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cavaliere@cavalierecapital.com WEEKLY NEWSLETTER VOL 2 ISSUE 7
CAVALIERE CAPITAL CORPORATION
WEEKLY PETROLEUM, SUGAR-BASED ETHANOL, and ECONOMICS NEWSLETTER VOL 2 ISSUE 7
Jose A please visit our website for more information www.cavalierecapital.com
Sunday, February 17, 2008. VOL 2 ISSUE 7.
--OIL PRICES PASS $96, BUT SETTLE FLAT. --CRUNCH TIME FOR MEXICAN OIL. --IEA CUTS OIL DEMAND FORECAST ON SLOWING ECONOMIC ACTIVITY. --UBS CONFIRMS HUGE FOURTH-QUARTER LOSS. --MORE GRAIN PRODUCTION SOUGHT. --THERE IS NO INFLATION, BUT EVERYTHING WE BUY IS UP (My Opinion).
Oil Prices Pass $96, But Settle Flat
Crunch Time For Mexican Oil Crude-oil futures sped past $96 a barrel Friday before ending all but flat, unnerved by
gloomy U.S. economic reports and deflated by profit-taking ahead of a long holiday weekend. Light, sweet crude for March delivery closed 4 cents, or 0.04%, higher to settle at $95.50 a barrel on the New York Mercantile Exchange, after earlier rising to $96.67 a barrel. April Brent crude on the ICE futures exchange closed at $94.68 a barrel, down 48 cents. The quiet close belied a strong week that lifted the front-month Nymex contract 4.1%. Friday's close is a five-week high. Crude has risen in six of the last seven sessions. Supply worries re-entered the picture over the week as a legal standoff between oil-producer Venezuela and ExxonMobilCorp. prompted the South American nation to stop delivering crude to Exxon. The amount of oil affected is fairly small, however, and analysts doubted Venezuela would seek to cut off additional oil to other U.S. customers. The head of the International Energy Agency, the energy watchdog for the wealthiest industrialized countries, said Friday consuming countries won't need to tap strategic petroleum stocks to offset halted Venezuelan oil flows. An assortment of economic reports Friday pointed to an economic slowdown in the U.S., the world's top energy consumer. Manufacturing activity in the New York Federal Reserve's region declined markedly to its weakest level in nearly two years. Consumer confidence registered a striking drop this month, according to the Reuters/University of Michigan midFebruary consumer sentiment index. "A bevy of not-so-friendly economic numbers that came out today really took the air out of the bulls' balloon," said Stephen Schork, editor of the energy markets newsletter the Schork Report in Villanova, Pa. The Organization of Petroleum Exporting Countries on Friday trimmed its forecast for 2008 global oil demand growth by 100,000 barrels a day to 1.2 million barrels a day, representing a rise of 1.4% from 2007. Total crude consumption globally this year is expected at 87 million barrels a day. Releasing its February oil market report, OPEC hinted weakening world economic growth and demand prospects and ongoing increases in U.S. and European crude and gasoline inventories could force the group to pare production. "These unfolding developments in the world economy and the oil market warrant close monitoring in the months ahead to ensure a timely response to changing conditions," OPEC said. OPEC next meets to review production policy March 5.
