Wednesday, August 13, 2008

Armada Correction and Trillions of Dollars of Computer Nails

The good folk at have debunked the numerous reports (that caught me like a fish) about an Armada being assembled next to Iran. The USS Ronald Reagan is moving in the right direction, with its formidable battle group, but the USS T. Roosevelt is still in Norfolk. The whipping up of "noise" just as the economic slowdown-recession caused a huge drop in the demand for oil, was likely a game played to talk traders into "buying the dip". Massive speculative positions, long of oil and gold, are being unwound, the pain of unwinding big positions that have gone south was soothed by talking others into sharing the pain. The pain for those who are long of gold and oil will get worse, but that same pain will provide relief for those who are struggling to buy food and gasoline.

Undisputed reports include a sharp drop-off in demand for petroleum products. If anything, the reports understate the reduction in final demand. US refiners ran at only 87% of capacity, in July. US drivers drove 12 billion fewer miles last month and the economic slowdown has spilled over to Japan, Europe and most of the rest of the world. The history of sharp declines in oil during economic recession is no secret. The trouble is that fear will rise as those who enjoyed the rise in prices are caught in the same recession as those who were hurt by the rise in prices. Only a few weeks ago, pension fund managers were joining the fray to buy oil at any price, now they are getting out of commodity investments as fast as they can (this mornings slight bounce in gold and oil prices should fade in hours or days).

As expected, emerging growth countries have been hit harder by high food and energy prices than have developed countries. In emerging growth countries, a high portion of consumer's take home pay is spent on fuel and food. Bloomberg reports that investment dollars are flowing out of "BRIC" and into the US Dollar. "BRIC" is a short cut for Brazil, Russia, India and China. The big difference within the group is that Brazil and Russia are resource rich and India and China are resource dependent. The sharp decline in oil prices will ultimately help China and India. The huge drop-off in China's importation of oil has been blamed on preparation for the Olympics, but it is also related to the capping off of China's SPR. Holding an SPR is a wise investment that helps hold down risk premiums, but building an SPR does take oil off the market. An SPR is like having an emergency fund in the bank, it takes effort to build an emergency fund and you will not earn much interest on it but the total benefit is much more than the earnings.

This morning, a guest on CNBC said more oil has been discovered in the past 5 years than in the prior 25 years. His numbers are consistent with my general knowledge. We don't often hear much about the big finds in Kazakhstan or India but the more recent discoveries in Brazil have made the news. The total of Brazilian offshore oil is a minimum of 17 billion barrels and can easily be 70 billion or more. We will gradually learn more as additional exploratory wells are completed this year and next. The key point remains that pending doom from peak oil is the Nancy Pelosi hoax. Recent discoveries of natural gas have increased US reserves to 118 years at current production rates. Production rates will increase but other discoveries will be found. The world is not about to flood because of global warming and the world is not about to suffer a great depression because of inadequate energy supplies.

The chatter about a pending confrontation with Iran has included reports of Iranian naval exercises in the Caspian Sea (suggesting that Iran wants to guard against attack from Russia) to Iranian claims of developing an advanced unmanned submarine which will be deployed in the Straight of Hormuz. The chatter could be part of the Israeli game of psychological warfare with Iran but the curious thing is that one of the armada reports came out of Lebanon. Perhaps the Israelis fooled the Lebanese? The third possible reason for the exaggeration of pending conflict could have been a way to explain the lack of US response to the invasion of Georgia. Bush is sending Condi Rice to follow-up on the negotiations completed by Sarkozy of France. The US will send humanitarian aid. Without question, the US response to invasion has been weak.

Countries must pick their battles. Countries must spend more on defense in order to assure peace. If Georgia, its friendly neighbors such as Ukraine and Europe had the forces to meet Russia head to head, the invasion would never have taken place. An SPR and a strong military are similar types of insurance policies.

