THE FOUR LEGGED STOOL

The following reader comments show that psychology is weighing down the market:

"Interesting that in the last 20 odd years, the Fed has pumped the system with liquidity and each of those times we have run smack into some type of bubble. You would remember better than I the bubbles of the 80's but we had the tech bubble in the 90's and then the liquidity ran dry and now they are pumping the system and the money, so they say, is flooding into oil and commodities. When the music stops this time and it will, the money will rush out and I think the tidal move out will be as almost as ugly as the tech deflation. It probably will not happen with Bush in the White House."

"When Warren Buffet says we are in a recession, people listen. The fundamental measures do not matter in my opinion, the psychology is the reality right now."

Readers who quote Warren should remember that he was the one to say that the key to making money in the market is to buy when others are fearful.

Readers should also remember that the strongest buy signal is when the market is supported by the "four legged stool" and one of those legs is skeptical psychology.

The readers comments are consistent with the comments of OPEC members who, under pressure from Bush to increase production, maintained production. The spokesman said that the current price is not consistent with the fundamentals. He is right in many ways. The fundamentals include oil prices well above the equivalent price of natural gas (although the extra cold winter has caused this gap to tighten) and increasing inventories in the US for 7 weeks in a row as a clear result of slowing demand in a slowing economy. What is not included is the fundamental that Iran is being backed into a corner or that Venezuela has chosen to rattle sabers next to Columbia. It is fundamental to me that the price of gold and oil includes an extended risk premium at a time when the country with the second largest reserves in the middle east is under extreme pressure.

Another fundamental is that major investments of all kinds are about to produce fruit, therefore, it is time for the powerful to "create the psychology" needed to unload massive quantities of investments. Investors should always remember that the rich and powerful own or have friends who own media outlets.

A GOOD POKER PLAYER

A good poker player is not terribly upset when he gets caught running a bluff. A good player does not bluff often and he tries to win his bluffs, but, getting caught only serves as the "advertisement" needed to induce callers against really powerful hands. What do you think about George Bush and ethanol? Do you really believe this "good old boy, Texan" really supports converting corn to oil? I don't have access to the Karl Rove play book but I find it interesting that after a few years of silly spending on corn oil, there are suddenly a couple of hundred more coal fired electricity plants and 30 nuclear power plants in various stages of development. Do you think it is possible that Bush has been willing to give the environmental crowd enough rope to hang themselves with?

There is no doubt that the fundamentals will eventually support alternative energy in a major way, but the capital spending binge of the railroads suggests that replacing coal and oil is going to take a "super invention or two".

It is interesting that a lot of alternative energy technologies "work" while oil is trading at over $100 per barrel. For example, the GM partner that uses enzymes to digest every thing from corn stalks to tires claims it can produce at the wholesale equivalent of $1 per gallon of gasoline. I expect that price to be a bit of an exaggeration but it is interesting that that is about the cost of extracting oil from abundant supplies of tar sands in Canada.

The last two "elephant fields" including the monster in Brazil, will be expensive to develop as far as oil fields go, still, the wholesale per gallon cost from either will be significantly less than $1. So, the fundamentals tell us that even with a lot of oil and coal around that is cheaper than ethanol, wind, and solar, we choose to spend large amounts of government money on ethanol, wind and solar.

In other words, if we want to talk about government, there is a huge gap between fundamentals and spending. As far as the markets are concerned, prices of stocks have been pushed down by psychology and prices of gold and oil have been pushed up by psychology but psychology can only push so hard. The other three legs of the investment stool are supporting prices.

If you want to play the game of "how bad can things get?", we still have a very long way to go to the absolute bottom. I can't remember the exact number but I believe price earnings ratios went to around 5 or 6 near the bottom in 1982. On this measure, stocks are still double where they could go and of course the bottom in 1982 was nothing like the bottom during the great depression.

On the other hand, the prime interest rate in 1981 or 1982 was at 21%. Stock prices were facing powerful head winds.

BACK TO MY FAVORITE EXAMPLE

In the past couple of days, British Airways and American Airlines each announced traffic increases of better than 5%. China announced increases of better than 8%. Both British Airways and American are dealing with labor negotiations but their numbers show that the fundamentals of the business are not causing the low share prices. Here you have an industry sitting on the edge of its "bubble cycle" while the share prices are low. The companies are making money even in the face of unrealistic and unsustainable fuel prices. So, yes, prices are out of line with fundamentals. What an opportunity!