Sunday, March 30, 2008

Food prices are more important than Energy prices

Finally, the Mainstream Media is picking up on the cost of food.

I will repeat myself:  People don't need to drive but they do need to eat.  

Gasoline shortages might have political repercussions - food shortages will have riotous social implications.  There is a big difference.

No, rich folks living in Boca Raton, Florida or Beverly Hills, California will not be missing any meals any time soon.  But far more people receive food assistance in the U.S. than make over $300,000 per year annually - a common measure of "rich" versus "middle class" in the U.S. - and for those folks this is serious stuff.  Did I mention that they vote? 

Opportunities abound for investors, but we must take the political ramifications of probable outcomes into consideration as well.

Egg prices.  Now there is something you don't talk about every day, but egg prices are up 45% in a year.  I am amazed that the financial media accepts the U.S. Governments inflation data.  Nothing in the government's data is consistent with what the American public experiences at the gas pump, grocery check out counter, healthcare, college tuition, etc...   What's up with that?

Milk costs more than gasoline.  The article is using data from the U.S.'s North and South Dakota.  Milk in Florida is already nearly $5 per gallon.  The diesel costs for transporting milk, over 90% of which is transported by truck obviously increase the farther distance.  Florida is a long way from Wisconsin.

Surprisingly, price increases for bread have trailed milk and eggs, but is still up more than 10% per year for each of the past 3 years.

I don't have to go into gasoline prices...

So... you are an employer.  Your employees have a zero savings rate and their transportation, food, and utility costs are rising better than 10% per year.  How long before you have to give them a raise just to get them to come to work?  Wage inflation pressures come from many directions.  Until a year or 2 ago your employees were being subsidized by home equity loans - but not now.  Somewhere in all of this you going to have to pay your people more.  But how can
you pass these costs on to your customers?  They have a zero savings rate and increasing expenses, too.  

This is why I tell business owners and employers to reconsider your plans for "growth". Growth costs money, it does not come for free.  Business owners would be far better off to use the capital (read profits) they had previously been using to grow their business to buy hard assets.  

Think about this:  A coupe of months ago Bear Stearns was the cock of the walk - now where are they?  The value of their business collapsed almost overnight.  I know a great many former Bear Stearns Managing Directors who wish they had traded their stock certificates for gold bullion, or oil futures, or Iowa farmland long ago.  But way back then (3 months ago) it was INCONCEIVABLE that the value of their stock certificates would be worth little more than expensive wall paper.  It is always that way.

Remember that I am speaking in terms of CONSTANT, or real, dollars.  Nominally I fully expect many sectors of the U.S. equity market to rise.  In real and nominal terms I believe fixed income investors are not being compensated for the risks they are taking in holding bonds at these yields with the trade deficit being what it is and accordingly I am not holding this stuff.  (Yes, I know bond investors have done better than equity investor over the past 12 months - but they are not even on the map when compared to returns in the commodity sector.  And the game ain't over.)

Borrowing money for business expansion is a very tricky issue.  Yes, inflation benefits debtors (and I am in the inflation camp) but only if the asset you are leveraging benefits from said inflation.  If not, that strategy is a fast dance step to bankruptcy court.  

Protecting your assets as well as your the source of your wealth in this environment is paramount.  Don't fail yourself.

Yours for a better world,

Mentatt (at) yahoo (d0t) com

Saturday, March 29, 2008

Which Straw Breaks the Camel's Back?

The following is a guest post by Dr. Saif K. Lalani.  Nothing in this commentary is to be construed as advice - economic, financial, or otherwise.  I would tell you to seek the council of a qualified investment professional if believed that there was such a thing for the issues that confront us.  I do not, and so will not.  While I am precluded from making specific recommendations and predictions, Dr. Lalani is under no such restriction.  Accordingly, I have left his article as is and have not redacted or censored it in anyway.  At the end of the day, Saif and I merely enjoy the Web for what it is:  A place for people without a shred of policy influence to shout into the wind...  