Nymex will suspend pit trading Monday for the U.S. Presidents Day holiday. Electronic trading will continue. Analysts said some of Friday's late selling was profit-taking in advance of the three-day weekend. Front-month March reformulated gasoline blendstock, or RBOB, rose 1.77 cents, or 0.7%, to settle at $2.4938 a gallon. March heating oil fell 1.97 cents, or 0.7%, to $2.6469 a gallon. CRUNCH TIME FOR MEXICAN OIL Political Will Lacking For Production Overhaul As Output Tumbles Mexico's oil industry is in decay and production is falling. But it doesn't appear the country is going to do anything about it anytime soon. President Felipe Calderón has made energy overhaul his top legislative priority for this year. But the evidence of the past few weeks suggests he faces long odds at a time when high oil prices mask the country's looming production crunch. OVER A BARREL • The Situation: Mexico's oil industry is in decay, and evidence suggests the odds of a turnaround aren't good. • The Outlook: Mexican output has fallen steadily from its peak of 3.4 million barrels a day in 2004; if the trend continues, the nation will likely cease oil exports within seven years. • Why It Matters: Mexico is a big supplier to the U.S., and oil is a huge revenue source for its government. Mexico's declining production could have a wide impact on oil markets, which are already under pressure from higher demand and price constraints, pushing oil from $30 a barrel to near $100 in four years. Mexican oil output has declined steadily from its peak of 3.4 million barrels a day in 2004 and is expected to fall to 2.8 million barrels a day by the end of this year. If that continues, Mexico will likely stop exporting oil within seven years. The country relies on oil exports for about a third of government revenue. And Mexico is the third-largest supplier of oil to the U.S., behind Canada and Saudi Arabia. Mr. Calderón needs to strike a balance between the country's history of oil nationalism and the need for new capital and technology to expand oil production, especially in the deep waters of the Gulf of Mexico. But defeating the forces of nationalism won't be easy. Mexico was the first major oil producer to kick out foreign companies, in 1938, a key event that is still celebrated in school textbooks there.
Despite optimism from the Calderón team in the past few months, the signs aren't encouraging for significant change. With the country moving toward the 70th anniversary of the nationalization on March 18, lawmakers have shied away from tackling the politically charged issue. Two of the three main parties are now asking Mr. Calderón, of the conservative National Action Party, to send an overhaul plan before launching debates, thereby washing their hands of any initial political backlash. "At the end of the day, any chances of a broad reform are limited," says John Padilla, a Mexico analyst with IPD, an energy consulting firm based in New York. The political players agree the industry needs more cash for exploration and production as the country's low-cost oil fields run dry, but there is little agreement on where the money should come from. The government wants to allow the private sector to join forces with state monopoly Petróleos Mexicanos, or Pemex. "We're looking for [Pemex] to have the flexibility to form associations like all the companies in the world," Energy Minister Georgina Kessel said during a television interview yesterday. The leftist Party of the Democratic Revolution wants to let Pemex go it alone, giving the company more money to invest by cutting its tax bill. In the past few weeks, lawmakers from the former ruling Institutional Revolutionary Party, known by its Spanish acronym PRI, whose support is critical for the government, shifted their focus from trying to allow private investment to giving Pemex more money. One reason why some PRI members don't feel the need for urgent change is that high oil prices allow Mexico to make more money despite less output. "With high prices this is one of the best moments for the industry. And it is now that we are going to share [by opening it up]?" says Francisco Rojas, a PRI member and former Pemex chief. Many top Mexican officials, and most economists, feel that Pemex's monopoly encourages corruption and waste. Pemex's budget has risen from about $2 billion in the mid 1990s to nearly $20 billion this year. But production is still falling and the company has made no major finds. Complicating matters, the oil debate has played into the hands of leftist Andrés Manuel López Obrador, who narrowly lost the 2006 presidential election to Mr. Calderón and has seized on the issue to try to become relevant again on a national level. "They want to hand our oil to foreign companies," Mr. López Obrador said to flag-waving supporters at a recent rally. "We will stop them, even if we have to paralyze the country." Depending on who wins, the energy overhaul will either be Mr. Calderón's biggest achievement to date or his first major stumble. Since the showdown over the 2006 election,
