Thursday, July 31, 2008

Oil and Speculation from the CFTC

The Interagency Task Force on Commodity Markets has released its Interim Report on Crude Oil. This publication addresses the role of "speculators" in the oil futures market. I am still wading through the report but I found an apparent contradiction between two points that the task force made.

On page 18, the report said:

"The current short-run demand for oil is relatively price inelastic, meaning the quantity demanded does not change much relative to price changes (it takes a very large price increase to reduce the quantity demanded significantly). In the short run, the supply of oil is inelastic as well: the quantity supplied is not responsive to changes in market price, due to low spare capacity, the inability to bring new supplies online quickly, and relatively low inventories to draw down."

On page 28, the report said:

"Crude oil inventories can also shed light on whether the price run-up depicted in Figure 13 reflects mostly fundamental supply and demand factors. Artificially high prices will create an imbalance between supply and demand that should lead to inventory accumulation. However, as shown in Figure 14, inventories of crude oil and petroleum products in the United States and in OECD countries have generally declined over the past year. Based on these inventory figures, current prices, although high, are not prompting the inventory accumulation that would be associated with artificially high prices."

Well you can't have it both ways. On page 18, they correctly stated that both oil supply and demand is inelastic in the short term. On page 28, they said that if prices were "artificially high" meaning propped up by speculators, then demand would fall or supply would increase, leading to an inventory accumulation.

Are they making a distinction between the impact of "artificially high" prices and just "high" prices? Or is the distinction between long and short term impacts? If it is the latter, then I don't think that they have given enough time for this inventory accumulation to appear.

Wednesday, July 30, 2008

A Psychoanalytic Interpretation of Stock Valuations and its Application to the Oil Market

I recently came across a paper by David Tuckett and Richard Taffler entitled "A Psychoanalytic Interpretation of Stock Valuations." I believe it can shed some light on the current situation in commodities.

The two authors examined the academic literature on the boom of the late 1990's from a psychoanalytical perspective and came up with five stages: Emerging to View, Rush to Possess, Psychic Defense, Panic Phase, and then finally Revulsion. These stages can be applied to Commodity Investing in general, and oil in particular.

Emerging to View

It is during this stage that an investment first comes to the attention of investors, usually due to the efforts of financial analysts and the Media. As interest builds in these investments, they become "alluring phantastic objects." For the Internet Bubble, the authors identify the Netscape IPO in 1995 as the starting event that kicked it off. Other seminal events that come to find were the $1000 Amazon (AMZN) price target prediction, the IPO, and many others that have been lost to history.

For oil, it is hard to come up with a starting event. Doug Terreson's piece on the "Golden Age of Refining" comes to mind, or perhaps the publication of Matt Simmons tome on peak oil, or T. Boone Picken's almost psychic predictions on the price of oil, but it doesn't seem like there was one dominating event to kick it off. It was more of a gradual process.

Rush to Possess

The second stage is called the "rush to possess." During this stage a stampede of sorts begins as investors engage in compulsive behavior. The key to this stage, according to the authors, is the introduction of the idea that some sort of "new world" is starting. For the Internet boom, it was the emergence of a "new economy" where old ways of doing business were no longer valid. Remember when no one was going to shop in malls, or read newspapers or bank in person. Get ready we are told, don't be left behind.

We are toward the end of this stage for oil as we have been told to prepare for the world of $7.00 gasoline by CIBC just last month. We must live in a resource constrained world, according to the pundits. Americans in particular, come under some harsh lecturing. We are accused of profligate consumption, without regard to anyone else. We are no longer the center of the world, it's time for China and India to have its share. If we had followed the European model, we would have been better prepared. Investors rush to possess the investments that will benefit from this new world.

Psychic Defense

The third phase is marked by an increase in skepticism by some investors who question the fundamentals behind the rise in the investment. There were many voices who raised objections during the Internet boom, but they were shouted down or ridiculed as "not understanding the new world."

Clearly, for oil, we are in this phase. Any attempt to question the assumptions behind the growth estimates for the emerging economies or supply growth is met with shrill objections by those who have the most at stake financially, and their followers, or what I call derisively call "barnacle investors" who cling to the bottom of the more well known investors in the space.

Psychic defenders of oil investing, on a psychoanalytical basis, engage in denial, projection or splitting. Evidence is seen only through the prism that supports their beliefs. Data is mined or ignored. Skeptics are shouted down or called names.