That disclosure aside, I give you Dr. Saif K. Lalani

“The Club of Rome”...Which straw breaks the camel's back?

The Club of Rome raised considerable public attention with its report “Limits to Growth”, which has sold 30 million copies in more than 30 translations, making it the best selling environmental book in world history. Kevin J. Krizek and Joe Power’s article: "A Planner's Guide to Sustainable Development" (Planning Advisory Service Report # 467, American Planning Assoc.) mentions this source and his author as stating that Paul Ehrlich's predictions in his 1968 book, "The Population Bomb" will come true within a century. Published in 1972 and presented for the first time at the ISC's annual Management Symposium in St. Gallen, Switzerland, it predicted that economic growth could not continue indefinitely because of the limited availability of natural resources, particularly oil.”


We are now 1-4 years away from the system breaking down due to limits on natural resources. But which resource will it be?

(Drum roll for the contenders...)

Oil: Coming in at number 1 for obvious reasons. Nothing else has been mentioned more frequently in the press than this high-flying commodity. Conventional world oil production has peaked. Total liquids production has peaked, or will peak within a year or so. Regardless of production, the export market will continue to contract rapidly. Rising consumption in Russia, Saudi Arabia, Iran and Mexico, combined with falling production virtually everywhere of importance will raise prices past $200 within 2 years. High prices are not the problem though. Our economic system will break-down rather rapidly if oil shortages appear.

Coal: In my opinion, Coal is slightly more likely than oil to bring the system down. Here the effects of the export-land model (courtesy Jeffery Brown) are even more pronounced. China consumes more than 2.5 billion short tons of coal per year. It recently turned into a net importer (2008 projected). The world export market is tiny and is less than 12% of the world coal production. China's coal consumption is rising at a 12-15% compounded annual rate. China's coal production growth rate is slowing dramatically and is projected to rise less than 5% this year. Putting these numbers together means that China will swallow all of the worlds exports in 2-4 years. Unless coal production can be ramped up dramatically elsewhere IT IS LIGHT’S OUT EVERYWHERE.

Natural Gas: This commodity is unlikely to bring down the system, as there is still some slack in this market. That said, if coal brings down the first domino then competition for LNG could reach unprecedented levels. That in turn would raise Natural Gas prices around the world. Natural Gas could also be the first domino if, heaven forbid, we have a bad hurricane season in the United States. Back in 2005 there was enough slack in the system. That coupled with an extraordinarily mild winter, prevented Natural Gas from being the straw that broke the camel's back.

Uranium: Although uranium prices remain depressed, I remain bullish on its long term prospects. Within 3 years Uranium prices will, at the least, rise past $250 a pound, in my humble opinion. Once again, it is unlikely to be the first domino to fall but an oil, natural gas or coal crisis could make countries start hoarding uranium. The Uranium market is at the mercy of a large amount of non-mine supply. Russia has shown reluctance to part with it and if a worldwide energy crisis is triggered expect the worst from them regarding honoring and extending uranium supply contracts. Of all the commodities, uranium supply has the longest lead time which would make things a lot worse even if below ground resources are present.

Silver: Silver's diverse set of uses make the system particularly vulnerable to its unavailability. Although silver mine production lags world consumption, a silver crisis is likely to be triggered in a US dollar collapse scenario rather than as a pure supply side situation. Flight into physical precious metal by even 1% of US households would cause marked silver shortages. Say goodbye to all electronics, photo-voltaic cells, windmills, new nuclear plants, etc... There is no viable substitution for silver.

Corn, Soybeans, Wheat and Rice: I have previously written about the bullish prospects for corn. The longer-term fundamentals for soybeans, wheat and rice are no less bullish. Rough rice, the least spoken about among the four, has seen the greatest price increases of the 4 major grains in the last 6 months. Our current food stocks are the lowest ever in terms of days supply. When shortages of food appear and hoarding starts does the economic system survive?

