Wednesday, November 16, 2005


For an airline stock holder, it is sweet to awake to find oil trading down. Not by a large number, but the market is projecting a bigger supply build than what was projected earlier. Demand has met its match for the near term. The question still remains for the intermediate to longer term but efforts are underway around the world to reduce demand and to increase supply.

Inflation is headed down! Back in 1977 the PPI index rose sharpley above the core PPI index and stayed higher for a very long time. It stayed higher all the way to the peak in inflation in wholesale inflation in 1980 and it stayed higher as the numbers turned down. By the summer of 1982, the PPI caught up with the core PPI on the way down; about the time the stock market started perhaps the greatest BULL MARKET ever. Bonds lead the way, but stocks were certainly not bashful.

We are currently approaching the kind of figures we saw in 1980. Not in nominal terms but in the pattern and length of time involved. This time the PPI went above the core PPI October of 2002. Inflation was not a big concern at the time because it was so low. The recent numbers show signs of a top. The wholesale PPI has made a quick double top and the core PPI has clearly turned down since peaking in July. CPI numbers will be out at 8:30. Month to month numbers are very volatile and unreliable. Seasonal adjustment calculations can throw short term statistics for a real loop. However, the trend in CPI is also down.

The simply answer to all of this is that the market works. While it is true that, like hogs and other agricultural products, the price of oil is relatively inelastic in the short run, it is elastic in the longer term. When there is money to be made, sows will be bred and explorers will ramp up drilling.

The idea that the earth is going to run out of oil is ludicrous. For example, arable land is available to grow soybeans and other oil rich products. Right now, the market is busy finding substitutes. In Arizona plants are being planted to replace petroleum in rubber and in Brazil sugar cane, soya beans and other agricultural products are being used to produce ethanol.

China is in hopeful talks with Brazil trying to buy ethanol production technology. Since 1995, soya exports from Brazil to China have grown by 10,685%! China, like the US has millions of hectares of arable land available. Despite the recent US legislation that mandates the production of ethanol, it makes absolutely no sense for the US or China to use this land for ethanol production for as long as there is oil to be found and plentiful coal available. The good news is the market will gradually increase the production of ethanol as it becomes a viable alternative.

The laws of trade and substitution suggest that Brazil should grow the beansrefine them and ship the finished product to world markets. Indeed 1.7 million hectares per year of Amazon rain forest are being converted to soya production.

The value of land in Brazil has sky rocketed in recent years. It is now up to about $400 per acre (an acre of good farm land in the US is probably 10 to 20 times as valuable)! The point here is that the supply of good land in the world is very large. As a conservative, I am hopeful and confident that good decisions will be made to protect millions of acres of rain forest. By the same token, it is nice that trade allows this productive land to be used to help solve the worlds need for food and energy.

The CPI will be out at 8:30. Bonds have rallied in anticipation of good numbers. It appears that bond traders have borrowed short to lend long in recent days. They are driving up short rates to own long bonds that will appreciate if inflation is in check. Larry Kudlow and others have harped about the dangers of an inverted yield curve without pointing out that at market peaks traders short short paper in order to buy more long paper. The big rally in financial stocks is another market suggestion that rates are at or near an intermediate term peak.

While writing this, I hear a TV anchor reporting that Google Base is up and running. Speaking of running, it is time for me make a trip through the neighborhood. It is a beautiful day. Today is a great day to live in America! Praise God from Whom all blessings flow!


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