KUDLOW GUEST IS WRONG, WRONG, WRONG

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.


MOMENTUM?

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.

COVERED BONDS

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!

WHAT DO I DO NOW? BUY MORE!

If you were lucky enough to have added to your CAL position at under $7, you may be asking, What do I do now that the price is above $15? The answer is BUY MORE!

We have been waiting for the break in oil prices for two years. Take advantage!


Will oil bounce? Yes, but from how low?.

Will airlines make a lot more money now that fares have been moved up and oil prices moved down? Yes!

Are oil prices going to go "all the way back down"? Not immediately.

How far down will they go? A tricky question that cannot be answered precisely.

There has not been a "true" recession, at least not an "old timey recession". A home builder or a Hummer salesman would strongly object but the underlying strength of the world wide economy has remained robust. If there was or was not a recession, what matters is that growth, while slowing around the world, has not stopped.

The implication is the demand for oil is going to continue to grow.

What the economic slow down has permitted is the chance for the energy market to "catch up".

High prices have been around long enough for adjustments to be made. Many of these adjustments will not be "taken back". The waiting list at the auto show rooms for hybrid vehicles is gradually being filled. All sorts of small cars are now available; Smart cars are now being advertised. Once purchased, the average car stays on the road 17 years, about twice as long as when I bought my first car. The fuel saved per car is small in the short run but huge in the long run.

When Amazon put the Kindle on the market in 2007, it quickly sold out. In April of 2008, it became available again. One can buy one now and forever more get "free" electronic delivery of books, magazines and newspapers. The buyers of electronic media reduce the number of trees harvested, the number of trips to book stores and libraries and the number of UPS deliveries. The savings to the consumer is about half the cost of books plus the cost of delivery minus the cost of the reader spread over the cost of purchases. The total fuel savings per page is a significant and the number of pages saved is going to sky rocket.

Those who have moved closer to their place of work are not likely to move "back to the suburbs" at $3 per gallon of gas.

However, we must not forget that 100's of millions of more people will move up to the middle class over then next 20 years. The demand for energy is not going to go away.

The marginal cost of production of energy has risen sharply, but it is a far cry from $120 per barrel. Saudi Arabia is still pumping oil that cost only $5 per barrel to lift but the cost to increase the production is probably in the $25 to $40 per barrel range. In Brazil, no one knows yet what the cost will be to produce from deep ocean wells that are beneath a layer of difficult salt but my wild guess is in the $35 to $70 range. It is known that oil produced from tar sands in Canada is coming in below estimates. As I recall, the cost was estimated as high as $65 per barrel originally but some fields are producing for less than $45 with the hope of lower future costs. After a "hot" nuclear power plant is built in Alberta, production costs should fall.

The marginal cost of nuclear is coming down. I need to do some homework to build firm numbers, but the equivalent cost per barrel of oil is quite low. A few years ago, the wholesale cost of dirty coal electricity was about 4 cents per kilowatt. The cost for oil was not a great amount higher but it has made sense to save oil for use as transportation fuel I vaguely remember that the wholesale cost is now up to 8 cents before accounting for the cost of using clean coal techniques. For sake of argument, lets assume a total marginal cost of 12 cents, which would make nuclear only about one third the current cost. One third of the current price of oil is $40. Add in increasing construction costs and $55 to $70 becomes a reasonable approximation.

The above $35 to $70 calculations for nuclear, tar sands, and deep water oil is rougher than a popcorn cob but it serves our purpose here. The 36 nuclear power plants under construction now, will only gradually come on line (4 this year). The 90 some on order will start coming on line in 5 years (however, China expects to have the construction time down to 2 years after a few more plants are completed).

Based on the rough calculations above, I expect oil to make it back to the $55 to $70 range within 6 years. How does this guesstimate compare to history?

Adjust for inflation, in terms of the 2000 dollar, the price of oil ran from $38 per barrel in January of 1979 to $85 in March of 1980. The peak was short lived. By October of 1980 the price was off 14% from the peak, at $73 per barrel. The following are a few key prices in the years that followed: $75 December 1980, $52 Feb 1982, $65 June 1982, $50 Jan 1983, $57 June 1983, $42 Dec 1984, $48 Nov 1985, $20 Jan 1986, $12 Dec 1998, $105 March 2008.

The total drop from $85 to $12 was 85%! History does not repeat itself but it does rhyme. Just before the recession of 1990-91, oil traded at $22 in June 1990. It zoomed to $46 in just 4 months and peaked at $46 in October. It was back down to $25 by February o1991. This spike was in response to the invasion of Kuwait by Iraq. The last run of oil from somewhere in the $100 area to the $147 peak was in response to the threat of war with Iran. This threat is waining quickly. Iran is being given chance after chance of accepting a huge package of benefits in exchange for ending its pursuit of nuclear bombs. On a "second track" Iran is being punished severely until it agrees to end its pursuit of nuclear weapons. Most importantly, the agreement to suspend pursuit of nuclear weapons will include the agreement to end support of terrorist.