The stage is now set for an epic battle between the Club of Rome and the conventional economists. Will the Club be proven right? Or will the hero of Conventional economists, Adam Smith, come with his 2-sided light saber of supply and demand and defeat the Club?

We will find out soon enough."

Dr. Saif K. Lalani

We are now in the Land of the Philistines

Russia, the world's largest producer of oil, is experiencing a decline in production.  Russia's internal consumption is climbing better than 6% per year.  There are 2 critical oil producers - Saudi Arabia and Russia.  Every other country, including Iraq and Iran, are "also rans".  When production Russia and Saudi Arabia begin their inevitable oil production declines - world production of of Crude & Condensate will have peaked (by mathematical necessity... Let's go to the video tape:  Declining production and increasing consumption means we must calculate 2 exponential functions to determine the the percentage decline in net exports.)

The U.S. was able to make up for the loss of oil production caused by the U.S. "Peak Oil" of the early 1970's by increasing imports.  Obviously, planet earth does not have this option.

So here we are, now what?  The Fed, as well as the other Central Banks, has injected huge sums of liquidity, lowered rates, and bailed out a major Wall Street investment bank.  With all of that liquidity the stock market (as measured by the S&P 500) can't manage a decent rally.  I would have thought one would have been forthcoming, though I was unenthusiastic (and I view any rally as a selling opportunity for anything not commodity related). 

Dr. Spock, (Dr. Saif Lalani) asked me if I thought the stock market could go higher if oil went to $120.  At first I thought, "sure, why not?  With all that liquidity..." but the more I think about it, it seems that if the "market" went up, it would be all commodity related equities going up more than non-commodity equities went down... well, that's not the same thing, is it?

Let us recap:  The U.S. has a negative savings rate, our equity markets are in decline, housing is in free fall, banks are tightening lending standards, food and energy prices are rising smartly, the U.S. $ has 2 black eyes and a couple of missing teeth, our trade deficit expanded in spite of a decline in the dollar which was supposed to fix that issue, and we still have Medicare and Social Security lurking in the background while at the same time the American Corporate Pension System has used a perpetual increase of financial assets of 9% in its model for funding pensions.

But at least we've got a couple of Presidential candidates that believe in "change" and "keeping hope alive"... so we got that going for us.

It seems that the peak in oil exports from oil exporting lands is upon us.  So far, the U.S. has avoided major disruptions by outbidding poor nations for the marginal barrels it needs.  That won't be possible for much longer, although I can't give a time period certain. 

I can tell you this with great certainty:

The challenges faced by the U.S. $, the international equity and bond markets, and U.S. real estate as of today will PALE BY COMPARISON when market participants fully realize that the oil import decline is permanent.  We will have to come up with a new moniker, crisis will not do.

What to do?  At the risk of repeating myself:

Hard assets rather than financial assets.

Instead of trying to expand your business, shrink it and take the capital you would have used for expansion and buy hard assets.

Stay clear of investments or businesses that are car, employee, or transportation dependent. Railroads over trucking and airfreight; apartment buildings over suburban housing.

The decline in energy availability will shrink aggregate GDP, which means that everyone, on average, will be poorer.  Yes, there will be exceptions on an individual basis but in the aggregate this, too, is a mathematical fact.

The time to blow up the life raft is BEFORE your boat sinks.

Yours for a better world,

Mentatt (at) yahoo (d0t) com

Sunday, March 23, 2008

Now What?

I am truly blessed. 

As a fund manager and broker, I have the good fortune of living in place populated with the PERFECT contra-indicators for any financial, commodity, or real estate market.  

Members of the "Lucky Sperm Club" often confuse brains with a bull market (or a fortunate crib in the maternity ward), but some do so more than others... my contra indicators are now th telling me that oil, gold, and corn have peaked, and Real Estate has bottomed.  (I should have been born rich instead of so damn good looking...)

