Friday, December 26, 2008

The future: Oil and Inflation

Some investors think that a Treasury bubble is forming. As you know, investors around the globe are placing huge amounts of money in U.S. Treasuries, some of which have a negative return! Eventually, with global governmental economic stimulation in the form of cash subsidies to nearly every industry, bailouts and forgiveness of everything from mortgages to credit card debt to student loans, we will have inflation. Actually, in an effort to stave-off deflation, governments around the world are trying hard to create inflation! Inflation....deflation.... as we can see these forces are not easy to control. 

How does one deal with the specter of hyper-inflation? Investment in commodities is the old standby. As the threat of inflation looms the Fed will raise interest rates in an effort to contain it. Here's an investment to consider: RRPIX. RRPIX is an ETF that bets on rising interest rates. As interest rates rise RRPIX goes up disproportionately. 

Once economies start to roar the price of oil will spike-up.... the incoming U.S. administration has taken a stance opposing drilling, against atomic power, against coal. That means, without a major energy break-thru, not currently on the radar screen, we are stuck with known oil reserves.

At today's price of gasoline, U.S. consumers are spending - get this - ONE BILLION DOLLARS A DAY LESS than they were over the previous 6 months! That is a huge number. On the back of recovery, with inflation nipping at our heels, the price of oil will come back with a vengeance. And a return to high oil prices will plunge us back into recession - that billion dollar a day tax will take its toll again. Remember, this billion dollar a day "gas tax" figure is only the amount levied on U.S. users, the "tax" is actually levied world-wide!

Think of the world's available pool of oil as a giant lake, say a thousand miles across. Now imagine that that lake is only 6 inches deep and the dam at the end of it is only 6 inches high. The oil is trickling in on one end and, in spite of all attempts, it can't be stopped (the countries that produce it must keep-up production or face insolvency and political unrest)..... and it can't be increased significantly (peak production problems). Any unused oil spills over the dam onto the world market and forcefully drives the price down. Conversely, any increase in its use dramatically reduces the lake's level and the the stuff zooms-up in price. Right now the dam is overflowing... some say the price of oil may drop to $25 a barrel. But when world-wide economies turn positive... watch-out! All this... with the added certainty that it will take decades to develop an "alternative" source of energy, even if we turned to the nuclear option today.

What does all this mean? It may portend a new historic world-wide trend to Whip-Sawn economies. Sharp inflation followed by dramatic recessions - one on the heels of the other. This oscillation will only get worse with every cycle. In spite of Al Gore and Co., mankind will, for the foreseeable future, continue to use fossil fuel as humanity's primary source of energy.

Happy New Year!