the president has taken pride in his ability to pass legislation through a divided congress by striking closed-door deals with the PRI and even some PRD members, despite opposition to nearly every initiative from Mr. López Obrador. This time around, the Calderón team hoped to have an agreement in place with the PRI before even sending a bill to Mexico's Congress. But as a result, the public doesn't know exactly what the government wants from the reforms, allowing Mr. López Obrador to take the initiative and accuse the government of trying to sell out the country. "Mexico needs to have an open and honest debate about its oil industry, and until that happens real change will be difficult," says Luis de la Calle, a political consultant and former trade negotiator. Polls show a majority of Mexicans are opposed to letting private investment enter the oil industry. But polls also show many here misunderstand the issue. Half of all Mexicans think that allowing private investment means selling off Pemex to the private sector, rather than keeping Pemex in state hands and allowing it to partner with private or other state-run firms. It is a misconception that Mr. López Obrador exploits every day, accusing the government of wanting to privatize Pemex. "Oil is not just a commodity in Mexico, it's a political commodity," said pollster Jorge Buendia, the director in Mexico for Ipsos, a Paris polling firm. Mr. Buendia thinks the government needs to do a better job of making its case and explaining to the public what is at stake. IEA CUTS OIL DEMAND FORECAST ON SLOWING ECONOMIC ACTIVITY The International Energy Agency on Wednesday slashed its 2008 global oil demand growth forecast by nearly half a percentage point and pinned the expected drop on slowing world economic activity caused by U.S. financial woes that are taking root elsewhere in the world. In its widely watched monthly oil market report, the Paris-based energy adviser to the world's wealthiest nations, cut its world crude consumption forecast by 310,000 barrels a day from its January report after the International Monetary Fund recently lowered its outlook for world economic activity. "As gross domestic product assumptions have been coming down, we've been revising down our oil demand growth numbers," said Lawrence Eagles, head of the IEA's oil market division. The IEA sees 2008 world oil demand growing by 1.7 million barrels a day from last year, down from 1.98 million barrels a day forecast in January.
Overall, crude consumption globally is expected to average 87.6 million barrels a day, representing an increase of 1.9% from 2007, down from the IEA's forecast of 2.3% in January. Declining oil consumption, which tends to closely track economic activity, could inject some slack into the relatively tight global oil market and provide some relief to consumers with weaker crude prices, which hover today at almost $96 a barrel. But shrinking crude consumption could also move the Organization of Petroleum Exporting Countries to tighten its leash on production when it meets in early March if the producer group feels global crude supplies could build too quickly and threaten oil prices below $80 a barrel. UBS CONFIRMS FOURTH-QUARTER LOSS ON SUBPRIME-RELATED WRITE-DOWNS Switzerland's UBS AG, Europe's worst-hit bank by the U.S. subprime-mortgage crisis, Thursday confirmed it swung to a fourth-quarter and full-year loss after being hit by $13.7 billion in subprime losses, and warned of further headwinds this year. The Zurich-based bank confirmed its fourth-quarter net loss as 12.45 billion Swiss francs ($11.23 billion) after suffering heavy losses on mortgage securities, compared with a yearearlier net profit of 3.41 billion francs. The bank also posted its first full-year net loss in the 10-year history since it emerged from a mega-merger between Swiss Bank Corp. and Union Bank of Switzerland in 1997. "UBS expects 2008 to be another difficult year," the bank said in a statement. UBS still holds $27.59 billion in securities linked to subprime mortgages, down from $38.77 billion in September, the bank said. The Swiss bank's mortgage losses, which have weakened its financial stability and forced UBS to seek 13 billion francs in fresh capital from a Singapore government fund and an unnamed Middle Eastern investor, have resulted in spiraling write-downs totaling $18.4 billion so far. UBS shares, which have slumped 22% this year on fears of even greater losses, fell 0.2% to 40.75 francs in morning trading. The bank has let numerous executives go as a result of the losses, including Chief Executive Peter Wuffli, investment-banking head Huw Jenkins and financial chief Clive Standish. Several Swiss institutional shareholders have called publicly on UBS to let existing holders in on its capital increase to avoid dilution of their shares, which the bank has so far resisted. The measures are appropriate and ultimately beneficial for all existing shareholders, UBS reiterated in a statement Thursday.