Now, I know that past performance does not indicate future results... but these guys have been so perfect in the past!!!  Buying, and leveraging, South Florida Condominiums and McMansions, in 2003, 2004 and 2005 while pooh-poohing the commodity markets - they told me "they aren't making any more Real Estate".  Betting BIG on tech stocks in 1999 and early 2000. When these guys tell you something you should listen closely - and take the other side of the trade.

Mentatt (at) yahoo (d0t) com

Wednesday, March 19, 2008

Be Careful What You Ask For, You may Just Get It

The U.S. Federal Reserve Bank cut its Fed Funds rate to 2.25 from 3% yesterday.  The funny thing is, many investors wanted more.

The U.S. Equity market "loved" the rate cut.  And why not?  The Fed pretty much eliminated competition from short term fixed income and cash instruments for equities, and real estate is no longer a player, leaving equities and commodities as the only game in town.  If the Fed increases the money supply, that money is going to go into something.

Grudgingly, it is my expectation that the equity market will continue to rally for a while.  As before, my bets will be almost entirely on the natural resource sector of the market.  The Fed might delay the inevitable, but cannot eliminate it.  I would use the rally as an opportunity to sell other sectors.  As to when, you are on your own.

Now that the Fed has unequivocally abandoned the $ the other major central banks will be forced at some point into coordinating some kind of support for the U.S. currency vis a vi their respective currencies.  Look for this to REALLY ignite commodity inflation.

The deflation/inflation debate continues, with some sharp, well respected folks on both sides.  As for me, I am in the inflation camp, although housing will not be included in that thinking.

Monetary policy cannot be THE economy.  The U.S. is going to have to produce goods and services to trade with its import partners, and the American people will eventually be required to save enough capital to support our domestic borrowing needs.  If the decline of the $ continues apace, this will be a most shocking adjustment.

It seems that people cannot conceive that anything can change in their particular environment.  Several years ago, South Florida residential real estate was as hot as a pistol.  When we issued a white paper to our real estate clients that the market was in critical condition and subject to an immanent plunge in prices the paper was welcomed with derision.  

Several days ago I had a conversation with a prospect living in one of the residential hotspots of the Colorado ski industry.  This market has not been hit yet - but it is as doomed as South Florida was.  Energy prices and availability will doom these areas - yet my prospect could not conceive of this, and I probably impressed my prospect as being an intellectual dolt.  After all, this market has been red hot for years!  How could that possibly ever change?  How indeed.

Stay tuned.

Yours for a better world, 

Mentatt (at) yahoo (dot) com

Monday, March 17, 2008

A Moment of Silence

Bear Stearns 1923 - 2008 R.I.P.

I used to work for Bear Stearns, and it is a sad day in Mudville indeed.  

I read so many on the Web cheering their demise.  I don't know why.  When I worked there the folks I reported to were honorable and conscientious.  Of course, I did not work in mortgage trading, the area that brought them low.

Here is the thing... Bear Stearns is not likely the last big blow-up.  Maybe Hollywood should do a sequel to "There Will Be Blood"... "There Will Be Blow-Ups".

No I ask you - is J.P. Morgan going to be able to take a Lehman Brothers or Citi Group under its wing?  They are going to be a bit busy wiping up after Bear's big spill.  And where was Goldman Sachs?  Why wasn't Goldman tapped to pick up the pieces?  Maybe there was an Anti Trust issue... yea, sure....

The American financial system is no better today than it was last week.  The dollar is certainly no better fundamentally and home prices are no higher and manufacturing is no more productive.  To quote the elder George Bush:  "We are in deep do-do".

The Bear Stearns story is going to play out over and over again in Corporate America.  Here is how the story goes:

Wealthy shareholders on tuesday won't have 2 nickels to rub together on wednesday.  The Federal Reserve will try and bail out their wealthy constituents at taxpayer expense, further devaluing the U.S. $, and making us all poorer in the process.  

And the energy crisis has not hit the U.S. with all its fury - yet.  When (not if) that comes, the dollar will collapse in earnest and the markets will be decimated.  If your portfolio consists of only financial assets you are going to be in a state of shock.

