the lunatic category.* Anyone who argues against this classification also ends up in lunatic category.* Ad infitinum, including repeated Cantor diagonalization.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 11:24 AM   #17
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Re: It is NOT about the OIL after all

Quote:
Originally Posted by youbet
Generally agree except for this detail.* Isn't demand created by speculative purchasing just a subset of total demand.* I mean the market price is still determined by supply and demand, right?
Well, I see a fundamental difference between consumer demand and speculator/investor demand. * *Gold is the classic example. * Consumer demand is weak, so the price only moves when speculators jump in. * *The speculators aren't consumers. * *And they don't hold for "investment," which is generally something that produces income/earnings. * *So, speculators are very fickle. * They buy or sell based on what they think other speculators are going to do. * *That creates volatility, and ultimately a crash when the party is over.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 11:40 AM   #18
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Re: It is NOT about the OIL after all

(newguy88)
"Anyway americans have really no alternatives to getting to work,..."

Actually, I think the people that are really having trouble affording fuel can cut their costs in half by finding a carpool. The more blue collar people start to do it, the less "communist" it will be, then even more people will do it.
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Re: It is NOT about the OIL after all
Old 05-19-2006, 11:49 AM   #19
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Re: It is NOT about the OIL after all

Back "home" in southern Indiana, carpooling is a way of life for many folks, who have to drive 30-45 miles one-way to get to Cummins in Columbus, or GE or Ford in Louisville...
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Re: It is NOT about the OIL after all
Old 05-19-2006, 11:54 AM   #20
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Re: It is NOT about the OIL after all

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Back "home" in southern Indiana, carpooling is a way of life for many folks, who have to drive 30-45 miles one-way to get to Cummins in Columbus, or GE or Ford in Louisville...
But it would be nice if a TRAIN could get them to work.

Heck think about the jobs we could develop here in america if we decided to build a world class train system!!
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