Panic Phase

There is usually an event that pricks the bubble. For the Internet bubble, the authors cite the article in Barron's on March 20, 2000, that stated the 25% of all companies would run out of cash within a year. Once "material reality" imposes its will on the "phantastic objects" that investors held so dear, panic sets in.

We don't know what this event will be for oil. Perhaps it will be sub par growth from China, or a stunning drop in demand in the OECD.


The blame game begins as participants begin to question all the assumptions that everyone took for granted during phases 1-3.

Read my other posts on oil investing.

Tuesday, July 29, 2008

Two More Banks Go Down

Last Friday, the Federal Deposit Insurance Corporation (FDIC), issued its usual late afternoon press release announcing the seizure of two more banks. This Friday afternoon watch is starting to become a popular blogging sport for many of us. There is not much to add to this story since it has been well covered, but I will publish the final stats for the banks from 3/31/2008.

First National Bank of Nevada - Reno, NV

Noncurrent assets plus other real estate owned to assets - 4.28%
Percent of loans noncurrent - 8.35%
Total risk-based capital ratio - 9.67%
Tier 1 risk-based capital ratio - 8.40%
Core capital (leverage) ratio - 6.24%
Equity capital to assets - 7.37%

First Heritage Bank - Newport Beach, CA

Noncurrent assets plus other real estate owned to assets - 1.26%
Noncurrent loans to loans - 1.89%
Equity capital to assets - 11.89%
Core capital (leverage) ratio - 12.16%
Tier 1 risk-based capital ratio - 14.40%
Total risk-based capital ratio - 15.66%

This bank has very high capital ratios, and fairly low rates of non current loans, which begs the question of what did them in. The OCC said it closed the bank because it was undercapitalized, which is not reflected in the numbers above so a lot must have happened since the end of March 2008.

Read my post on the failure of Hume Bank and First Integrity Bank

Monday, July 28, 2008

An Ominous Cloud

The June report on Japan's trade surplus shows why oil should keep falling in price. The highlights of the report:

1) Exports to the U.S. were down 15.4 percent, the tenth straight monthly drop and the largest since November 2003.

2) Exports to Europe fell 11.2 percent, the second straight decline.

3) Total exports decreased 1.7 percent in June from a year earlier.

An Oil Bull then pops his head up and screams, "Oh don't worry, China and the rest of the emerging markets will make up the slack, you'll see."

Well, not quite:

4)Exports to Asia grew 1.5 percent, the slowest in two years.

5)Exports to China grew 5.1 percent, less than the 12.2 percent growth in May 2008, and down from 23% growth in May 2007.

It won't be long until official figures from China show a slowdown and/or decline in China exports.

A global slowdown in economic activity starts in the U.S., spreads to Europe and Japan, and then hits China and the rest of the emerging economies of the World. This makes perfect sense since we are the largest consumers in the world, and it takes some time for a slowdown in that consumer spending to work its way through the supply chain.

Wednesday, July 23, 2008

Confirmatory Bias and Oil Investing - Part Three

I recently came across a post on the Victor Niederhoffer Blog about the concept of Confirmatory Bias. I shall reprint the standard quote from Sir Francis Bacon that is used in much of the literature on this subject:

"The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate..."

After searching further, I came across a paper published in the Review of General Psychology in 1998 authored by Raymond S. Nickerson of Tufts University. I believe that the concepts he discusses have applicability to current beliefs by bullish energy investors in the oil market.

He presents a modern definition of the concept of Confirmatory Bias;

"...the seeking or interpreting of evidence in ways that are partial to existing beliefs, expectations, or a hypothesis in hand."

In his paper he reduces the concept to its component parts.

I have already discussed the first two parts last week, and parts three and four here.

Today I present my own concepts. They don't really come under the strict definition of Confirmatory Bias, but they are certainly biases that support the bubble, and after all, its my blog and if I want to write about them I will.

Glorification of results or the market must be right.

Oil and Energy has been in a multi year bull market and if there is one thing I have noticed in investing, it is the presumption that because the "market" says something, then the "market" must be right. This is a situation where the "psychological high" that accompanies good investment results is substituted by investors for thorough analytical thought.

Commodities are up 50% this year, well there must be something to it. "These guys must know what they are doing, I guess I'm just not smart enough to figure it out," an investor mumbles under his breath as he heads to his broker, bitter about missing out on the good times.

I can find quotes to apply to other bubbles as well. How about this one for the Housing Bubble. "My neighbor owns five houses and flipped three last year, why can't I do the same? Home prices never go down so what do I have to worry about."