Good luck to all.

Mentatt (at) yahoo (dot) com

Tuesday, March 11, 2008

You Like Apples?

You like apples?  Well the U.S. Trade Deficit is growing IN SPITE of a week U.S. $... How do you like them apples?

Remember how a cheap dollar was supposed to soup up our export market and tame that pain in the ass Trade Deficit of ours? Well, something weird happened on the way to Grandma's (Medicare & Social Security and the Baby Boomers) house. The freaking Wolf (The Oil Exporters) dressed up in higher oil prices and beat the stuffing out of Grandma. The Woodsman (Illegal but cheap Labor) joined the Municipal Worker's Union, "developed" carpel tunnel syndrome, not to mention an allergy to honest work (the New American Way), leaving him and his axe nowhere to be found at the moment of truth. Our heroine, Little Red Riding Hood (The American People) was forced to turn tricks for Elliot Spitzer in order to pay for food and fuel to get through the cold winter...

But the Spring soon came, and the U.S. Dollar collapsed, the economy ground to a halt, and unemployment hit 25% before gardening became classified as a "job", but at least Britney Spears was pregnant with twins and had, at last count, been sober for 2 weeks, 3 days, 5 hours, and 27 minutes - so we got that going for us...

And they all lived happily ever after.

The End

Monday, March 10, 2008

Policy Makers Can't Sweep $108 Oil Under The Rug

Things can get weird now, fast.

I have been following the "Peak Oil' story for over 5 years. I am neither a geologist nor a petroleum reservoir engineer - but I am an investor. As such I read everything I could get my hands on on the issues of oil reserves, production, and supply. As the story unfolded, I took the "long" side, betting that oil prices would rise, initially because I never fight the tape, and later because as prices rose supply into the market place did not increase. After spending thousands of hours researching the issue I was confident that NO ONE had a perfect model for predicting future production flows, so I felt that the collective international oil markets would vote with their dollars (and yen, and euros, and rubles...).

As I write this the price of the front month contract for crude oil last traded $108.03. I gotta tell you, at $108 per barrel there is an absolutely irrepressible amount of incentive to pump every last cup/gallon/barrel of oil, not to mention to run around and collect it from engine oil recycling centers, french fry vats, and left over salad dressing. Don't believe one freaking word out of OPEC. These guys would stab each other in the back to move 1 more tanker than the other guy (Very Large Crude Carriers often hold over 2 million barrels of oil - just do the math).

This is IT. Ground Zero. The End. If these prices do not bring substantial additional supply to the market... If all the bloody money in the world can't lure more oil out of the ground, onto a tanker, and on to our shores... Then the Oil simply is not there. The guys at CERA and ASPO can keep at each other until hell (along with Chicago, Boston, Minneapolis, etc...) freezes over. The debate is over, the crisis is clear - and it is here.

Now if 3 million more barrels per day show up... false alarm.

Whatever it is, it is. And whatever it ain't, it ain't. That's technical speak for Bayesian Probability Theory...

No, the world won't come to an end tomorrow, but your life savings, the totality of your investments as measured in REAL or CONSTANT Dollars, certainly could. Think me dramatic? Perhaps I just have more grey in my beard. Anyone who can remember the economic environment of the 1970's and early 1980's clearly will likely not think me too off base.

If Oil prices keep rising, to say $150 per barrel, all else being equal The U.S. "OIL ONLY" TRADE DEFICIT WOULD BE $711 BILLION PER YEAR. The only way that is even remotely possible is if we increase NOMINAL GDP (read INFLATION), destroy the Dollar, which in turn will destroy the bond and equity markets... But there is SOME good news. If you are upside down in a home mortgage this environment might just bail you out. Of course there is the pesky problem of not enough fuel to DRIVE to that newly upside right mortgaged house...