DRILL, DRILL, DRILL

The American people are gradually being sold on the benefits of opening up energy markets just when the economic slow-down is reducing demand and just as the tensions of war are quickly fading. At the rate we are moving now, within a month or two, democrats and republicans will be stumbling all over each other to get to the front of the parade toward more energy supplies. When 10-year out oil futures were selling for $147 even the country of Mexico got into the act. It takes a serious financial commitment to drill deep in the Gulf of Mexico, by pre-selling oil, as yet to be discovered, Mexico has dramatically reduced its risks. Someone needs to give some of our congressional representatives a lesson in economics. The speculators who bet on high oil prices in the future are the very folks that lower our oil costs. If speculators (investors) know that drilling is permitted in fertile areas, the price in the futures market will be reduced. It will not take 5, 10 or 20 (Obama) years for OCS oil to lower prices. A partial reduction will occur immediately.

Last quarter, under duress, CAL produced positive cash flow of about $500 million. This quarter a lot of that cash will be used but the performance in these circumstances is remarkable. Over the next several years, as oil retraces its steps, CAL is going to make a lot of money. Assuming the congress permits its petition for antitrust exemption in regard to a set of partners, profits will really soar. The globalization of our economy has just started. Cloud computers are making it all the more easy for business to be conducted anywhere in the world. On full margin, one can almost make 500% returns on 100% moves and 2500% returns on 200% moves.

What do I do now? Buy more!

BAD NEW -- GOOD NEWS AHEAD! THE WATER IS FINE.

As high interest rates from Columbia to Russia bite, the world economic news is going to be "bad". There should be a steady flow of stories about slowing growth in China or recession in one country or another. Please note that this type of "bad news" will turn out to be good news for non resource related stocks. It will be good news for long bond rates, good news for mortgage rates, good news for real estate (even bad news about real estate will be good news for real estate), good news for airlines, good news for autos, good news for semi-conductors and good news for all sorts of new technology. Have you noticed the up-tick in big pharma? New drugs are changing the world.

One benefit of the decline in energy prices will be that we can stop wasting so much money on wind and ethanol subsides, making capital available for all sorts of innovations. A minor innovation example, the Segway was billed as a world changing transportation system. It is. Toyota has joined the club with the production of the Winglet. It is a "mini-Seaway". Even though the Segway has been a big yawn so far, in the not so distant future, millions of people will scoot around on these types of "vehicles". So far, this is a chicken or the egg situation but the production of low cost Winglet's will bring new vision to many. The idea of living within a short distance of ones work will become all the more attractive. A major innovation example is nuclear power, I believe I have made a strong case for nuclear power (the costs have gone down dramatically while the efficiency has gone up dramatically). If one chooses to invest in nuclear, he should invest in the builders, not the fuel. There are many tons of nuclear waste available that is good fuel for some of the reactors.

MAKE BIG $$$ OFF THE AMBER WAVES OF CHANGE!!!!!

TURN, TURN, TURN: THE CHANGE WE HAVE BEEN WAITING FOR.

Change has happened and is happening fast. A slooooow cycle up a hill has turned into a fast downward grade trip and new gear after new gear is having to be hit just to keep up.


The financial news shows continue to give primary credit for the big drop in oil to the change in attitude that is going on in regard to drilling for oil. A couple of months ago, McCain came out in favor of OCS drilling. A couple of weeks weeks ago, Bush removed the executive branch moratorium on OCS drilling. Congress adjourned Friday but 30 republicans are "still in session". They stand on the house floor and make drilling speeches to visitors. They are demonstrating that they are ready to do their jobs and to vote on a drilling bill. The Senate gang of 10 came up with a plan that includes too much pork but it is a drilling compromise bill that could become the vehicle of CHANGE. Meantime, the Nancy Pelosi freight train is racing toward a cliff.

Nancy says the house will not vote on drilling. There are more than one, not so minor problems, with her stance. The key problem for her is that the congressional moratorium on drilling is a part of the congressional budget. In the past, this was not a problem: who would dare to cut off funding for the entire government over OCS drilling? This year, a number of republicans stand ready to pass a continuing resolution, only after a vote on drilling. Should the congress not pass a continuing resolution by October 1, the US government will be partially shut down. Emergency services will be maintained but many employees will be put on furlough. Government shut downs are risky business. They make voters mad. Voters are already mad about $4 gasoline.

The good news is that the hand writing is on the wall for all to see. Smart politicians move in advance of events so they can take credit. Obama, who is running a campaign of CHANGE, has gone from flat out opposition to any drilling to conditional support. He is now in favor of drilling, provided certain other things happen. Kind of like my wife saying she will cook dinner tonight if I agree to take her on a round the world cruise (one that I would greatly enjoy). Should we compromise on a cruise to Alaska, should I eat another Big Mac for dinner or should I bargain for 500 dinners? Obama wants the 500 dinners and the cruise. The situation is comical. We can all save thousands of dollars per year on our fuel bill by increasing the supply of energy but only if we agree to pay off owners of wind mill farms and only if we increase income taxes on Exxon. Exxon, the company that pays more in taxes than 150 million Americans combined.