The Cheerleader Effect or talking heads on TV as the second coming of Jesus

Investors are constantly bombarded with information in support of the bull from talking heads on Television, either from professional investors, or from sell side analysts, the great facilitators of the bull market whose job it is to hold our hands while we continue our journey through commodity investing. All of these people have vested financial interests in the bull, and although this is disclosed, usually at the conclusion of the appearance, I don't think that it is generally understood.

This positive reinforcement has a huge unconscious effect on investors. I think that being on television somehow leads to this aura of omniscience that filters down to investors who watch them. Is it that hard to get on television? I don't know - they do need a constant flow of material to entertain us with.

What I do know is that sometimes it is hard to take what they say seriously when two weeks earlier, I saw the same guy during a conference, trying to fondle an 18 year old stripper who was bouncing around on his lap during the evening entertainment hour. Incidents like that tend to dissipate any aura around them in my eyes. These people are not Gods, they are not divine and they did not spring from the head of Zeus.

Investors will usually deny this effect, which can be subtitled "cult investing," but if you read between the lines you will see it is true. These analysts and pundits let you down before when it came to Internet stocks, and they let you down when it came to Real Estate. Are you going to believe them this time? Remember, Growth always disappoints in the end.

The misinterpretation of information usually by twisting it intentionally.

There is an entire cottage industry of analysts and talking heads whose job it is to manage and shape investors thoughts. If, God forbid, any bearish or contrary ideas begin to bubble up to the surface, it is their job to squash it in its womb, so nothing will impede the march of the Bull. As contradictory and bearish evidence begins to mount during the late part of a cycle, this becomes more and more difficult to do. This is the Wall Street equivalent of "spin control" in politics. Here is an example:

China and other Asian countries have partially removed subsidies on products refined from Oil, and sold to its citizens, many of whom have been shielded from the soaring cost of oil, and the resulting soaring cost of gasoline. So common sense would tell you that as the price of gasoline and other products go up, people should use less of it thus reducing demand. While this demand response tends to be closer to inelastic than elastic in the short term, there is an effect. Anyone who doubts this should look at highway miles driven in the United States the last three months.

Somehow this negative data point has been ridiculously twisted to instead mean that Asian countries will actually import more oil to refine into product because they can now lose less money than before, since they can charge more. So here's how it really works - if you sell 5 million gallons of gas and lose 50 cents a gallon you have lost $2.5 million. If you sell 10 million gallons and lose only 25 cents a gallon, well guess what, you've lost the same thing.

This reminds me of an old story that my father used to tell me. He worked in the garment or "schmata" business. After reviewing a new line of clothes, it was determined that to sell them at a competitive price, they would lose money on every piece they sold. The executive just leaned back in his chair, smiled and said, "don't worry, we'll make it up on volume."

Tuesday, July 22, 2008

Investing Carnival # 4: The Dead Cat Bounce Edition

Welcome to the fourth edition of the Investing Carnival. Last week the Carnival was subtitled the "Bear Market" edition so based on the partial rebound the last few days, I will call this week the Dead Cat Bounce Edition.

KCLau presents How to Calculate Your Investment Portfolio Return? This is a solid primer on how to calculate your investment returns, which is not as easy as it sounds. His blog is called KClau's Money Tips.

Passive Income Investor presents Monthly Online Income Breaks $2,000 Barrier! Living Off Dividends has done what most of us only dream of - making a partial living off blogging. His blog is called Living Off Dividends.

Tyler presents Progressive Introduces A New Dividend Model. He discusses a new variable dividend policy introduced by one company. His blog is called Dividend Money.

Mike Markin presents Insights on Income: Foreign Markets are a Necessary Profit Play for Today’s Income Investor. Mike believes strongly in the value of investing in Foreign markets if you are a dividend investor. His blog is called Contrarian Profits.

Raag Vamdatt presents The stock market is falling - Time to invest? . Raag discusses the SENSEX, which is an index of 30 stocks trading on the Mumbai Exchange, and whether it is a good time to get back in. His blog is called Raag Vamdatt: Financial Planning Demystified.

Dividends4Life presents Which International Income ETF to Buy? posted at Dividends4Life. He discusses man different income ETF's for inclusion into a portfolio.

Erica O'Leary presents Combine Sections 121 & 1031 for Maximum Tax Benefit posted at Bankers Exchange Services. Erica talks about tax strategies that could save thousands of dollars for retirees.