You will know soon enough, this won't take long to sort out. The question is:

Are you just going to stand there like a deer in the headlights of an oncoming 18 wheeler? I should think "Road Kill" to be a completely unacceptable and unsatisfactory epithet.

Yours for a better world,

Mentatt (at) yahoo (d0t) com

Saturday, March 8, 2008

Markets: 101

While I have been VERY bullish on oil for the past 5 years or so, I would like to remind all who visit here that markets will zig and zag; they don't zig and zig and zig.

Commodities such as Oil, Silver, Natural Gas, Palladium, Corn have been zigging rather hard lately. The U.S. $ has been zagging for years and that trend will likely continue. Still, there will be interruptions in these trends.

Let's get back to Crude Oil: Will it reach $120 on this rally, $15 from Friday's close, or will it pull back to $90 (also $15 from Friday's close)? I have no idea - and anyone who tells you they are terribly sure about market outcomes in the short term are full of it. I could make the case that the "trend is your friend"... but which trend (and/or combination thereof)?

Trend 1: The trend in the past is that the second quarter is usually tough on crude. Winter heating demand ends in the Northern Hemisphere and Summer driving demand has not materialized yet (the "Shoulder Period").

Trend 2: Oil is priced in U.S. $'s, and $ is going down like rock in a pond, so Oil prices rise all else being equal.

Trend 3: OECD inventories are tight - VERY TIGHT. Builds in country "A" are for the most part offset by draw downs in country "B". Competition for tanker deliveries of oil is fierce.

Trend 4: Collapsing credit markets worldwide, and in the U.S. mortgage market in particular, are pushing much of the OECD to the brink of recession. When economies contract, energy demand wanes (actually, there is not as much support for that contention as one might think. With the exception of the oil supply shocks of the 1970's, no other post War recession caused 2 years of declining oil consumption).

Trend 5: Increasing consumption on the part of China, India, Vietnam, the Middle East, and Russia, etc... is intensifying competition for the declining pool of exported oil (excess production over consumption in oil producing nations is declining as the producing nation's internal consumption is growing briskly due to the positive feedback loop of: higher oil prices = greater economic growth = more domestic oil consumption = less exports = higher oil prices = ...)

I could easily enumerate a dozen more trends... but you get the idea. This is a tremendously complicated puzzle involving lots of moving parts. But the 2nd quarter will come and go, and maybe the credit crisis will, too. What about trends 2,3, and 5? Are they going away anytime soon?

Don't be a hero, but don't be afraid when opportunities present themselves, either.

Yours for a better world,

Mentatt (at) yahoo (d0t) com

Thursday, March 6, 2008

$200/barrel will bring a supply avalanche..............NOT!

The following is a guest post by Dr. Saif K. Lalani of Vanderbilt University

$200/barrel will bring a supply avalanche..............NOT!

This is what everyone says nowadays. Gone are the days when $35/barrel would bring a recession, $50/barrel would get supplies out of canadian tar sands, $75 would make oil shale economical and $100 would get supplies from camel's posteriors in Saudi Arabia.

The super optimists now focus on a new higher target to prove their economic theory of supply and demand. I have long tried to explain to readers the difference between geology and economics. While Geologists are generally intelligent enough to grasp economics, economists seem to think the rules of geology do not apply when they use the magical hand of Adam Smith.

I have failed to explain basic geology to these morons. So now I am going to have to argue with them at their level. Fair enough.

Why will $200 not work?

The cornucopians argue that $200 will allow us to access oil at the super marginal levels, i.e oil that was, say, unprofitable at $175/barrel. This will allow supply to come back on and will save the day. High prices will prove peakists wrong. This logic is inherently flawed.

The world uses about 87 million barrels of oil a day. Current decline rates are at least 4%. That means that we need to find about 3.5 million barrels/day worth of supply, this year, next year, and every year thereafter - just to stay flat. Any field or fields that need to make a dent in this demand will need to be of at least 100,000 barrels a day or greater. So tell me where are these 100,000 barrel-per-day fields being sequestered? Which company has announced that it will not develop a certain field at current prices? Presumably there are tons of these fields - which will come to the rescue until every Indian has a car, right?