Chairman Marcel Ospel, who has more operational say-so than his peers at other banks, has come under repeated criticism for his role in vetting Dillon Read Capital Management, the inhouse hedge fund responsible for the bulk of UBS's losses. UBS sought to reassure investors that its flagship private bank, where healthy profits have been wiped out by the mortgage losses, is running largely untainted by the crisis. Net new money inflows, a closely watched gauge of future revenue, was positive thus far in 2008, CEO Marcel Rohner told a conference call. Analysts have expressed concern that smaller rivals without trading operations will take clients and market share from UBS as a result of the crisis. MORE GRAIN PRODUCTION SOUGHT Farmers, Baking Industry Urge Government Action As High Prices Take Toll With the price of wheat and other grains soaring, food producers are calling on the government to help farmers ratchet up output. Some are calling for loosening a federal conservation program that compensates growers for leaving fields fallow. Others are calling for restrictions on exports, an effort that's unlikely to gain traction but that illustrates the depth of their concerns. • The News: Higher grain prices are pushing some food-producer groups for changes in Washington, including the easing of a habitat-conservation program and restrictions on grain exports. • The Impetus: Food producers are facing significantly higher prices for wheat and other grains due to high demand from overseas, rising biofuel production and problems among key producers such as Australia. • The Prospects: Export restrictions are unlikely to gain traction, but some farming groups favor relaxing the conservation program to allow growers to plant more crops. So far, the government is resisting, but the growing chorus for government action signals a new phase in a long-term shift in the global grain markets. For years, U.S. farmers have groused about low prices brought on by overproduction. Now, surging demand from emerging nations and the biofuels industry have sent prices sharply higher. In a letter to the Agriculture Department late last month, 45 organizations, including the National Chicken Council and the American Meat Institute, asked the newly sworn-in secretary, Ed Schafer, to release farmers from long-term contracts that idle land to preserve wildlife habitats under an effort called the Conservation Reserve Program. Meanwhile, the baking industry's lobbying group, representing giants like Sara Lee Corp., Kellogg Co. and Interstate Bakeries Corp., plans to gather food-company employees as well
as smaller bakers for a march on Washington next month to lobby for reduced wheat exports and to loosen the conservation program. Robb MacKie, president of the Washington-based American Bakers Association, is calling on government officials, including Congress, to respond to the high prices, which he contends are "raising serious domestic food security issues." Whether supplies meet such dire predictions depends on conditions in the U.S. and elsewhere. Key wheat-producing nations such Australia and Ukraine have had poor growing seasons. Global wheat stocks are at their lowest level in 30 years, while U.S. wheat stocks are the lowest they've been in 60 years, according to the USDA. Hard red spring wheat, the high-protein variety used to make high-quality bread and pizza crust, among other things, is the scarcest of all. Millers and bakers might have to put up with high prices for only another three to five months; by then, the U.S. spring wheat crop will have been harvested and world wheat production is expected to increase, says Dan Basse, president of AgResource, an agricultureresearch company in Chicago. After that, the price could soften. However, if there's a drought, the already-low grain reserves could go even lower, pushing prices even higher for a more protracted period. Over the past year, corn and soybean prices hit records. Now, wheat prices are on a tear. On the Minneapolis Grain Exchange, hard red spring wheat closed at $17.63 a bushel yesterday, up from $4.92 a year earlier. In the cash markets, some farmers are fetching more than $20 a bushel. Many farmers are sitting on their grain, waiting for the price to go even higher, exacerbating the jump in prices. Wheat prices have risen so swiftly that bakers can't adjust their prices fast enough to offset the impact, said Len Amoroso, executive vice president of Amoroso's Baking Co. in Philadelphia. "We are talking about prices that are just unheard of," he said. Tuesday, Mr. Amoroso said, he was quoted $48 per 100 pounds of flour from hard red spring wheat, which he uses to make sandwich rolls and other products. A year ago, he paid about $14.60. Whether Washington acts may depend on how much consumers are affected. Already, prices have risen for everything from steak to pasta. Food prices rose about 5% in the U.S. last year, the highest rate since 1990, while overall inflation rose by about 4%. Some analysts expect food inflation to rise faster this year. The average retail price for whole-wheat bread rose 12% to $1.78 per pound in November from a year earlier. Last month, food giants Kraft Foods Inc. and Kellogg said fourth-quarter profits declined because of higher ingredient costs. Mr. MacKie and other bakers are asking the Agriculture Department to curtail wheat exports until there's a guaranteed supply at home. They cite export tariffs in Russia and China, which have supply concerns. Wheat exports from July to December of last year were 74%