Dividend Growth Investor presents Some Cheap Stocks to Consider posted at Dividend Growth Investor. His post includes a spreadsheet with more than two dozen names as a starting point to invest in what he calls bargain stocks.

Silicon Valley Blogger presents 7 Compelling Reasons Why Long Term Investing Is Better Than Short Term Trading posted at The Digerati Life. This is an excellent well thought out article.

Value Seeker presents Stock Investment Resource: Stock Market Investing Tips - Don't Overleverage posted at Stock. If only some of our best and brightest had listened to this advice.

David Templeton presents Risk Tolerance And The Estate Plan posted at Disciplined Approach to Investing. David discusses Estate Planning and Risk.

Joe Manausa presents Housing Prices Decline Slightly - A Clear Picture Is Forming posted at Tallahassee Real Estate Blog. Do you live in Tallahassee, and own, or are planning to buy a house? This blog is required reading.

Maria Gudelis presents Is real estate investing today like catching a falling knife posted at Maria Gudelis.

Dorian Wales presents A Look at Global Stocks Markets 6 Months into 2008 – 4 Important Lessons Learned Yet Again posted at The Personal Financier.

That concludes the fourth carnival edition. Submit your blog article to the next edition of Investing Carnival using our carnival submission form. Past posts and future hosts can be found on The DIV-Net's blog carnival index page .

Thursday, July 17, 2008

Confirmatory Bias and Oil Investing - Part Two

I recently came across a post on the Victor Niederhoffer Blog about the concept of Confirmatory Bias. I shall reprint the standard quote from Sir Francis Bacon that is used in much of the literature on this subject:

"The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate..."

After searching further, I came across a paper published in the Review of General Psychology in 1998 authored by Raymond S. Nickerson of Tufts University. I believe that the concepts he discusses have applicability to current beliefs by bullish energy investors in the oil market.

He presents a modern definition of the concept of Confirmatory Bias:

"...the seeking or interpreting of evidence in ways that are partial to existing beliefs, expectations, or a hypothesis in hand."

In his paper he reduces the concept to its component parts. Yesterday, I discussed the first two parts, and today I present my discussion of Parts 3 and 4.

Number 3 - Overweighting positive confirmatory instances.

"Studies of social judgment provide evidence that people tend to overweight positive confirmatory evidence or underweight negative discomfirmatory evidence."

The International Agency Energy (IEA) last week revised its estimates for the supply and demand situation in oil. The part of the report that made the headline was its prediction that the oil market would remain "tight" for the next five years. What was ignored was the negative information that the IEA had cut demand growth from 2.2 to 1.6% per year on average for the next five years. Although this cut in demand came from the mature economies and not the emerging economies, it is the equivalent of 500 thousand barrel a day of demand being taken off the market. This equals all of the growth in China every year for the next five years.

Number 4 - Seeing what one is looking for.

"People sometimes see in data the patterns for which they are looking, regardless of whether the patterns are really there."

This is also very prevalent in oil markets. Every other week there is news about some labor strife in Nigeria, a major oil exporter. This usually results in a couple hundred thousand barrels a day being temporarily removed from the market, and a $4 dollar a barrel rise in price. Yet when Saudi Arabia increases production by 500 thousand barrels a day, the market doesn't care. Investors see a temporary supply disruption as permanent, and ignore a permanent increase.

Wednesday, July 16, 2008

Confirmatory Bias and Oil Investing - Part One

I recently came across a post on the Victor Niederhoffer Blog about the concept of Confirmatory Bias. I shall reprint the standard quote from Sir Francis Bacon that is used in much of the literature on this subject:

"The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate..."

After searching further, I came across a paper published in the Review of General Psychology in 1998 authored by Raymond S. Nickerson of Tufts University. I believe that the concepts he discusses have applicability to current beliefs by bullish energy investors about Oil.

Nickerson presents a modern definition of the concept of Confirmatory Bias;

"...the seeking or interpreting of evidence in ways that are partial to existing beliefs, expectations, or a hypothesis in hand."

In his paper he reduces the concept to its component parts. I will discuss four of them, and then present my own.

Number 1 - Restriction of attention to a favored hypothesis.

"If one entertains only a single possible explanation of some event or phenomenon, one precludes the possibility of interpreting data as supportive of any alternative explanation."