The truth of course is that there are no such fields. At current prices $100/barrel generates $10 million per day for a 100,000 barrels/day field. Regardless of the high rig rates (some as high as $600,000 a day), that is extremely profitable. Nobody is mothballing any such fields. The only fields that may come online at those prices are those that will produce less than a 1000 barrels a day. Those are the ones that are not profitable now and may become profitable at higher prices. Sure, there will be a few of them. Not enough to make a difference.

All that is assuming we can find the rigs (notice high prices above) and skilled personnel to devote to hundreds of such mini projects. Our current rig fleet is about 3 decades old and will fall apart slowly over the next decade. Rebuilding it will be a great challenge; expanding it will be Herculean effort. The supply of newly minted Geologist’s borders on the pathetic, as few young people were wise or lucky enough to join this field in the last of decade.

But wait: these supremely witty individuals think that this oil is yet to be discovered. In other words at $200 we will all go out prospecting to the vast untapped reserves of the Arctic, Antarctic and Saturn (the planet, not the car). The EIA is its infinite wisdom finds it necessary to say that there are billions and billions of barrels in such places where no one has ever looked. No one has ever looked? But the EIA knows? That is either a boatload of B.S. or the EIA is employing some pretty nifty psychics. Unfortunately these psychic’s are one trick ponies and only specialize in finding oil and not predicting its price as the EIA's long term prediction history will show.

So friends, supply is inelastic regardless of price so the only elasticity is going to come through economic (demand) destruction. $200 barrel will also come to pass (probably after 2010) without any great new supplies."

Yours for a better world,

Mentatt (at) yahoo (d0t) com

Saturday, March 1, 2008

Reality Sets In

Oil has been trading over U.S. $100 for the past week.

Gold is within a whisker of $1000 per ounce

Silver! Has gone ballistic

The media is (FINALLY) rife with reports of projected food shortages in the coming years (if we do not do something NOW, “projected” will be replaced by the word “chronic”).

The banking/debt/housing crisis has barely begun, and is not even remotely understood, and in my opinion all of this PALES IN COMPARISON to the coming Credit Default Swap DISASTER coming soon to a portfolio near you.

The US$ has fallen, as measured by the Dollar Index, to 73.63 - THE LOWEST LEVEL SINCE THE INDEX’S START IN 1973. I can remember when it was believed that 80 would be the end of the world. And lest this should give you false confidence that since the world DID NOT end yet all is well… read on.

The U.S. Dollar will not survive in its present form. Yes, it is the world’s reserve currency, and yes, no other currency, not even the Euro, can replace it. That does not, not for one bloody minute, mean that the SYSTEM that uses the U.S. Dollar as its reserve currency will survive as it is presently constituted. I have no idea how or with what that SYSTEM will be replaced, so I won’t waste your time with the myriad possibilities at this moment – there will be plenty of time for that – but I will make the case as to why the U.S. Dollar’s future is ineluctable.

First, a definition of sorts:

“The global current account deficit of the United States is now larger than it has ever been—nearing $800 billion, almost 7 percent of US GDP. To finance both the current account deficit and its own sizable foreign investments, the United States must import about $1 trillion of foreign capital every year or more than $4 billion every working day. The situation is unsustainable in both international financial and domestic political (i.e., trade policy) terms. Correcting it must be the highest priority for US foreign economic policy. The most constructive remedy in the short term is a three-part package that includes credible, sizable reductions in the US budget deficit, expansion of domestic demand in major economies outside the United States, and a gradual but substantial realignment of exchange rates.” – Peterson Institute for International Economics


“Anybody who believes exponential growth can go on forever in a finite world is either a madman or an economist.” - Kenneth Boulding

In the conflict between economics and mathematics, the natural laws of mathematics win EVERY time. It ain’t even close. But, I digress…