higher than they were in the same period the previous year, and they're expected to run strong in coming months, the USDA says. Restrictions on exports are unlikely because of opposition from farm groups and U.S. trading partners. Such a move would be a throw back to the 1980s, when President Carter imposed an embargo on U.S. grain shipments to the Soviet Union, a move that was unpopular with U.S. farmers. "That's not an option," said Mark Keenum, undersecretary of farm and foreign agricultural services at the USDA. "We're in the business of promoting agricultural exports, not impeding" them. Easing the conservation program has some support from growers. Some land in the Conservation Reserve Program would be perfect for planting food grains, Mr. MacKie says. So far, the USDA, under heavy pressure from conservation groups like Ducks Unlimited and Pheasants Forever, has said that the market will do its job and that farmers who want to be released from their contracts will have to pay a hefty penalty. "We are not ruling anything out entirely, but at this time, there are no intentions of allowing early-out of the CRP program," Mr. Keenum said. "We don't feel like the market situation or the price situation warrants that at this time." Brian Leier, a 35-year-old grain farmer in Linton, N.D., said he favors freeing up land that has been idled for conservation. "It's either we release some CRP acres or there are going to be plenty of people starving around the world, I believe," Mr. Leier said. OVERDUE AUTO LOANS CLIMB TO 10-YEAR HIGH Auto loans that are at least two months delinquent hit a 10-year high in January, said Fitch Ratings, signaling the continued spread of consumer weakness to debts beyond homes and credit cards. The firm, a unit of Fimalac SA of Paris, said 0.77% of U.S. prime and subprime auto assetbacked securities were more than 60 days behind on payments, with the rate jumping 12% from December and 44% from a year ago. Subprime delinquencies topped the 4% level for the first time since late 1997, reaching 4.03% last month, up 10% from December and 43% from a year earlier. Fitch's prime auto ABS annualized-net-loss index was at 1.28% in January, a 4.5% decline from December but 44% higher than a year earlier. For subprime loans, the index rose 12% from December, to 8.48%, the highest level since January 2007.
THERE IS NO INFLATION, BUT EVERYTHING WE BUY IS UP (My Opinion) Not since Tom Sawyer cajoled all those neighborhood kids into paying him for the privilege of putting three coats of whitewash on his Aunt Polly's fence, has there been a con job equal to the one the United States has pulled on foreign economies. By convincing Asians that the toil of the harvest is a reward made possible by the Americans who enjoy its bounty, we might just have done young Tom one better. Having become a nation of consumers instead of producers, the United States has been destroying wealth instead of creating it. By borrowing to finance consumption, instead of saving to finance production, our country has dug itself into an economic hole far deeper than has any other nation in history. An economic dislocation of the magnitude expected, and indeed already well on its way, will cause shockwaves worldwide, but will also present unique opportunities for Americans who have liquidity and an understanding of the events transpiring. What Is Wrong? A viable economy grows by savings and under-consumption. In the U.S. we have turned this basic economic concept on its head. Americans are encouraged to go deeper into debt to over-consume. A sensible economy under-consumes so that it can generate the savings necessary to finance capital formation. An economy in which government policy is deliberately designed to discourage under-consumption is doomed to fail. I find it ironic, to say the least, that our country is actually encouraging its trading partners to follow its misguided footsteps. More often than not, at high profile international economic summits, American delegates, representing the world's largest debtor nation, are found advising delegates from the world's largest creditor nations on ways to improve their economies. That is analogous to an F student advising honor students on ways to improve their grades. For some reason, it does not seem to occur to the American delegates to wonder just who would do all the saving and producing if the rest of the world adopted our borrow-andconsume philosophy. Everyone cannot ride in the wagon. Someone has to be outside doing the pushing!