For a number of years, international thought has been that conflicts will be reduced if country boundaries are permanent. Thus, the idea of splitting Iraq into three parts was hit by cold water. Earlier this year, the US and Europe encouraged the break away of Kosovo from Serbia. Russia has returned the favor by encouraging the break away of South Ossetia from Georgia. Americans should never forget what a special home we have. A place where every ethnic group from all over the world has found peace.

The US is determined to work out a deal with Iran. Yesterday, five additional Iranian entities have been sanctioned for supporting terror. The US does not want to provoke war with Iran. The US wants to apply all the pressure it can without causing a rash reaction. A regular reader, whose opinion I have learned to respect over the last 25 years, believes Iran will deny Bush a deal, just as they refused to make a deal with Carter. He believes a deal will materialize but that Iran will not give Bush the satisfaction of taking credit. If my friend is right, the Iranians will have played a huge game of chicken. The words of Obama give Iranian leaders hope. The words of McCain cause them fear. Will Iran turn down the huge basket of incentives currently being offered in the hope that things will be much better under Obama? Obama has stated that Iran must not be allowed to have nuclear weapons. Iran needs to make a deal.


In the midst of talk of war, the world moves forward on many fronts. By 2010, China will have 7 of the 10 largest shopping malls in the world. There are already 4 malls in China that are bigger than the Mall of the Americas. Two of the new malls to be built will set new world records. TV pundits talk about a consumer lead recession without seeming to notice that the biggest savers in the world are quickly turning into US style consumers. US exports are running at 21% more than last year!

Now that the straw has broken the energy and food camels backs, prices will fall back to "normal", returning purchasing power to consumers around the world. Consumer lead recession my foot. Consumer spending was diverted to extra spending for food and fuel but that money is coming back in a rush. During the run up in food and energy the waterfall of lower mobile computing and communication costs did not slow down one iota. The fall in computing price is deeply hidden by huge increases in power. Our weak minds have great difficulty in appreciating the power of compounding. Computers makers are driving the 64th nail.

The old story that is best for helping one get ones mind around the power of compounding is the old story of the man who wanted his horse shod. He was not happy with the blacksmiths price of $4, $1 per shoe. The blacksmith offered an alternative price. He would drive the first nail for a penny, the second for 2 pennies and continue to double the price per nail. The customer quickly agreed. Four shoes times 8 nails made a total of 32 nails. The first 31 nails cost the customers about $2.5 million dollars and the 32nd nail cost another $2.5 million dollars.

Unfortunately, millions of people have heard the above story without applying it to life in the 21st century. Compounding works throughout our lives. Over the centuries, we have doubled our productivity many more than 32 times. One man can now do what it once took thousands to do. In the world of computing, companies are shoeing the third horse. Computers are doubling their power in about 18 months. The relative power of a computer today to one 30 years ago is huge. The computer story has not stopped, it has not slowed down, with each new doubling, the speed of change accelerates. One can now buy a hand held device, charged by 2 cents worth of electricity, that will do more than a room room full of air conditioned computers could do 5 years ago. Soon, computers will carry on complete conversations with us.

As the 6.5 billion people in the world communicate more and in more ways, the savings will be huge. The possibilities will expand in ways we cannot even imagine. The 64th horse shoe nail would have cost $2,500 trillion dollars. I can't even remember the name of the number that is equal to 1,000 Trillion. Computers are doing 2,500 trillion times the work for the same money. The new Apple application store is a function of the fact that computing software has not come close to keeping up with computing power. An explosion in delivery of computer software is in the works. Google is another leader in the disbursement of computer software. Yesterday Marilyn got a good laugh about an application offered on a knitting site she visits. The iPhone can be used to keep count knits and pearls. Fast forward and the program will be very useful when it keeps count automatically and speaks up if a mistake is made. Voice recognition is changing the world. NUAN has come from 53 cents in 2000 to $16 recently. The move is not over.

The world is changing fast. Billions of people are being lifted out of poverty even during an economic slowdown. Markets lead economic cycles. Before the slowdown is over, stocks will soar!