Here is the problem:

The U.S. has NET IMPORTS of Petroleum Products of 13,000,0000 per (give or take – the U.S. imports over 14mm barrels of oil every day but also exports gasoline, diesel and other finished products to Canada and Mexico – but it is the NET volume that matters). At $100 per barrel multiplied by 13mm the U.S. trade deficit resulting from international oil purchases is $1.3 BILLION every day of the year, or $474.5 BILLION every year. Nearly 60% of the current account deficit at yesterday’s prices is for OIL ALONE. There is no chance that this issue will be mitigated by ANYTHING in U.S. policy. After all, if we do not import the 13 million barrels of oil every day, our car/transportation fuel dependant economy will spiral down and grind to a halt, markets will crash, the banking system will fail, and more importantly, my son’s little league games will be called off because no one will be able to drive their kids to the baseball diamond.

The only possible reduction in borrowing to fund oil purchases will come when our export partners REFUSE TO SELL US OIL FOR U.S. DOLLARS. And that’s coming, not right away, but as sure as G-d made little green apples, that is coming. (What do you think Al-Quida is trying to accomplish?)

IF oil prices continue higher, and IF the U.S. were able to continue to get their trading partners to take more U.S. dollars in exchange for the oil, by definition the tsunami of dollars that would need to be created/printed would wash all of the existing dollars’ value away. At $200 per barrel the U.S. would experience a $950 BILLION TRADE DEFICIT FOR OIL ALONE???!!!! WHAT ABOUT $300 PER BARRLEL OIL?? That would mean a trade deficit of 15% of U.S. GDP!! Is that even possible??

And that is before we start to import Liquified Natural Gas in earnest.

OK. So what to do. (Theoretically, that is. None of this is intended as specific financial advice for all persons in all circumstances. (For example, if you are over 65 you might be better off just playing defense.) I won't tell you to seek a qualified investment professional as there very few of those for the environment I foresee. I will tell you to educate yourself as if your life depended on it, but only because the quality of your life does. If you were smart enough to make money, you are smart enough to figure most of this out. And my favorite reason for doing this yourself? As Warren Buffet famously said: "Wall Street is the only place that people drive to in Rolls Royce's to get advice from people who came to work on the subway." If Bull S--t were good financial advice you wouldn't need deodorant.)

First off, I am assuming that you are a person of means. If so (and none of this is THE perfect solution, there are none of those):

Sell your sub-urban real estate. All of it. McMansions won’t be worth spit. Rent the home you live in. In most markets you are being SUBSIDIZED to rent. Exchange the sub-urban properties for farmland you can rent, and city property that has walkable amenities. No, you don’t have to live in the city or the country (yet), but these properties, unlike sub-urban properties, are very, very rentable. Farmland will likely hold its value extremely well in a U.S. $ crash, as will properties that do not require a car to get to and from.

Be creative in the ownership of hard assets. Gold, silver, platinum, palladium, oil, natural gas, corn, wheat, soy beans, coal (notice I have left out the industrial base metals. I might be wrong, but they are not in my portfolio), Agricultural LAND, livestock, timber, mines, oil and gas wells, railroad cars… the opportunities are rampant. Be careful not to over leverage (or even leverage at all), and make sure you DIVERSIFY.

Financial assets? Of course, but they must be in industries that benefit (or are not harmed) from commodity inflation and high energy prices.

Still trying to build a business that depends on the U.S.$ or car traffic/employees that commute? Good luck. Not for my money or efforts. If already have one, strip it down and convert the cash flow of the next couple of years into those hard assets listed above and a new business that takes all of this into consideration.

Could I be wrong? Maybe, but check my math. I would not bet against it. And if I am? You would own a diversified portfolio of real estate, hard assets, financial assets, precious metals, etc… No harm, no foul.

And if I am correct? The above mind set will save your bacon.

Yours for a better world,

Mentatt (at) Yahoo (d0t) cam