How Did A Nation Of Savers Become A Nation Of Borrowers? Obviously, it was not planned. At one point the U.S. economy was much freer, was much less regulated, and had much lower taxes. We thus had more money to save and became accustomed to a certain standard of living. I believe that what happened was that government got more expensive as it started to expand and increased taxes to pay for that expansion. Americans resisted the reduction in their standard of living that the higher taxes required, so we used our savings and when the savings were gone we used debt. It was resistance to giving things up that helped perpetuate the problem. We bought some time when women entered the labor force and added to the number of people working to help pay the higher taxes. But then came more regulation, more insurance, more necessities that cost more money, higher interest because of more borrowing, and more costs with the government involved more in health care and education. All those costs resulted in higher taxes and made our standard of living harder to maintain. So we started borrowing more and since there were no repercussions we kept doing it and things seemed to be going just fine. Saving, by contrast, means sacrificing, seeing something you want and not having it. It is harder and requires discipline. But consuming—buying what you want when you want it—is fun, childishly so, but still fun. And the world played right into this. They wanted dollars and were happy to supply us with all the things we wanted. Of course, the Asians did not realize that the dollars they wanted so badly no longer had gold backing and the fiat currency of a nation turning into a wasteland would soon become worthless. So they kept shipping, we kept borrowing, and here we are. But it would not be fair, either, simply to blame the decline in the savings rate on the American character. Our politically driven system of government has a built-in bias that encourages consumption at the expense of saving. The most blatant example of this is the Social Security system, which, under the pretext of doing our saving for us, takes our money and promptly spends it. Social Security and other unfunded pensions, which people understandably think of as a form of savings, are in fact liabilities and a form of debt. Another example is the tax code, which allows deductions for interest expense related to home equity loans, for example, but fully taxes interest income. How's that for an incentive to borrow and a disincentive to save?
Social Security is Not Your Legal Right The nation's biggest entitlement program is about to get hit by the "Silver Tsunami." The first of almost 80 million babies born between 1946 and 1964 are now receiving Social Security benefits. More than 10,000 a day are being added to the rolls. This would be great if the money for future payments was actually in the "trust fund," a figment of Congress' imagination, or if benefits were paid by aliens from another planet, or even illegal aliens. Unfortunately, that's not the case. And the long-term outlook is not good. David Brooks of The New York Times recently wrote that "the U.S. government has $43 trillion in unfunded liabilities, or $350,000 for every taxpayer. Standard & Poor's projects that in 2012, the U.S. will lose its AAA bond rating." Laurence Kotlikoff, an economist at Boston University, calculates that future workers would have to pay tax rates from 55% to 80% over their lifetimes to sustain current Social Security, Medicare and Medicaid benefits. Let's be honest. That is not going to happen. And that means entitlements will eventually be cut. Some people have trouble believing that Uncle Sam won't keep his promises. But there's the rub. Entitlement obligations are not a contractual government promise like a T-bond. In a landmark 1960 decision, Flemming v. Nestor, the Supreme Court ruled that there is no legal right to Social Security. Sobering? So is this: The federal government's own website says the "current Social Security system is unsustainable in the long run." I'm not an alarmist. But facts are facts. There are not going to be enough workers to maintain the current level of benefits indefinitely. Sure, the nation's #1 entitlement program will survive in some form. But many New Deal and Great Society programs were designed for another era – and cannot be maintained at current levels indefinitely. Even in the most optimistic scenario, workers should only count on Social Security to cover a small portion of their retirement expenses. If you're retired or close to it, you can count on politicians – most of whom value incumbency like the rest of us value oxygen – to keep current benefits coming. For those further out, you better plan on your investment portfolio doing some very heavy lifting. And it better not be invested in dollar denominated assets either. The Rest of The World
The global economy is about to be doing even better, all thanks to the U.S. recession. The recession might be a good one, might be a bad one, it might even last for years… regardless, a U.S. recession is going to be good news for the global economy. Think about it for second: What happens when we get some bad economic info here in the United States. The markets turn down and along with them, the prices of oil, natural gas, industrial metals and all useful natural resources start to fall right along with them. These lower prices for energy and industrial materials are only going to make it cheaper for China, India, Asia and other countries to keep their economy rolling on. Sure, there are going to be some hiccups along the way, but falling prices for natural resources is only going to help the hyper-growth emerged economies continue to grow. The worse the U.S. recession gets, the better it will be for the rest of the world. It's counterintuitive to think, but with each bit of bad news here in the U.S., the more excited I get about international opportunities. The U.S. is no longer the world's only consumer, and countries that actually produce things will be able to buy their own products for once. With a recession in full bloom here in the United States and commodity prices remaining relatively high, it's clear global demand is able to soak up declining consumption here in the U.S. A Flood of Money Ignoring the flood of money — first created as credit and now stacked up in Treasury bonds across the emerging economies — would mean ignoring the connection between growth in the money supply and inflation in prices. The People's Bank of China is rumored to want money supply growth of 15% per year, down from the current 18% plus. India's broad M3 money supply is rising 22.4% per year. Singapore's money supply increased by 14% in 2007. Britain's broad M4 measure of money has expanded by 12.3% since Jan. '07. Western Europe is "enjoying" monetary inflation of 11.5% per year, three times the central bank's target. Last year saw 16% money supply growth in Australia, 13% in Canada and 22% in Saudi Arabia.