Oil bulls believe that the only thing that can explain high oil prices is the trite hypothesis currently circulating in the market - that strong demand from emerging economies and limited, or even peak supply, is responsible. All other evidence to the contrary is ignored. The possibility that "speculators" or "traders" or "momentum players" may be partly responsible for a premium is scorned.

This belief, of course, ignores 220 years of history in the American financial markets, where there have been many cases of market speculation and/or manipulation, from Erie Canal bonds to Railroad bonds to Internet stocks. The real question that one should ask is the inverse of this - is there any financial instrument and/or Commodity that hasn't been subject to speculation or manipulation or overvaluation?

Number 2 - Preferential treatment of evidence supporting existing beliefs.

"...the tendency to give greater weight to information that is supportive of existing beliefs or opinions than to information that runs counter to them. This does not necessarily mean completely ignoring the counter indicative information but means being less receptive to it..."

This is seen regularly in any statistical report issued regarding oil. If the Department of Energy (DOE) or the International Agency Energy (IEA) comes out with any report that challenges the bull - the report is "bad data." Any statistics that support the bull is trumpeted for the world to see, thus proving the investment case.

If economic activity in the U.S. and other OECD nations slows down, leading to less demand for oil, it doesn't matter, as long as demand in China continues to grow at its absolute number of 500 thousand barrels a day. The fact that a 2% contraction in oil demand by the OECD would be twice China's absolute growth is not given any weight by the market.

I will present Part 2 tomorrow.

Tuesday, July 15, 2008

Will the SEC End the Short Sale Party?

I just saw this headline in the Wall Street Journal a few minutes ago:

"WASHINGTON--The Securities and Exchange Commission announced an emergency action aimed at reducing short-selling that targets Wall Street brokerage firms as well as Fannie Mae and Freddie Mac, and will immediately begin considering new rules to extend new requirements to the rest of the market."

Not only will it involve selling short FRE and FNM, but according to the journal, it will also apply to Lehman Brothers (LEH) , Goldman Sachs (GS), Merrill Lynch (MER) and Morgan Stanley (MS).

I tried to find this emergency order on the SEC web site, but could not. Please send a link my way if anyone can find it.

Monday, July 14, 2008

College Kids Gone Wild

There is a site called College Analysts that aggregates content from about a dozen college students across the U.S. It has some decent content, and I have been a reader for some time.

On Friday, the site took what I consider a disturbing foray away from Finance and Investments into Politics with a post blasting our nations alliance with Israel. The post was written by Stephen Frankola and contained many broad generalizations, factual errors and misstatements about the situation over in the Middle East.

He argues that the birth of Israel was possibly "unfair," and that our alliance with Israel "has been the biggest foreign policy blunder since the Vietnam era."

The post pretty much blames our support for Israel as causing hatred of us by the Arab population, high oil prices, and much of the terrorism directed against the United States. Or as he puts it:

"the relationship has been detrimental to US foreign goodwill, especially in the Middle East. Oil is outrageously expensive, and we have been attacked by radical Arab groups, and our pockets have been slowly emptied. What have we gained?"

Israel is a bully that treats its Palestinian resident as sub citizens, according to Frankola. The exact quote is:

"Israel, you’re a bully. We, the United States, claim to target other bullies all across the world, but we hold your hand, supply you with your weapons, and then promise to protect you, if you should ever get yourself into trouble that you can’t handle. That has created a volatile, undesirable situation for the United States - and ultimately, we care about us, NOT you. Fight your own war if you really want to, but don’t come crying to daddy if things get bad."

I was going to let his post slide, and blame it on the exuberance of youth. After trading comments with him over the weekend, he showed little remorse for his statements, and I feel that I would be remiss if I didn't give it wider distribution so those with more time than I could add their opinions.

The full post is here.

Saturday, July 12, 2008

What About the FDIC?

If you think Fannie Mae or Freddie Mac are under capitalized, then how about this very rough, and very non analytical back of the envelope capitalization for the Federal Deposit Insurance Corporation (FDIC) insurance deposit fund.

Combined Deposit Insurance Fund Balance - $ 52.8 billion (before Indy Mac failure).
Insured Deposits $4.4 trillion.
Reserve Ratio - 1.19%.

Of course I am sure there is more to it than that. The FDIC can raise premiums, and ultimately, the U.S. Government is there.

Here are some historical nuggets that I gleaned from the same page:

1) The chart goes back to 1990, which is the year that failed assets peaked at $145.339 billion. Indy Mac has $32 billion in assets so we are already at 20% of the 1990 peak.