CHANGE, CHANGE, CHANGE

Thomas Friedman is a liberal with a streak of common sense, a rare combination. He is a New York Times, Pulitzer Prize winning author. His book, "The World is Flat", helped us understand the significance of globalization (should I say, of global CHANGE). So far, Obama and most other democrats running for office, are not willing to accept that the war in Iraq has been an important part of the war on terror or that the surge has worked. Obama has tried to throw off the electorate by elevating the importance of the war in Afghanistan and by making it seem that killing Osama bin Laden should be the primary objective. Sunday, Friedman wrote, "I think Barack Obama needs to ask himself honestly" 'Am I for sending more troops to Afghanistan because I really think we can win there, because I really think that will bring an end to terrorism, or am I doing it ..to get elected..'" He goes on, "The truth is that Iraq, Afghanistan, Saudi Arabia, Lebanon and Pakistan are just different fronts in the same war on terror."

Friedman understands what many Americans and Obama need to understand. Killing a man hiding in a remote cave in the high mountains of Pakistan will not change the attitude of the millions who believe it is acceptable to try to force the Islamic religion on others; the millions who support blowing up innocents to make "progress". Friedman also understands that the terror will not end unless the male dominated fiefdoms of the Middle East are brought into the modern age. (The Saudis have made plans to let women drive.)

Iraq is setting an example for the rest of the Middle East. Rapid changes are taking place. Now that the great majority of the terrorist have been banished, there is a "democratic awakening". Sunnis have rejoined the government, a political deal has been reached in regard to Kirkuk. Voting is back on the schedule for October 1. A deal has been reached in regard to US troop presence. Power and clean water are being "turned on". Male and female children attend school. The Iraqi Army has made great strides, many soldiers have quickly become professionals. The US has agreed to sell 10.8 Billion Dollars worth of arms to Iraq. Contracts are about to be let on drilling in a 5 Billion Barrel oil reserve, in East Baghdad, that has had no production for years. Basra, run by militia just a few months ago, is rapidly becoming a great place to live, and yes, the province is producing more oil, more income for the country.

The above mentioned deal for US troop presence has not been officially announced or even signed off at the top, but the list of arms being sold to Iraq has been made public. It includes 24 helicopters, about 400 light, armored vehicles and 140 tanks. I assure you that the agreement to sale these arms will not be executed until other agreements are executed. The old military rule, understood by McCain but not by Obama is that Iraq must stand-up before the USA can stand-down.

There have been other interesting developments and a number of exciting rumors. One rumor is in regard to the visit of Assad of Syria with Amadinejhad on Sunday. It has been said that Assad gave Amadinejhad the bad news that Syria is ready to agree to the negotiated peace deal with Israel. This deal will include Syria's responsibility of pulling back from "engagement" with Iran. Today, Assad is back in Turkey, whose leaders have been mediating the negotiations. At the least, it appears that Assad is engaged in "shuttle diplomacy".

In Iran, workers at a tire plant set fire to stacks of old tires. They protest not being paid for four months. Protests are spreading across the land. Yesterday, thirty male university students wore neckties to class. The implication being that it is time for Iran to join the modern world. Five students were severely beaten in the public square. The hangings and beatings in the public square will not put food on the shelves. Gasoline, in particular, is in short supply. The people are rightfully angry.

The UN 5+1 continues to wait patiently for a formal response to its latest offers. The deadline passed but there is no rush to add more sanctions. It is clear that the third round of sanctions are biting hard. The fourth round of sanctions will be negotiated between the 5+1 and proposed to the UN at a September meeting. Ouch! Most victims of death by 1,000 cuts, "ling chi" or "lingering death", do not make it to 1,000 before they end their own lives. The leaders of Iran are protesting their treatment after each cut, while they gradually bleed. The people, domiciled and exiled, are agitating for CHANGE, CHANGE, CHANGE.

Various pieces of this puzzle keep getting close to coming together. The PM of Israel, Olmert, met with Palestinians again today. Olmert, whose resignation takes effect in a couple of months, is eager to sign peace agreements with Lebanon, Syria and Palestinians, before he leaves office. A tall order but conditions are ripe.

ECONOMIC TURN, TURN, TURN

Yesterday's numbers showed a significant upturn in the US economy. Just as high interest rates are finally biting into the strength of the worlds economies, low interest rates in America are starting to revive the US economy, just as the price of fuel is starting to give us all a "tax cut". Brian Wesbury made a key point yesterday.

Before getting to Brian's point, let me say again that pundits like to yell and scream about the phony inflation rates reported by the US Government. Inflation is a complicated beast to understand or to measure. If a sick person visits one of the new health clinics, located at places from J.C.Penny to Walgreen's to Wal-Mart, and if he pays $49 for services that would have cost him $89 at his local doctors office, what was the inflation rate? Was the visit the same? The doctor might say that he got an inferior product. The well patient may be in awe of the $40 in his pocket.

Brian notes that part of the confusion is in regard to the difference in price indexes and deflators. The GDP deflator is a measure of price changes in goods produced in the USA. The CPI index is a tricky measure of what we buy, including foreign goods. Since America imports much of the oil we use, the recent huge run up in the price is not captured in the deflator but it is captured in the CPI. However, this does not mean that the CPI should be used to adjust the CPI. It takes a horse and a donkey to make a mule but only the truly stubborn will insist that any of the three is the best animal. The right animal should be used for the right purpose. It is wrong to suggest that the economy did not grow as fast as reported due to improperly reported inflation numbers. Unit labor cost increases which averaged around 12% in 1980 was at 2% in May. Inflation is seen in the eyes of the beholder.