The U.S. money supply — if the Fed still reported M3 — is now guesstimated to be showing 15% annual expansion. Remember, that near-perfect connection between money supply growth and consumer-price inflation is one of the few clearly established facts in economics. Over a 30-year horizon, they match each other almost exactly. Which is to say, they won't necessarily move together this week or next. Similarly, the last time runaway inflation hit, the cost of living for Western consumers raced ahead AFTER raw commodity prices had begun to slow down: During the inflationary '70s, the price of commodities — as measured by the Reuters/CRB continuous index — peaked out in November 1980. For the next 21 years, it was then downhill all the way. Adjusted for inflation, however, the price of raw materials had, in fact, been falling since February 1974. That was when the rate of U.S. consumer-price inflation overtook growth in the CRB index, surging on the previous commodity price hikes and feeding into service prices and wage demands. Inflation in the cost of living finally peaked out in April 1980, hitting an all-time record high of 14.7% year on year. How did consumer-price inflation keep soaring for more than five years after commodityprice inflation began slowing? No doubt things really are different today, starting with the fact that the current bull market in commodity prices — beginning in 2002 — represents the only real secular bull run for raw materials since the Reuters/CRB index began in 1956. We are told that the 1973 doubling of commodity prices came thanks to the first OPEC oil shock. Might the Federal Reserve be taking things a little too coolly — not least with the value of dollars — by saying it "expects inflation to moderate in coming quarters" as it cuts the returns paid to dollar holders? "The OPEC [oil cartel] would trim output if oil prices slip to $80 per barrel," according to a Bloomberg report. It cites one unnamed OPEC delegate for the price target; two other members told the newswire that $70 would be "unacceptable." Says Johannes Benigni of JBC Energy in Vienna, "It wasn't OPEC's fault it moved above $80, but now it's there, they justify keeping it." And then there's the pile of dollars stashed away by the central bank in Beijing...up from $156 billion at the start of 2000 to more than $1.5 trillion at last count. If the sorry demise of the U.S. consumer really does dent the buying power of China, might the Chinese government not step in — and bid for crude oil, copper, soybeans and grain — to keep the
fastest growing economy growing just as fast as it can? Conjecture and guesswork are no substitutes for an answer, of course. And for as long as gold prices keep screaming that somewhere something is amiss between inflation and bond yields, that dumb lump of metal might just keep finding a bid. Gold has now risen in 18 of the last 24 weeks. On Friday alone, it hit new record highs against both pounds sterling and Euros. As of Thursday's close, the Reuters / Jefferies CRB index (a widely watched commodity gauge) just hit new record highs. Natural gas is the highest it's been in a year. Crude oil is back above $95. (That $100 level seems to draw traders like a magnet.) Also as of Thursday's close, silver, soybeans, corn, cocoa, coffee, rough rice, oats and platinum were all trading at or near multi-decade highs. Gold and wheat are still within sprinting distance of the same. Coal is at an all time high! Still, nothing to worry about. The U.S. recession is sure to send inflation to zero — just as it didn't in four of the last five recessions. What about Oil Prices? According to Larry G. Chorn, chief economist of Platts, the oil industry needed to have spent $350 billion on drilling and producing in 2005 to meet the 90 million barrels of oil a day required in 2010. But the International Energy Agency estimates that spending on oil-field production in 2005 came to only about $225 billion. Just listen to a man named Sadad Ibrahim Al Husseini, who is the former head of exploration and production at Saudi Arabia's national oil company. In London last month, Mr. Husseini went public with his oil doubts - saying that he didn't believe there were enough engineers or equipment to ramp up oil production fast enough to keep up with the thirsty global economy. What's more, he said that new oil discoveries are tending to be smaller and more complex to develop. This is from a man who was head of exploration and production in Saudi Arabia... so, of anyone else in the world, he knows what he's talking about. You see, most of the world's biggest fields are aging, and their production is declining rapidly. Just to keep global production at current levels, the oil industry needs to add at least four million daily barrels of new oil production every year. This added demand is roughly five times the daily production of Alaska's Prudhoe Bay field -
