August 12, 2008 

How To Get $2 Gasoline

Oil prices are finally listening to me.  Whew! 

The main reason oil prices had risen so high is that the world was consuming 87 million barrels a day, and only 86 million barrels a day was being produced.  Like a dog chasing its tail, prices kept getting bid up and up and up because that is what happens in a free market when there is a shortage of supply or an excess of demand.  And the oil markets really are a free market.

Several times over the last year I have suggested that supply and demand just had to fall back into line and bring some price relief.  I cited declining usage as we all cut back a bit.  I cited global declining demand as other economies contract in response to our economic slowdown.  But would the oil markets listen to me?  Nooooo.  Finally! Commodity prices appear to have topped out and are headed down, including oil.

The really good news is that oil prices can now be pushed down beyond reason just as far as they were pushed up beyond reason in the past year or two.  Markets rarely stop at rational pricing, but fluctuate between extremes on both the high and low ends. 

It is hard to believe, but 10 years ago, oil was $10 a barrel.  It may never get back that low, but the guy quoted in the Prescott Courier this week as saying gas will never, ever get back to $3 better get ready to eat his words.  I'm expecting gasoline will be $2 by the end of next year.  All you have to do to get $2 a gallon gas is wait for it.  Remember, you heard it here first!

But how can I be so sure?  First of all, my analysis of the difference in T-bill and T-Note yields tells me that forces of recession are still building, not waning.  And data from overseas suggests previously hot economies, like China and India, have cooled off dramatically.  Recessions push down demand which deflates prices rather than inflating them.

But the government says we aren't in a recession.  What about that?

The government statistics are focused on what is called Gross Domestic Product.  GDP is just the total of all goods and services sold in that period.  GDP has risen from a year ago, granted.  But $352 billion of the rise was just due to higher prices.  A smaller amount of growth, $213 billion dollars worth, was due to actual increased productivity.  But granted, there was some growth in GDP.  (Figures are as reported by Hoisington Capital Management in John Mauldin's Outside the Box newsletter)

But let's compare this gain to the loss in wealth over the past year which GDP does not count.  Stock market investors have lost more than $2.1 trillion in the past 12 months.  Trillion, with a T.  I'm not even sure how to describe the real size of a trillion, but there are a lot of zeros involved.   The Case-Shiller Housing Index suggests that homeowners lost another $3.1 trillion during the same period.  That means Americans are over $5 trillion dollars less wealthy than last year. 

To put this in perspective, if we figure that most losses are concentrated in the half of the population that owns 90% of the assets, this means the average family has lost over $140,000 in the last 12 months.

Now you know why so many consumers are tightening their belts with a trickle-down effect that affects all of us.

The bottom line is that dollars are being wiped out by losses so fast that they are overwhelming the amount of dollars being created by inflation by a factor of 14 to one.  And inflation has been what has driven oil prices up so high. 

This is more evidence that when history is written, deflation will be the hallmark of this economic environment, not inflation.  


Our Rose Bushes

We get many comments on how nice our new offices look following our complete renovation of the old house last year.  Thanks for your nice comments.

Occasionally I am asked what happened to the beautiful rose bushes that lined the front walk of the old place.  I'm happy to say that 15 out of the 16 rose bushes survived transplanting and now grace my back yard at home.  


INFLATION: cutting money in half without damaging the paper

WRINKLES: something other people have, similar to my character lines


Great Time Saver

When I find a technology that makes my life simpler, I like to share it. is one of those marvels.  I just love it!

I can call Jott from my phone, dictate a message that will be transcribed into text and emailed either to my house or office as I want.  Back at the office, I can cut and paste the text into notes or my calendar.  Often I just use it to remind myself of something I need to do.  It really works well. 

And it's free.   Check it out.

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Account Updates 

The HCM model1 called Careful Growth remains half in cash and half invested in stocks.  For the past month or so, the market has not gone up or down, but has gone sideways within a fairly narrow trading range.  As of this writing (August 8th) Careful Growth is up 1.80% for the month, and up.46% for the year.  The S&P 500 Index2 is down 11.72% for year.  One way to look at this 12% difference in performance is that I have earned for you about 5 or 6 years worth of  fees already this year.  Whenever you can get 5 times your money on something you have made a good investment.

I do think the probabilities favor higher stock prices in the near future. I wish I could be more certain, but unfortunately all I can deal in is probabilities. 

This is probably not the end of the bear market, however, and at some point a barrage of bad economic news will end the current market rally.  I'm not being a pessimist, but a realist.  My working assumption is that we are in a recession and a bear market for stocks. 

So, why bother?  Why take any risk at all? Why not just sit comfortably in the money market fund?  Why be invested in rallies that I believe will end before too long? 

For the same reason that I react quickly to downturns - we never know when a small decline is the beginning of a big decline, so we have to respect each one. 

And we never know when a small rally is the beginning of the next big bull market.  We likely will not recognize the bull for what it is right away, but the stock markets will turn strongly up long before signs of improvement are apparent in the economy.  We must respect the latent power in each rally that could be the beginnings of the next bull market.  There is great upside potential in getting into the next bull market early.

As long as we keep a good handle on risk management there is limited risk in working these rallies like I do.

Our Flexible Income model1 has not changed since my last writing.  We are about 1/3 in a peso fund that is working very well for us, 1/3 in a fund that goes up as junk bonds go down, and 1/3 in a fund that goes up as interest rates go up.  Overall Flexible Income is up a fraction of a % for the year.  All numbers I quote are after all fees and expenses have been deducted.

 1.         The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed.   Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account.  Not all trades are profitable.  It should not be assumed that current or future holdings will be profitable.   A list of all trades in these accounts for the past 12 months will be provided upon written request.
2.         The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market.  Investors cannot invest directly in the S&P 500 Index.
 Information in this newsletter is derived from sources deemed to be reliable; however we cannot guarantee its accuracy.  Please discuss any legal or tax matters with your advisors in those areas.  Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.