Tuesday, August 05, 2008


I don't recall the name of the guest on Kudlow who is going on about the buying opportunity in commodities but he is wrong. There could be a bounce and it is possible that the deal with Iran will fall through but the odds are that this roll over in commodities is real. The chances of $90 per barrel oil by year end are much higher than the chances of $150 oil. A $30 per barrel drop will still leave great incentives for drillers to drill and consumers to conserve. Supply meets demand at a price and the price of oil is very elastic (flexible) given enough time for producers and consumers to react.

Not that it matters a lot, but the guest has suggested that Bernanke is not likely to raise rates again any time soon. The truth is that Bernanke moved slightly more into the "fight inflation camp" today. The thing is that even though the USA now has low rates relative to the rest of the world, we can continue to have lower rates because we use less energy per dollar of GNP than do most countries. It takes very little energy for Amazon to send a 300 page book to a Kindle over the Sprint cell telephone network, but Amazons profits are probably much higher than the profits made by company in China that makes tennis shoes. Some say the good jobs have all gone overseas but I say the author who sells millions of books through Amazon has an excellent job. So do Amazon's buyers, programmers, marketing professionals, etc.


The US dollar has rallied in line with the drop in the price of oil (the peace in Iraq is positive for the US dollar). At what point in time does the dollar trade on momentum. The folks out west are very well aware that a wild fire creates its own wind. Now that the dollar has turned, it is producing its own wind. Investors from the majority of all countries now have the opportunity to buy US stocks very, very cheaply. The Euro investor gets $1.55 worth for 1 Euro. Should the dollar soar to its height of 1999, the $1.55 will buy 1.8 Euros. This 80% gain does not include the profits made off the US investments.

By the way, if you bought 100 shares of CAL at 50, you invested $5,000. If you invest $5,000 at $16, you will get 312 more shares. When the stock gets back to 50, you will have $20,600. Not bad for a $10,000 investment. Triple up and the $10,000 invested at $16 will be worth $62,400 when you break even on the first $5,000.


I asked a banking friend about covered bonds today. He says they will provide liquidity to the mortgage market but it remains to be seen how popular they will be. The banks will sell more of these bonds as confidence rises in the health of banks. Because the capital requirements of Fannie and Freddie are likely to be increased to "bank rates", banks are going to be in much better competitive position on standard, 20% down mortgages. They will gain market share. Lower standard mortgages will ultimately return but these will most likely only be available though finance companies with high capital cost. As is always true, the best time to buy real estate is when it is difficult to arrange financing.

Again, the roll over of commodity prices will take the pressure off bond rates and banks. Banks are coming off massive losses but many of these losses will ultimately be recaptured. Some folk believe the housing crisis still has a long way to go but prices of homes in most communities are stable. Besides, these folk are not factoring in oil at $90 a barrel or less. The are not factoring a successful end to the Iranian crisis. Those who lend money must be cautious. They need solid collateral to maintain relatively small profit spreads. Equity investors bet on the future. Equity investors are starting to smell success. Many are smelling lower oil prices as a result of a congress and presidential candidates who are trying to get in front of the coming tidal wave. It really does not matter for which reason oil prices come down. When they do, the value of a profit stream soars. A profit stream of 15% that is being eaten away by inflation of 5% will compound to a tiny fraction of the same 15% profit stream that is hit by only 2% inflation. Add leverage and a losing situation turns into a wonderful cash flow machine. Like Einstein said, "the most powerful force on the planet is compounded interest".

The Kudlow guest is providing a service to you. By making poor investments and by telling others to make poor investments, the returns for the rest of us will be higher. Take advantage!