and it doesn't assume any demand growth at all. Needless to say, this WILL NOT happen. Just listen to the experts: "The fact remains that oil giants are struggling to pump more oil and gas." - The Economist, November 8th 2007 "Years of under investment in new talent have led to a limited and aging pool of skilled workers." - Andrew Gould, the CEO of Schlumberger, quoted in The Wall Street Journal, November 19, 2007 "Oil production fell 9% on average. No matter how high the price goes, the oil majors cannot make a profit from oil they do not produce." - The Economist, November 8th 2007 The most telling quote comes from Joseph Quinlan of Investment Strategies Group, who is commenting on the fact that oil production in developing nations accounted for 81% of oil production last year. He said: "World oil production increasingly under the control of these nations [means] U.S. energy companies either gain access to these deposits or risk gradual decline in their production, reserves... and fortunes." So, what is the world's current monetary system? Simple. Arab nations export oil. Europe exports luxuries. Asia exports autos and gadgets. America exports dollars. Yes, dear reader, the dollar gets around. The U.S. Treasury Department tells us that most of the world's dollars are now outside the 50 states. Sixty percent of them pass from hand to hand without hearing an English word, or getting a chance to go to a baseball game. The same is true for U.S. government debt. There's three times as much of it in the hands of foreigners, $2.11 trillion, as there is in American hands. We are headed to a future with so many treacherous waters that it is very hard to determine which one will topple us over. Will it be our trade deficit? Will it be our national debt and unfunded obligations? Will it be ever increasing energy costs? Will it be the ever decreasing standard of living in America? Will it be our creditors, who finally will demand just compensation for the ever decreasing value of our currency? Will it be political instability? Will it be the sub-prime loan crisis? Will it be the bond insurance crisis? Perhaps it will be the cascading fall of dominoes set off by freefalling real estate prices! My dear reader, live as if you were living already for the second time, and as if you had acted the first time as wrongly as you are about to act now.
"We must never forget that we may also find meaning in life even when confronted with a hopeless situation, when facing a fate that cannot be changed. For what then matters is to bear witness to the uniquely human potential at its best, which is to transform a personal tragedy into a triumph, to turn one's predicament into a human achievement. When we are no longer able to change a situation... we are challenged to change ourselves." Frankl By now, if you have been reading my newsletters, you are well aware of what I think. I will spare you the details of why sugar-based ethanol is a great investment. I will also spare you of my plea to immediately divest yourself of all dollar denominated assets. I will only remind you that vision and leadership are paramount in times of crisis. "An army of deer led by a lion is more to be feared than an army of lions led by a deer." Philip II, king of Macedonia If the urge strikes you, write to me. I will gladly respond and help, if I can. Jose Cavaliere cavaliere@cavalierecapital.com
Nothing in this e-mail should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. The information in this newsletter has been gathered from a number of sources including the mainstream media such as The Wall Street Journal, the Associated Press, as well as CCC's own insights, industry relationships, and analysis of this and other data. CAVALIERE CAPITAL CORPORATION 41414 WOODWAY MAGNOLIA, TEXAS 77354 (281) 259-7121 www.cavalierecapital.com
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