It is true that inflation has risen in recent weeks. The reason for economic slow downs is to cure inflation, therefore, there is nothing unusual about high inflation rates after an economic slowdown is underway, central banks do not always wait until inflation is out of hand to react. Plus, economic slowdowns cause a reduction of production of the least demanded goods while the price of the most demanded are often increased. In the current cycle, high interest rates around the globe are going to force the price of commodities down, giving the citizens of the world a "tax break" just as low rates in America are stimulating our economy. The pundits complain about the lack of available credit but the new covered bonds will gradually re-liquefy the mortgage market just as the energy "tax cut" begins to be realized. Some rocky times are still ahead in the markets as the rotation out of resource stocks and into "early cycle" stocks progresses. Buy the right stuff now and you will make very high returns!

The bottom lines are that Personal Income is up at the annual rate of 5.7%, personal consumption up 5.3% (consumers are spending a lot of money but saving a .4% of their income). After tax income is even better at 7.6% growth! Times are good. We do not need the wrong kind of CHANGE!

$1,000 Rebate Plus New Taxes or $1,000 Lower Gas Bill?

The energy debate is an economic debate. A large number of environmental extremist want the price of energy to stay high because high prices are the way "to save the planet from Global Warming". The extremist recognize that the only way the American people will go along with massive subsidies for windmill and ethanol farms, paid out to political friends, is if they are sold on impending doom. There are both republican and democratic "feeders". The strategy is akin to flooding the top floor of a 50 story building and then fighting to keep the water from flowing to lower floors. Water will find the tiniest of holes to flood through until at least one of them, in response to pressure, becomes a big hole.

Extremist have blocked the construction of nuclear power and the results have included the burning of trillions of tons of dirty coal and a windmill subsidy boondoggle. Rich people are being paid $350,000 to build million dollar wind mills. The rich builders get to keep the million dollar windmills in exchange for investments of only $650,000. To add insult and additional injury, the people then must pay a 1.9 cent subsidy for the energy plus full price for the electricity produced. It sounds a bit like going to a proctologist for a root canal. To win the votes of the extremist, politicians have blocked drilling for oil in many parts of the US. The results have included an annual importation of oil that has reached 700 Billion Dollars, a $.46 per gallon wasteful subsidy of corn oil, and extremely high food prices.


Sunday, Al Gore appeared on Meet the Press to lobby for more, more, more. Al called for a dramatic, virtually impossible and extremely costly response. Al is good at choosing his words. While talking about alternative energy, he never used the word nuclear. Even with nuclear thrown-in, there is no way to do what Al wants to do in 10 years. He, his friends and republicans such as T. Boone would certainly go to the bank off of the attempt.

Obama has started this week with an advertisement about energy. A couple of days ago, Obama finally started his energy flip-flop. He is now in favor of some off shore drilling and he is in favor of releasing oil from our SPR. He says he is willing to place hard sanctions on Iran to prevent nuclear power but then he is willing to give up an ace in the hole for a short term gain! His support for drilling is all talk and no hat. He supports drilling in a few areas provided his buddies in the wind business get paid off. To help hold that water on the 50th floor, he goes on to offer $1,000 rebates to the middle class, to pass out billions of windmill and ethanol subsidies and, for good measure, he would spend a few trillion on his health care plan.

$1,000 REBATES -- HOW?

If we are going to annually give out $1,000 tax rebates, where do we get the money? One way would be to allow the supply of energy to increase. We could save much more than $1,000 per person through lower transportation, heating and air conditioning costs. We could save even more per person by increasing the supply of health care.

Last week, Blue Cross -- Blue Shield of Minnesota agreed to eliminate the copay for health care clinic visits! This is a remarkable development because Blue Cross -- Blue Shield is a "doctor owned" health care insurance company. Over the past several years, the growth of health care clinics has been dramatic, despite fierce resistance by some Medical Societies. Many people in many states have found that they can get timely care while saving money and time at clinics staffed by nurse practitioners. Nurse Practitioners, as highly trained professionals, are specialist. They can efficiently treat common ailments and can give provide routine "maintenance" for diseases such as high blood pressure and diabetes. By handling the routine and referring to doctors offices as appropriate, they provide a screening service that is good for the patients and the doctors. Because care is so much more readily available for more hours per day, many a child who went untreated before is now routinely seen. In the work place, there has been a rebirth of the company clinic. Here again, the minor ailment can be treated for a tiny fraction of the former cost.

Health care inflation has slowed and the future potential savings on medical care is huge. Similar savings are being realized in education. Home schooled children are taking a big chunk out of education budgets across the country. A growing amount of home school lessons are low cost, computer delivered lessons. Parents are also specializing to assist one another.

The "hot" issue of the moment is energy. Obama's response to high oil prices is to add taxes to the oil companies. When is enough, enough? Exxon will pay more income tax this year than half of all Americans combined! The shareholders of Exxon, who include the majority of all people who own retirement accounts, should not be forced to pay more than 50% of profits in taxes. Besides, an increase on domestic taxes would only increase importation and drive gasoline prices higher.

