Agora Financial’s Rude Awakening

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Laguna Beach, California

• Is the “oil rule” the new “golden rule?”
• A curious divergence between oil stocks and the stuff itself,
• Where the vultures shall gather and plenty more…  

Eric Fry, reporting from Laguna Beach, California…

Oil up, oil down, oil back up again…and then up some more. The oil market is out of control! Daily price moves of $3 to $5 are becoming commonplace. Last week, the oil price rocketed $16 higher in just two trading sessions.

Oil skeptics cite this extreme volatility as proof that “speculators” are running the show in the trading pits and that the “oil bubble” is about to burst. But your editors here at the Rude Awakening merely observe the pyrotechnics with awe…and a chuckle. After all, wasn’t this the same commodity that so many experts pronounced “overbought” at $70 a barrel, then at $80 a barrel, then at $90 a barrel? And by the time oil topped $100 a barrel, didn’t the experts rush to dismiss the advance as a “blowoff top?” And now that oil refuses to fall back below $100 a barrel “where it belongs,” hasn’t the word “bubble” became a staple of the experts’ vernacular?

“Certainly,” the oil skeptics have been insisting for many months, “fundamental demand is not boosting the oil price. Obviously,” the skeptics continued to insist, “the speculative buying will end and the oil price will tumble back to its ‘fair value.’”

But so far, the “certain” and “obvious” trades in the oil market have produced disastrous results. The oil market will retreat if and when it wishes, not before.

Certainly and obviously, the oil market is “overdue” for a correction. The oil price has become extraordinarily volatile, which is a trait that tends to accompany market tops. Nine times this year, the oil price has moved more than 4% in a single trading day. For perspective, the oil price achieved this
feat only eight times during all of 2007 and only three times in 2006. So something different is going on.

But oil’s toppy short-term action does not negate the powerful long-term forces that have been driving it price higher…and will likely continue to do so. Global demand for the precious black goo remains robust, while global supplies remain constrained.

And let’s not ignore one additional “long-term force” that is also wielding a powerful – albeit subtle - influence over the oil price: Dollar devaluation. The skyrocketing oil price is as much a monetary phenomenon as a geophysical one.

Several previous editions of the Rude Awakening have examined the growing connection between the falling value of dollars and the rising value of crude oil. [See: "Selling Dollars, Buying Stuff" June 5, 2007 and "What Comes After A Trillion?" May 8, 2008.]

In today’s column, Byron King, editor of Outstanding Investments, contributes a few additional insights about the “Anti-Dollar.”

— Byron King’s Energy & Scarcity Investor —

The breakthrough that could put oil refineries out of business…

This tiny company’s private technology refines crude oil as it’s pulled out of the ground

And you can get in on it today for a potential 250% gain this year - but you must act before the “Oil Vacuum” achieves a milestone targeted for no later than July 12, 2008.  Read On…

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The Anti-Dollar
By Byron W. King

Oil has become the “anti-dollar” of modern times. Oil is now serving as the source of global monetary discipline that gold used to perform.

Oil is the energy life-blood of all modern economies. So when a nation debauches its currency, the oil markets react instantly. And oil will not accept monetary malpractice, certainly not by the U.S. Federal Reserve. If traders perceive that the dollar is declining, this perception lights the
fuse for oil prices to rise.

There is an old saying that “You can’t fight the Fed.” But oil is fighting the Fed. In fact, oil is scoring a knockout, like Muhammad Ali over Sonny Liston. Oil is floating like a butterfly and stinging like a bee - landing body blows and pinning the Fed against the ropes.

The Fed can no longer cheat with the money supply and get away with it.  There is a new gold standard and it’s called “oil.” This may not be a monetary “fact” that central bankers would acknowledge publicly. But it is a monetary fact of life out in the trading pits.

Even the President himself is powerless to alter this new fact of life. He cannot simply fortify the dollar’s supremacy by seizing the world’s oil at $20.67 a barrel, like Franklin Roosevelt seized America’s privately held gold for $20.67 an ounce in 1933. And even if the President could confiscate the world’s oil at below-market prices, he might not understand how such a confiscation would influence the dollar’s value.

The “oil connection” to monetary policy is a new and poorly understood development. It’s not what people expect. It’s not how we all grew up. It sure did not used to be this way. 

For the past 149 years, it has been a fairly safe bet that the world’s oil supply would grow. The only truly difficult period for oil was between 1979 and 1981, when the Iranian oil industry collapsed in the wake of revolution.  The world supply-chain lost nearly five million barrels per day of output.
And that loss helped produce the worst recession in the U.S. since the 1930s. 

But even back in the early 1980s, new oil sources were coming online.  Everybody could see it. The fields of Alaska, the North Sea, Mexico, Angola and other places were just kicking into gear. So the price of oil could not go “too high” because there was a clear indication in the marketplace that there would be more oil coming down the pipes. 

