Thursday, March 27, 2008


The three days of military-police action by the Iraqi Security Forces is another big step forward in the fight on terrorism. For the first time, the elected government is exercising control of its country. In the short run, the market is worried over the Basra oil pipeline. In the long run, the actions of the Shiite dominated government against radical Shiite forces is an indication that the radicals must attempt to achieve their objectives in the political arena or stand the risk of military destruction. It is always hard to be "on the side of war" but "When in the course of human events..." war is sometimes necessary. I grieve for each one of the 4,000 US soldiers killed in Iraq but how many more would have been killed if this war had been postponed? McCain's recent take is that even if invading Iraq was a mistake, al-Qaeda forces are there now and it would be a mistake to leave now. As Iraqi forces take control, the power of the US behind them gives them gravitas, a strong military reduces the amount of fighting needed. The local militias have been in cease fire mode for some time. They do not want to take on US forces. In the mean time, militia members have been involved in crimes against the state, including the theft of oil. The Iraqi government is forcing these militias to make a choice, fight on the battlefield or join in the building of a democratic government. GOOD NEWS!


Mortgage rates as posted by Bankrate Monitor are 5.68% for 30 year fixed rate loans and 5.2% for 15 year fixed rate loans. A number of Credit Unions are offering significantly better deals. One NC Credit Union is offering to refi variable rate loans at 4.25%. These loans will reset at 2.5% above the one year treasury index with a maximum increase of 1% after two years. The maximum is capped at 9.25%. A whole lot of people qualify for a whole lot of house at 4.25%. It is a good speculation that the value of a house will rebound more than 4.25% per year for the next two year and more than 5.25% per year over the next two years. A rented house should offer substantial net returns. The result is that in many areas of the US, the best deals are getting scooped up. A friend of mine just got an incredible deal at a foreclosure auction. By the way, a large percentage of the foreclosures are being purchased by first time home buyers. The American public is pretty smart when it comes to home buying. Despite the recent sharp decline, many an American has been trained by his parents and the experience of his parents to buy for the long term. In today's markets, homes are priced well below replacement costs. Of course, the pain in the dramatically over built areas will last a while longer but even here houses are very cheap in terms of Euros.


Why do you suppose so many airplanes are suddenly being inspected for wiring problems? Has there been a crash or two that suddenly makes the wiring in 25 year old planes suspect? No!

Have you read about the lengths that union members will go to "win"? The biggest fights were long ago in steel mills and at trucking firms, but there are airline employees who are willing to "play dirty". Do you suppose that AMR might have gotten a "bomb threat call" before suddenly canceling 300 or so scheduled flights at the last minute? Do you suppose that "bomb threat" could have been that an airline employee had crossed a few wires?

There is no way for me to confirm my suspicions but AMR has been trying to settle its union contracts in advance. At the same time, AMR unions have been asking for substantial wage increases. The employees feel that they deserve to regain wage rates given up to help AMR avoid bankruptcy. The problem the employees have is that airline industry is no longer a government protected oligopoly. The management that agrees to pay more in wages than the next airline will ultimately be forced to cut back on service, shrink the airline and, barring a change, file for bankruptcy. DAL and NWA which went through bankruptcy to reduce wages and CAL which negotiated lower wages without going through bankruptcy, all have wage costs substantially lower than AMR. The unions can push very hard if they like but they are not likely to "win" the return of past wages. Of course, should an airline employee get caught making a false "bomb threat call", he could spend the rest of his life in jail. It is true that the legacy carriers have enjoyed huge cash flows and that they are sitting on large sums of cash. It is also true that they need this cash to update fleets in order to compete with international carriers.


Carlo Magnifico has posted some great charts at One can easily eyeball 20 years of history on his charts. One example is the price of the Dow Jones Industrial Average relative to the price of gold. The ratio of the two swings to extremes in both directions. In 1995 the Dow was only 10 times the price of gold; by late 1999, the Dow traded at 42 times the price of gold; today, the Dow sells for only 13 times the price of gold. While it is true that the Dow got a little bit cheaper in 1995, we do not know that the Dow will get this cheap this time. The big turn in gold just last week indicates that the relative turn is here. The Dow is likely to appreciate to 40 times the price of gold over the next 5 years.

Last night on Kudlow and Company, an executive of Norfolk Southern Railroad mentioned that trains are fully loaded and carrying exports to ports. Of course, the exports include coal and corn but, surprise, surprise, also autos. US autos are cheap in terms of foreign currencies. The value of the US Dollar has certainly made the "full cycle". The ratio of gold to the US Dollar went from 1.2 times in 2001 to 13 times in 2008. This ratio is now back at levels not seen since the recession of 1991.

Many other ratios are "out of whack". The ratio of the Dow Transportation Index relative to the price of oil has gone from 21 in 1990 to 270 in 1998 and to 47 last week. Here again, the price of oil is not as "crazy" as it was in 1990 but it is not cheap. Oil is extremely expensive relative to natural gas but families pay only 6% of their disposable income for energy today, compared with 8% some 20 years ago. The Dow Industrial Average is "cheap" in terms of gold but also in terms of oil. In 1990, the Industrial:oil ratio was 62, it reached 812 in 1998 and it is now at 122. GM has also gone full cycle, trading at $18 per share in 1991, at $77 in 2000 and at $19 or so now. In 1991, the dollar was not nearly as cheap as it is now so the coming rebound should be huge.


A couple of days ago, my wife and I decided to buy a hot dog for lunch but instead of driving 4 miles to our favorite stand, we decided to try the hot dogs at the local barbecue shack. The hot dogs were excellent. It took $3.19 gas to get us to try the local hot dogs, the next time, the local option will be automatic. Saving 8 miles to buy a hot dog is no big deal but how many millions of similar decisions are being made daily?

Last year the wholesale price of gas was at $2.41 at the start of the summer driving season and the retail price peaked at about $3.21. Today's wholesale price of $2.71 implies a retail price of $3.31 and the summer driving season is still a couple of months away. It appears likely that gas will be selling for $3.50 by summer.

On the other hand, how many others have found "good hot dogs close at hand"? I have seen a couple of smartfor2 cars in Clemmons. Demand destruction is taking place. The EIA figures show a significant increase in new production and attitudes are changing. Investors should remember that the price of all the oil is set by the price of that very last barrel. Once Brazil or Angola or Kazakhstan reduces its price for the last barrel to get it sold, the rest of the sellers will meet the price. In the past two days, the market for gold and oil has rebounded but neither has made new highs. The failure to keep the trend alive will result in a new trend. Take advantage!