Wednesday, November 02, 2005


The guest on CNBC just talked about the possibility that oil will be down to $30 per barrel by the second quarter of next year. A couple of months back when I wrote about $55 oil being likely, I couldn't find any support. Now that the price has dropped from $70 to $59 the talk is about $30 oil.

I still anticipate a "dance" around $55 for a good while. There has not been enough time for exploration and production to catch up with new demand in China and India. For now, the price shock has slowed demand growth but the world wide economy is still strong; demand growth will be modest but there will be growth.

I have argued that coal and tar sands are plentiful at a cost of conversion of less than $45 per barrel. In two or three years, $45 will be new "top" price. The lower end of the range will depend on how much more "easy" oil is discovered. I understand that a field in Thailand is showing great promise.

Transportation stocks often lead the market. The most recent example was at the top in 2000; transports actually showed weak relative strength for a year before the top was made. Today, transports are trading at all time highs (I believe this is true for the S&P and the Dow Jones Transport indices). The break out of the transports says the economy and corporate profits are going to be strong. It may mean that the FOMC raises rates three or four more times. JP Morgan has posted a forecast of a 5% Fed Funds rate by next May.

Today, a number of accounts I monitor are enjoying excellent gains. Those that have heavy weightings in AMR, CAL or LCC are particularly strong. Most of these accounts also own GOOG which is resting today. Google is likely to advertise on satellite video feeds in the near future. I'll write more about this at a latter time.

For now, don't get caught in the hype about oil and inflation. Ironically, one of the arguments of those who are using inflation as a battle ax (I believe most of these guys are democrats making a political point), is that real wages have not done well. They are trying to make the point that inflation is eroding purchasing power. However, as an investor, I am concerned about the "total" inflation rate. Wages are the biggest component of inflation. Wages have grown at a very moderate pace over the past year. Total employment costs have risen faster than wages because items such as heath care costs have seen large increases. Still, investors can take comfort in the fact that inflation has been largely focused on only a small part of the total picture. Indeed, the other factor in production besides materials and labor is capital. The cost of borrowing money is still very low. Yes, increases in interest rates show up as inflation. However, increases in interest rates are like applying the brakes to commodity price increases. For example, the cost to hold an ounce of gold has gone up more than 100% in the past year.

Once the price of commodities is broken, there will no longer need to be increases in interest rates. In other words, once the FOMC gets on top of the inflation curve, two of the components of any product will no longer have inflation. Indeed, it is likely the the price of commodities will fall for several years to come.

The bottom line is that folks who believe that oil is about to go to $100 need an attitude change. However, just because it is not going to $100 in the immediate future does not mean it is going to $30 in the near future. In 1999, when oil traded as low as $12, drilling virtually stopped. I can assure you that drills are running around the world today with oil at $59. New rigs will continue to be manufactured and put to work for as long as oil is trading above $35. The probability of $55 oil within 2 years is very high and within 6 months very probable. Investors should note that AMR, CAL, and LCC will all make nice profits if oil gets back to $55 and stays there.