Which would you rather have, a $1,000 tax rebate, $5 per gallon gasoline, purchased from Saudi Arabia, 12 cents per kilowatt electricity and a war in the middle east or $2 per gallon home grown gasoline and 6 cents per kilowatt electricity? That's not all. Obama's taxes on Exxon would be used to subsidize windmills but his $1,000 rebate would come at the expense of higher taxes on our most productive assets. The one saving grace in the past several years has been productivity growth. Obama is willing to tax achievers in order to "be fair". At least Al Gore would fund his program by decreasing the tax on work in exchange for increased taxes on energy.

A more important question: do you really want to continue to breath toxic poisons emitted from coal smokestacks? In addition to longer lives and better health, we can in effect offer more than a $1,000 rebate by converting our electricity production from dirty coal to clean nuclear. Millions of Americans have suffered from noxious fumes. Hundreds of thousands have died early deaths. The money we pay for cheap coal fired electricity does not include the electricity costs.

One of the ironies of coal electricity is that the coal plants emit substantial amounts of radiation, much more than nuclear plants. Of course, the sun is the biggest nuclear power plant in our solar system but we should not forget that the earth itself is a nuclear power plant. The hot molten core of the earth is heated by fission. Millions of Americans who are opposed to nuclear power just spent vacation time soaking up rays from the sun. We are all constantly bombarded by radiation.


THE WATER IS LEAKING

Only a few weeks ago, the year over year price increase in oil hit 100%. It is now rolling over. It did not begin to roll over until the economic slowdown started to spread around the world. The US economy slumped about 6 months ahead of the European economy and about 12 months ahead of emerging growth economies. US vehicle sales have fallen to 1993 levels. The % decline is similar to what happened in 1996, when there was no recession, but oil price relief is needed. Congress is on vacation until after the conventions. On the other hand, the negotiations with Iran continue. Again, the water is going to find a way down. A good deal with Iran is more important than the ultimate agreement of congress to drill. This week, interest rate decisions in developed countries will give an indication if the fight against inflation is going to reverse and become a fight to battle off recession. With history as a guide, it is likely that central bankers will stay tight too long. With high rates around the globe, economies are going to continue to slow and the price of oil is going to fall.

TECHNOLOGY TO THE RESCUE

Technology is showing up in all sorts of products. The common nail has been around for centuries but it has been improved. Bostich is selling many tons of hurricane/earthquake nails. The additional cost to build a house with these nails is about $15. These nails increase the resistance of a home by about 50%. I gathered this bit of information from the Next Big Future web site. How much would you guess the expenditure of $15 on nails would save in insurance premiums over 30 years?

Even so, these nails are only a very tiny addition to the innovations that are in progress. Another tiny addition was the deployment of the MQ-9 Reaper, drone aircraft, two weeks ago. Fighter planes can stay aloft over Iraq from a maximum of 3 to 6 hours. Reapers can stay aloft for 24 hours. The "pilots", stationed in Nevada, are not in harms way. Fighters will still be in the theater but the fuel savings are substantial. More importantly, lives are saved by the "persistent stare" from the sky. Reapers can drop 500 pound laser guided bombs.

Huge, but the dollar savings are nothing when compared to the savings being delivered by "cloud computers". If you have some money to invest, sprinkle it between IBM, Google and Amazon. These three are offering computer services at a fraction of the costs to operate a private IT department. Companies such as Oracle and Salesforce are also specialist that allow thousands of companies to focus on what they do best. Operators half way around the world can help maintain systems that run 24/7. Ricardo would be proud indeed.

Companies with and without their own servers are starting to learn the power and savings available though "social networks". Most of us think of MySpace and FaceBook as something for "kids" to play with. Companies such as GE bring the right resources to bear by using "professional networks". It is easy for a manager to solve a problem if he has a great data base to search. Identifying the right person for the job at hand becomes a matter of an "instant" search.

SPREADING THE $1,000 REBATE AROUND THE WORLD

The US just deployed AFRICOM. The US is active in the peace process around the world. SARRC just agreed to fight terror by freezing the funds of sponsors. The action by SARRC is just one more demonstration of the success of new robust US Intelligence efforts. When terrorist are exposed to the light, the people of South Asia are more open to fighting terrorism than are Americans. This morning, India announced a 450 million dollar contribution to the war effort in Afghanistan. India has been the leader of the NAM (non-aligned movement). This contribution is another demonstration that Russia, America, the NAM and all but a very few countries are on the same side of fighting terrorism.

The good news is that the people of India will receive more than a $1,000 "rebate" from success in the war. India has suffered many more terrorist attacks than has the USA. The costs of terror are enormous; this truth is brought to mind every time we go through a court house or airport check point. We all owe it to one another to finish the job. Some years from now, we will be thankful for the peace that we enjoy.

Will Iranian Government Survive?

Iran has had to resort to SWAT teams to control the citizens who are protesting economic conditions and political decisions. Yesterday, a group of shop keepers hit the streets to protest daily 5 hour power blackouts. A police SWAT team opened fire, wounding several protesters. Thirty or so were arrested.

To intimidate citizens, public executions have become common. A few days ago, 29 criminals were hanged in the public square. Of course, the killings only angered more citizens.