2) The fund balance went negative in 1991, at $6.9 billion.

3) The current reserve ratio of 1.19%, is the lowest since 1995, when it was 1.08%. This is calculated before the latest bank failure. If we use the mid point of the estimated losses of $4-8 billion, then the fund balance falls to $46 billion, and the reserve ratio falls to approximately 1.04%.

I don't understand why the FDIC let the reserve ratio run down from a high of 1.38% in 1999, considering that everyone and their mother saw this storm coming. During the good times is when they should have over assessed the banks to prepare for this.

Friday, July 11, 2008

Smart Money - May You Rest in Peace

I don't mean to rub salt in a wound, since I have had my share of bad investments, but I have always despised the concept of "smart money." It implies that everyone else is not smart money, but rather is "dumb money." I also maintain that a belief in this theory promotes a herd instinct among investors, which is something we desperately need less of.

So to finally put this theory in its grave, here is a list of the largest holders of Freddie Mac (FRE) and Fannie Mae (FNM).

The data is as of 3/31/2008, so there may have been some major changes since then. Also, some of the holders are index funds. The biggest losers appear to be American Capital Group, which holds large amounts of both, mostly in three of its largest funds, the Washington Mutual Fund, the Investment Company of America and the Growth Fund of America. This large ownership is somewhat mitigated by the absolute size of these funds.

If you measure by what percent of an individual mutual fund is held in both FRE and FNMA then the following will be the most hurt:


Lord Abbett Affiliated Fund - 2.2%
Fidelity VIP II Contrafund Portfolio - 1.7%
AMCAP Fund - 1.4%


John Hancock Classic Value Fund - 4.6%
Hotchkis and Wiley Large Cap Value Fund - 3.7%
Legg Mason Value Trust, Inc. - 3.6%
DWS Dreman High Return Equity Fund - 2.7%

The Legg Mason listing is in the fund run by Bill Miller, an investor that is familiar to everyone, and the DWS Dreman High Return Equity Fund is run by David Dreman, another very well regarded Value Investor.

Thursday, July 10, 2008

Gas Use at Five Year Low but.....

The weekly report from the Energy Information Administration (EIA) was released yesterday, and the headline that was picked up by the media was that gasoline usage over the July 4th holiday hit a five year low, and dropped 3.3% from last year to 9.347 million barrels a day. This fits in nicely with my thesis that oil prices are ridiculously over priced, and was a source of considerable joy for me when I read it last night. The chart is below.

Now it is no secret that I am bearish on oil prices, and have received considerable contempt and scorn for this position. However, there was another nugget of data in the EIA report that was stunning and not supportive of my bearish position. It would be easy for me to ignore this data, as it seems that the media has, and just see what I want to see in the report, but then I would be guilty of what I frequently accuse oil bulls of doing. I try my best not to ignore data, or mine it to find want I want to find in it.

The EIA also reported that U.S. Crude Oil Production fell to 4.96 million barrels per day for the week ending 7/4/2008. On a four week moving average, production was 5.09 million barrels per day. This is the lowest production measured on a weekly basis since July 2006.

One component of my bearish thesis on oil prices is that domestic oil production will begin to move higher over the next few years due to all the exploration and development being done, and this data point would seem to contradict my position. Now it would be expedient for me to dismiss this as a one week aberration, or as some sort of holiday weekend related drop, but I will not do that and will take the data as it stands and incorporate it into my thinking on the oil supply and demand situation.

Wednesday, July 9, 2008

Why Is Oil Up Today?

A plethora of bad news hits the oil market, but the market continues to ignore it.

1) The Energy Information Administration (EIA) releases its July 2008 Short Term Energy Outlook showing that OPEC production will hit 32.7 million barrels per day when the Saudis follow through on its promise to increase production to 9.7 million barrels per day. More supply and less demand over the last six months should not lead to a 50% increase in oil prices.

2) It would seem that not all oil in the world is hard to find after all. The Wall Street Journal reports that oil still seeps to the surface in Kurdistan. The WSJ writes:

"Iraq is well known as one of the planet's last great oil repositories, with more than 115 billion barrels of reserves, by most estimates. The surprise is how much oil -- and easily accessible oil -- there appears to be in Iraq's Kurdish region, a rugged, Switzerland-size area that has seen centuries of conflict but essentially no oil exploration, until now."