And that’s exactly what happened. By the mid-1980s, oil was selling for less than $15 per barrel. Cheap energy made a lot of things look easy, from growing the economy to winning the Cold War. 

There was a dark side to cheap oil, however. It produced and nurtured the illusion that oil would be cheap forever…or at least for a very long time. But looking ahead from today, it is crystal clear that it will be more difficult to grow the worldwide oil supply than in the past. We may be at
Peak Oil right now, but we won’t know that for a while. 

Oil-producing areas like Alaska, the North Sea and Mexico, are in decline.  Meanwhile, as worldwide oil demand grows quickly, oil output is at a measurable plateau. There is almost no “spare” capacity anywhere outside of Saudi Arabia, and the Saudi margin is smaller than most people think. At the same time, net oil exports are decreasing from most oil-producing nations.  Internal demand is rising in almost all oil-producing states. So there is simply less oil to go around. And unlike in the early 1980s, there’s no relief in sight. 

Oil supplies are severely constrained. Dollar supplies aren’t. Perhaps these related facts are what inspired Alexey Miller, the CEO of Russia’s oil giant, Gazprom to predict that oil would rise to $250 a barrel in “the foreseeable future.” The Fed can “talk” a strong dollar all it wants, but as long as the
supply of dollars and dollar-denominated credit continues to grow, the oil price will continue to climb.

In the era of Bretton Woods, the global monetary system followed the golden rule: “He who has the gold makes the rules.” But today, the “rule of crude” dominates. Thus we are left to ask, what is the meaning of crude oil at $137?  It means that the reign of the dollar is coming to a close. The dollar has reached the end of its post-Second World War period of dominance as the world’s reserve currency. 

That’s why today’s oil buyers, like the late French President Charles de Gaulle, are so eager to exchange their dollars for a tangible asset. De Gaulle shipped France’s dollar reserves across the Atlantic in exchange for gold bars from the vaults of Fort Knox. Today oil traders are shipping their excess dollars to the New York Mercantile Exchange in exchange for barrels of oil. The motives are identical. Only the underlying monetary asset has changed.

So what of the U.S. dollar? Well, a man named Lazarus once rose from his death bed. But Lazarus had some help. Could the dollar be as fortunate as Lazarus? These words come to mind, from the Book of Luke at 17:37: “Where the corpse lies rotting, there the vultures shall gather.”

[Joel's Note: In an era where the Fed’s dollars are plentiful and Mother Earth’s resources are scarce, preserving the value of your investments is becoming increasingly important. And that’s precisely the aim of Byron’s Energy & Scarcity Investor research service: to seek out long term investment trends in an era of mounting human demand and dwindling natural supply.

Don’t let the stories of skyrocketing food prices and record oil sink your investment future…profit from it instead. For a sneak peak at Byron’s latest report, read on here.

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Did You Notice? – What to Do with Oil
By Eric Fry

Even ardent, long-term oil bulls might be anxiously wringing their hands these days. Sure, the oil price is heading higher, but the daily price volatility if terrifying. Some days the oil price plummets $3 or $4 dollars and looks every bit like a bubble about to burst. But then, just as suddenly and violently, the oil price soars $5 or $7 or $11 in a single day!

So what’s an investor to do? Buy oil or sell it? The answer may be “both.” In other words, sell crude oil and buy oil stocks. We realize that we are not the first market observers to identify this prospective pair trade. Further, we realize that any investor who has attempted this pair trade during the last several months has fared poorly, if not miserably. But so be it. We are happy to be “late” to this trade.

Admittedly, oil might continue to soar while oil stocks languish. But as the chart above illustrates, the divergence between crude oil and oil stocks has already reached a rare extreme. Could this divergence become even more extreme? You betcha. But on the other hand, some sort of regression toward the mean seems like the high-probability bet…at least for those who enjoy betting.

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[Rude Endnote: For the record…We begin this Thursday’s trading with the DJIA over 200 points lighter at 12,083.77. The S&P 500 kicks off 22 points lower at 1,335.49 and the NASDAQ, after slumping two and a quarter percent yesterday, begins trading at 2,394.01.

In the commodities sector, gold got belted in yesterday’s trading, falling $11 to around $871. Oil fell a buck fifty to sit a shade under $135 per barrel.

Meanwhile, the dollar index approached its highest level in a week, gaining to 73.565 after Bernanke assured us the risk of a deeper economic slowdown is receding.

Hmm…the highest rate of job losses in 22 years, $1.7 trillion of household equity wiped out in the first quarter, record oil squeezing manufacturers’ profits, ongoing debacle in the financial sector…

If this paints a rosy picture for Bernanke, we’d hate to see his doom and gloom report.

Until tomorrow…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com