A month or so ago, democrat and republican members of congress quietly authorized another $65 million to support regime change in Iran. Sixty five million is a drop in the bucket but it sends a clear message, Iran needs to negotiate with the P5+1 or face "severe consequences".

Today, EU negotiators said that the Saturday is not critical. If Iran needs a few more days, that is fine. As always, it is the threat of additional sanctions that is psychologically devastating. The shopkeepers and other citizens who are suffering now fear the unknown of what will happen next. UN negotiators have indicated that the forth round of sanctions, if necessary, will be severe.

Germany got into a little trouble with the rest of the negotiators when it agreed to build a natural gas to liquid fuel refinery for Iran. Germany used the loophole of building the refinery in Germany and shipping large completed parts to Iran. The point is that Iran is in a scramble to secure transportation fuel. This country of 70 million people had a per capita income of about $12,000 a few years ago. The people own cars. They don't have gasoline to operate them but they own cars.

In preparation for a rough winter, Iran has stopped exporting about 400,000 barrels of residual fuel oil. Turkmenistan is "having problems" delivering about half of the normal amounts of natural gas to Iran. If sanctions are increased, will they have trouble delivering the other half? What useful energy Iran has must be saved for in country consumption. While information is scarce, it is my understanding that about 1.7 million barrels per day of Iran's heavy oil production has been sequestered. This is 1.7 out of "normal" production of about 4.1 million total shipments. Americans are not happy with $4 gasoline but we are not being forced to ration consumption to 60% of our normal usage.

A MAJOR BATTLE BREWING?

Taliban forces are massing in the mountains of Pakistan. A significant number have left the battle of Kashmir being fought with India in order to reinforce the battle against Afghanistan. Other militants, Taliban and al-Qaeda have left Iraq, traveled across Iran and joined the crowd in Pakistan. Obama may be about to get what he wished for, a significant surge in Afghanistan. US and Nato forces are able to take on a conventional war and easily prevail.

Pakistani military forces have pulled out of forts in the high mountains. It appears that the Pakistani military is all set to make a major offensive. The above two sentences may sound counter intuitive but, in military strategy, if one cannot support a distant outpost, one should pull out of it before starting a major offensive. Starting the offensive while a couple of distant outpost are weakly held would be a like a death sentence to the soldiers in the outpost.

INTELLIGENCE -- LET THE LIGHT SHINE!

What is becoming more clear every day is the improvement of US intelligence. General Petraeus has correctly gained recognition for his execution of strategy but little credit has been given to the information that has made his strategy possible. Secretary of Defense, Robert Gates, is a career intelligence officer. He understands the importance of knowing before doing.

In recent days, the Prime Minister of Pakistan has been openly praised and simultaneously chastised severely by the Bush administration. Bush praised the Pakistani efforts while disclosing that intelligence shows that the Taliban has agents deep within the Pakistani Intelligence Service (the ISI). Evidence was leaked that the ISI was involved in a recent bomb attack against India. Of course, the Taliban continues to make attacks designed to pit opponents against one another. In Iraq, the real turn came when the people got totally fed up with the killing of Muslims just to incite the anger of other Muslims.

Intelligence, like diplomacy and war is a nasty but necessary business. Spying on ones allies seems so wrong but how else would it be known that the Pakistanis have been fighting themselves. Our educators have chosen to take a lot of details about US History out of our school books. We somehow have come to the belief that we must protect our children from the dirty truths of life. The bottom line is that good intelligence is like letting the light shine. Good intelligence, used properly has saved and will save millions of lives. I frequently describe by comparing it to a sharp knife in the kitchen. Intelligence is another needed sharp knife, a necessary tool that must be used carefully. After a long battle, the President just won a battle with congress that allows phone calls from foreign countries to be monitored. Our constitution gives us the right of privacy but it also makes security the primary responsibility of the federal government.

It is great news that the terrorist are aggregating in one location in isolated mountains. We should be very thankful that these terrorist are not in locations where they could do great harm.

A few months ago, Gates sacked a number of Air Force commanders. These commanders were focused on winning appropriations for new aircraft designed to win the next war. Gates has rightfully pushed hard to increase the air support for the current war in Afghanistan. In addition, Gates has pushed for the increased use of efficient, unmanned aircraft that can be flown by a Specialist Fourth Class from a computer terminal in a safe zone. The drone does not need to come back to base when the shift is over, the control can be shifted from a terminal in Florida to one in Oklahoma to keep fresh eyes on the job.

From a significant distance, a spotter can call down fire from heaven on specific targets. Yesterday, another Taliban commander went up in smoke without putting American soldiers at risk.

The Iranian government is likely to survive. The leaders are under severe pressure to make a deal. Top level meetings are being held this weekend. The cost benefit ratio is heavily in favor of a deal.

A hat tip should be given to the National Council of Resistance of Iran. The information above was pulled from many sources but the Nation Council site provided a few details not found elsewhere.