3) The Wall Street Journal also reported that Asia, the engine of global demand growth, is starting to slow its consumption as subsidies are removed. The WSJ writes:

"People in some Asian countries are reining in their oil consumption as prices climb and governments unwind subsidies, offering early signs of a shift after years of rapid growth in demand. Asia has been the world's biggest source of new oil demand, with China alone accounting for half the world's increase this year. Government subsidies have kept retail prices in the region artificially low, encouraging consumption."

4) Oil production in China surprised to the upside in the first half of 2008 according to FIG Research.

"The country’s crude output for June hit 15.92 million tonnes which is a 1.3% jump compared with last year. Upgrading of fields in the west has enabled China to offset depletion of crude production in mature fields in the east."

"Growth in crude production paled in comparison to the advances made by the country’s natural gas output. During the first half of the year, China’s natural gas production leapt 17.3% to 43 billion cubic metres compared with a year ago. In June, the country produced 7.8 billion cubic metres of natural gas, up by 14.5% versus a year ago."

Instead the market remains fixated on a mythical Israeli attack on Iran. Does the market feel that the Israeli air force will miss the Nuclear facilities and hit the oil infrastructure instead? Or does it fear that the United States will be unable to defend our allies oil facilities and/or prevent Iran from closing the Strait of Hormuz?

Neither scenario is likely except in the fertile minds of traders looking for another reason to keep the gravy train rolling along. While the Strait looks tiny on a map, it is 21 miles wide at its narrowest point. This is roughly the distance between the New York Mercantile Exchange in Lower Manhattan and Great Neck, N.Y., a tony suburb on Long Island where many oil traders no doubt live.

Another mitigating factor is that our fleet would only have to defend a "two-mile wide channels for inbound and outbound tanker traffic, as well as a two-mile wide buffer zone," according to the EIA. I would be disappointed as a taxpayer if our Navy couldn't handle this job.

We also have a Strategic Petroleum Reserve (SPR) that we have built up to cover the disruption of any oil supply. If we take two million barrels a day out of the SPR it would last almost two years. Any supply disruption should last only for a short time.

Monday, July 7, 2008

Is There Really a Conundrum?

I don't blog much about economics and there is a reason for that - I find the term "dismal science" a little bit too charitable for the subject. So go easy on me after reading this.

There is this consensus building in the market (God, how I hate that word) that the Federal Reserve is caught between a "rock and a hard place." The Fed wants to raise interest rates to fight inflation expectations that are clearly building in our society. This can be seen in the two charts below. The first is Household inflation expectations, and the second is the adjusted 10-year TIPS-derived expected inflation:

It is unable to fight these inflation expectations by raising rates since the economy is so fragile, and it is thought that any increase in short term rates will crush any incipient recovery in its womb.

But would higher rates actually have that effect? It seems the problem is more availability of credit, not the cost of credit. This can be seen in the results of the latest Senior Loan Officer Opinion Survey on bank lending practices conducted quarterly by the Federal Reserve. The survey reports the percent of lenders who,in this case, have tightened lending standards over the previous three months.

"55 percent of domestic banks—up from about 30 percent in the January survey—reported tightening lending standards on C&I loans to large and middle-market firms over the past three months."

"80 percent of domestic banks and 55 percent of foreign banks—fractions similar to those in the January survey—reported tightening their lending standards on commercial real estate loans over the past three months."

"60 percent of domestic respondents—a somewhat larger fraction than in the January survey—indicated that they had tightened their lending standards on prime mortgages."

An article in the Financial Times yesterday had the quote from a banker "...and the banks are canceling revolvers wherever they can.”

It might be better to raise rates to defend our currency. This would have the dual effect of breaking the upward momentum of Oil as traders will have to find another excuse to push it up. Once Oil starts trading back toward the level it should based on fundamentals, inflation expectations should come down. If gasoline prices follow oil down, then that will free up money for discretionary consumer spending.

Raising rates will have the deleterious effect of hurting those homeowners with adjustable rate mortgage resets, but the opening up of credit markets for them may be a side effect of a stronger dollar.

Saturday, July 5, 2008

Utah Takes the Plunge

Utah just became the first state to close government offices on Friday, and go to a four day work week beginning August 1. The Office of the Governor estimates that 1,000 of 3,000 state buildings will be closed on Fridays, cutting energy costs by about 20 percent. Minnesota is also considering such a move.

You can read the Press Release yourself, and they also have an excel spreadsheet with more data on the energy savings from this move.

Utah used six representative office buildings in its spreadsheet to detail the savings involved:

1) The annual energy savings for the state would be $123,220, or 13,653 MBtu.

2) The annual fuel reduction for employees would be 76,840 gallons of gasoline, or $312,971.

While these savings don't seem like much, they are based on only six buildings, while 1,000 buildings will be closed. My other thoughts on this:

The employee savings must assume that employees use less gasoline on the new day off than they would in commuting to work. If they all drive to the mall and burn as much fuel as usual, then the savings will be negligible.

The state savings are significant, but probably won't impact demand for oil. I don't know numbers for Utah, but nationally very little electricity is generated by oil.

My question is this - why doesn't the Federal Government go to a four day week? The savings would exceed anything a State or City government could do.

One day our country will have an Energy Policy that is comprehensive and for the benefit of everyone, rather than the patchwork of garbage we have now. A critical part of this Energy Policy should be a mechanism to shut off some demand for Energy when it is needed to moderate the market. Supply can be shut very quickly, at the whim of a foreign government, as we have seen.

I propose Federal Legislation that would mandate a four day work week for the Federal Government, all 50 states and the twenty largest cities. This would apply only to agencies that provide non essential services. This mandate would only be triggered if some predetermined event took place in the marketplace - some examples - capacity utilization in excess of 95%, or days of inventory falling below the five year range, etc.

The purpose of this would be to give us the ability to shut down a portion of demand. While it might seem that this would be, if I may use a cliche, a drop in the bucket, in a market that uses 86 million barrels of oil a day, the ability to remove 500 thousand or one million barrels per day of demand from the market may help in a tight market. This would also be only one part of a comprehensive Energy Policy that our country is in desperate need of.

Friday, July 4, 2008

Dear Mr. Icahn

Carl Icahn is well known for activist investing, most recently involving Yahoo and Motorola. Aside from the private investment partnerships that he manages, he also controls a publicly traded entity called Icahn Enterprises L.P. (IEP). The former name was American Real Estate Partners, L.P. The stock is down 50% since the beginning of 2008 as you can see below. Yahoo is also down, of course, but a more respectable 15%.

It is possible that an activist investor might turn the tables on Icahn and agitate for change at IEP? Unlikely, since I'm sure that Icahn was smart enough to structure IEP so he has majority control.

Thursday, July 3, 2008

The Dividend Investing and Value Network

I posted earlier in the Week that I joined the The Dividend Investing and Value Network (DIV-Net) as a charter member.

This is a new investing network focusing on dividend investing, value investing and a long-term buy and hold philosophy. My inaugural post was today, and I wrote about Barrett Business Services Inc. (BBSI), a company that I have been stalking for some time. The full post is at the DIV-Net site. I will be posting every Thursday on this new network.

Wednesday, July 2, 2008


There is too much information circulating out there for anyone to properly digest, and I have found it helpful to use a blog aggregator or some other similar type of site to help organize that information.

There is one I found called newsflashr that I find useful.

One feature is a page dedicated to business blogs that lists the feeds of 50 or so Stock Market blogs ranked by Alexa score. I have two blogs on the page. I am proud to say that I am number 37 on the list today.

The site has the same feature for other categories as well - politics, the election, etc.

I would recommend taking a look at this site.

Tuesday, July 1, 2008

The Good Ole Days

I just reviewed earnings for Lennar Corp (LEN) and as expected they were atrocious. I don't mean to pick on them since they have enough problems as it is, but while I was on the company web site, I came across a presentation from a sell side conference back in February 2006. The stock was at $60 back then as you can see below:

One of the slides in the presentation detailed the secular bull case for Housing. The reasons given were:

1) Demographics favor continued strong demand.

2) Land supply is constrained.

3) Strong balance sheet & liquidity drive expansion.

4) Market diversification.

5) Professional management teams.

6) Competitive advantage – economies of scale.

It's astounding to me how many institutional investors bought into this thesis. It's very difficult to resist the call of a bubble.

In defense of Lennar, they did present an alternative scenario in the next slide:

1) Rates rise.

2) Economy falters.

3) Unemployment up.

4) Affordability down.

5) Demand weakens.

6) Margins compressed.

Anyhow, I don't have to tell you how it ended and which scenario won out:

If you look at the last housing cycle for Lennar, it also shows a pretty interesting ride, and a great way to make a lot of money if your timing is right.

Disclosure - No Position in LEN.

Charts courtesy of Big Charts.