The Titanic Didn't Sink -- Inflate Your Tires

The US economy did not sink, the Titanic saved it. Partly as a result of export growth, our economy grew by 1.8% last quarter. The number one US export is industrial engineering, but who wants to write about industrial engineering? Our number two export is films. The new Batman has a shot at flying past the Titanic. The Titanic had gross receipts of 2.5 billion dollars! Americans spent 700 million dollars to view Titanic but the rest of the world paid 1.8 billion dollars. The second Pirates of the Caribbean movie made a few bucks too, taking in 1.5 billion dollars. The Pirates trilogy out ran Titanic.

Pessimist say that all the good jobs are going over seas, but I say Johnny Depp and Leonardo Dicaprio have pretty good jobs (sailing the seas with beautiful women). But Oh My! as evidenced by the death of Heath Legder, these are stressful jobs. Maybe the government should provide free health care counseling to help relieve the stress.


Speaking of health care, it is our fourth largest export. People come from around the world to get care that is not available in their home country. In recent weeks, US researchers have reported results from dozens of projects. For example, it has been learned that cholesterol drugs can be used to repair bone density losses. Another drug has been found that has been nicknamed the "exercise drug". Mice given the drug build strong muscles, without exercising. Mice that take the drug and exercise become superior "athletes". Every major drug company now has a dozen or more drugs (some were researched to cure Parkinson's or Alzheimer's disease) that enhance physical performance (sometimes sexual performance). We may get bent out of shape with ethical concerns, but the reality is that the modern athlete can out run, out jump, out swim and out throw (and out "love") the athletes of old. The coming health care crisis will be healthy 150 year old horny toad men and women (Viagra works for women too).

My two year old grand daughter and I enjoyed viewing Wall-e last week. It was fun and it showed one possible future. Without spoiling the story, I will simply say that Americans have it "too good".

The pessimist say that because we are running out of oil, we should not drill for more. What?! We are running out of oil in the USA so we should not drill for oil in the USA? Nancy Pelosi says she is saving the planet, by forcing oil companies to drill in the Atlantic Ocean off the coast of Nigeria rather than in the Atlantic Ocean 50 miles off the coast of Virginia. The Obama "solution" is even better than Pelosi's. He has even topped the Jimmy Carter plan to wear sweaters in the winter time. Obama has been on the campaign trail telling Americans that we should inflate our tires.

Obama also says the poor in America are getting poorer while the rich are getting richer. Is he blind, ignorant or lying? Has he not noticed that the new billionaires are in Russia, Brazil, Nigeria and other places where the governments permit oil drilling?

Besides, the poor in America are rich and getting richer. In 1919 it took an average of 9.5 hours of work in America to buy a bag of groceries. Today it takes an average of 1.7 hours. In 1920, it took an average of 7.4 hours of work to buy 10 gallons of gas. Today it takes 1.8 hours. (Data from Cox and Alm as mentioned below). Poor people in America own video games, microwave ovens and Nike branded shoes.

Pessimist have the largest ever amounts sitting in money market accounts. W. Michael Cox and Richard Alm posted a chart in the American Magazine that shows the price of this pessimism. In similar circumstances in 1982, the public had record amounts of money in money market accounts. Ten thousand dollars left in those accounts since 1982 is now worth $37,778. Ten thousand dollars invested in the average Dow Jones Industrial Stock in 1982 is now worth $288,163. The same investment in other indexes would be worth several times as much but with more volatility. Note that the $288,163 includes the decline in value of the past year.

Exports are so strong that American businesses do not have enough work area. Business structure spending was up more than 12% last quarter. The business cycle boom is already underway, even as the total world growth rate is slowing.

Brian Wesbury, "We are in control of our own destiny".

Brian Wesbury, Chief Economist at First Trust, is one of my favorite economist. I don't always agree with him but his sharp focus on the US economy is well thought out and consistent. In an exchange of emails this week, he and I discussed the incredible increases in short term interest rates in countries all around the world. For the past year or so, Brian has correctly asked the question, "What recession"? Brian suggests that US monetary policy is really not tight and that inflation is the bigger problem.

While I agree with Brian that the next move by the FOMC should be to tighten rates, my contention is that the sharp increases in short rates, from Columbia to Romania, Russia, India and beyond are slowing the "international inflation rate". Slower growth rates around the world are making the US an all the more attractive place to invest and the US dollar is showing strength, pulling down the cost of imported goods for Americans (including oil). Seven straight months of job losses in America indicates that there is pain in a growing list of industries. On the other hand, with growth in the middle class population of the world of hundreds of millions of people per year, chances are that Wall-e and Batman will do well. In our old time brains we may desire for the US to make cars (we are) but I assure you the profit margins on Wall-e trump the profit margins on car manufacturing by a country mile.

As my old broker mentor, Bill Lienbach liked to point out, international finance is like a big bathtub where the average level of the water does not change all that much in the short run even though there is a lot of sloshing around. The FOMC kept their foot on the short term rate brake for 19 months, which slowed the growth rate in the US and lowered the value of the dollar (despite the popular opinion, high rates do not increase the value of the dollar), now the FOMC offers extra low rates while the rest of the world is standing on the brakes. It is the standing on the brakes that is allowing the economy to transition to the "prosperity" phase of the business cycle.

Since it took forever for commodity prices to start rolling over in this cycle, some have been fooled into believing that we are just now in the early contraction phase of the slowdown. The recent strong moves in financial and consumer cyclical stocks suggest that we are at or close to the end of the late contraction phase. Ironically two other indications that the contraction is long in the tooth are high inflation numbers and a significantly higher unemployment rate.

The truth of the matter is that the US is further through the downturn than the rest of the world. Another truth is that rotations are never smooth. Without looking up the numbers, I can tell you that the total value of energy stocks has become a large percentage of the total stock market, just as technology stocks had become a large percentage of the total market value in 2,000. The difference is that the rotation out of tech stocks was into bonds and then into energy, materials and industrials. This time, there should not be a big move into bonds first because the 10-year treasury yields less than 4%.

In 2001 and 2002, the rotation to bonds got pretty crazy. Long rates got so low, around the world, that hard assets such as homes and commodities became very attractive. To put it another way, money is nothing but a commodity that sits on the other end of the see-saw from "hard" commodities. When money is very cheap, real estate is very affordable. As an aside did you know that cows were used as money for millennium? Cows served the purpose of facilitating trade because the producer of one good, such as barley might not know barley's relative value to hundreds of goods but the owners of hundreds of goods knew the relative value of their goods to the value of a cow or calf. The point is that money is nothing but a way to facilitate the exchange of goods.

A Tough Few Weeks or No?

The immediate future does not look bright. Congress is leaving town without having even voted on a drilling bill. There are resignations on both sides of the Syria-Israeli peace talks. The Iranians deny that there was ever a deadline. Prospects for dramatically lower oil prices seem to have stalled.

On the other hand, real estate, which works from the bottom up, has a new law that gives first time home buyers a $7,000 "tax credit loan". Furthermore, banks are now offering covered bonds which will re-liquefy the mortgage market.

Also, the President of Syria will spend Saturday and Sunday in talks with Iran. Iranian officials who denied that there was a deadline now suggest that the deadline is a couple of days after Saturday. When Sean McCormack, a US spokesperson, said that he "did not count the days", Iranian leaders spoke out to say that he has confirmed a later date.

Over in Iraq, the Bush deadline for a SOFA agreement was not met. However, the vice-president of Iraq, Adil Abd al-Mahdi says that an agreement has been reached. It is not a status of force agreement like the ones the US has with Germany or Korea but it will permit troops to stay in Iraq for some specified period of time as "conditions dictate". The once powerful cleric from Sadr is pleading with the people to oppose such an agreement. He is even willing to rejoin the government if the agreement is turned down. Wow! How magnanimous of him?

The political stalling in Iraq is mindful of the "no drilling vote" in the US. Nancy Pelosi and al-Sadr have a lot in common. al-Sadr has been blocking the Iraq congress from voting. At some point, democracies find their way around the tyranny of the few. The agreement on troops will be made between the executive branches of the Iraqi and the US government. The agreement will avoid certain promises and will thus not be a treaty that is subject to the approval of either congress.

The agreement to keep troops in Iraq is a vital piece to the success to the war on terror. Sunnis in Iraq and several other countries want the assurance that Iran will not reinvigorate its support for terror as soon as America leaves. The thousands of al-Qaeda forces, that left Iraq in order to bolster "the cause" in Afghanistan, can easily return.

Some of the troops that leave Iran should go finish the job in Afghanistan. Yesterday, another al-Qaeda leader bit the dust in Afghanistan. He escaped from an Afghanistan prison 3 years ago. A strike from the heavens sent him home for good.

Iran certainly wants US troops out of Iraq. As does Obama. Russia wanted US troops out of Berlin in 1948. Germans would be speaking Russian today if US troops had not stayed.

Time and Oil Discoveries March On

Even though the US congress has put 85% of projected US oil reserves off the market, drilling is taking place. Yesterday, Chevron announced that the Agbami field off the coast of Nigeria is cranking up with more than 100,000 barrels of production per day. By next year, it should be producing 250,000 barrels per day. The game score is going up to 85.25 million barrels per day.

Back in the USA, record numbers of wells are being completed. The mantra of drill, drill, drill started 5 years ago. Those who are looking for big profits in drilling now are 5 years behind the curve. In a growing number of cases, new wells in America are the very expensive, 4 mile long, horizontal wells, but supplies are being discovered. Americans are paying the extra price at the pump, but the oil companies have done a great job of keeping us supplied. Exxon just released its profit numbers for the past quarter. It did not enjoy nearly the margins of other businesses. In addition, for every $1 of profit it paid $3 in taxes, but the total profits were still great. Of course, the total taxes were three times as great.

India has finished the construction of three new nuclear power plants. The power plant built in Iran by Russia is also ready to go online. One nuclear power plant replaces about 200,000 barrels of oil per day! One ton of natural uranium ore is the substitute for 20,000 tons of coal (before the new efficiencies are included). There are currently 36 nuclear power plants under construction, 93 more on order and 218 planned. This all before the coming votes that will confirm negotiated 123 agreements.

Can you imagine the screaming out of Hollywood if the oil business enjoyed the same profit margins as the movie business?

Inflating our tires is not the answer. Taxing capital to support paying 35% of the cost of unreliable wind mills is not the answer. Turning the rain forest into soybean farms is not the answer. Corn alcohol in internal combustion engines is not the answer. Pessimism is not the answer!