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    Oil, the Rogue Commodity

    London, England - Johannesburg, South Africa

    Friday, 29 February 2008
    In This Issue:
    Origin forecasts good profits...

    Inflation could be worse than anyone thinks...

    William F. Buckley dies...


    From Dan Denning in Johannesburg, South Africa:

    -- What did we miss?

    -- Eighteen hours of flights and five hours of window shopping at Changi airport later, and someone has punched the accelerator on inflation. Oil hits a new high at over US$102. Gold futures are at $972.

    -- While commodities took off, U.S. existing home sales fell to an unlucky thirteen year low. Foreclosures are up 57% for the month in an ominous sign for the housing market (and owners of housing-backed bonds).

    -- Diggers and Drillers editor Al Robinson covered the oil story in today's Money Morning:

    "Yesterday, you saw gold pass US$960. Today, you're seeing gold at US$970... and the headline oil price is just under US$103 as we type.

    "Now it gets interesting.

    "Real commodities have been pushing pretty hard lately... and oil is on the verge of an all-time real high. This means that, despite all inflation in the prices of stuff over the years, oil is more expensive than it's even been... anywhere... anytime in history. Oil is harder for you to buy than it's ever been. It's making a big move at that price ceiling. It's rebelling like a defiant, pimply teenager clambering out his window at night to get to the wild party his parents have forbidden. Rock on, dude.

    "For investors, there's something important about that rebellion. Given the chat we had with our technical analyst Gabriel Andre yesterday, we think there's something you should know. Oil is now rising on momentum.

    "What does that mean? Well, the prices of oil and its refined products usually take their cues from various economic and political events. If a refinery explodes in the U-S of A, petrol and heating oil both rise in price.

    "If OPEC members squabble over who will get the biggest cut of oil profits (it's usually Saudi Arabia)... then, on hearing the news, traders everywhere will pick up their gaping jaws and bust their computer mouses, violently clicking the "buy" key in anticipation of a production cut.

    "If a major oil producer makes a big new find, oily traders will sell off with equal fervency.

    "But now... things are a little different. We've never been past this rung in the ladder before. Oil is trading with a lot of speculation. That doesn't mean the fundamentals no longer mean anything. But it means there's more of an emphasis on the technical aspect of the oil price.

    "Gabriel will be especially useful to you here. He's plied his trade for major hedge funds. He knows his stuff. We'll save the cream of his analysis for Diggers and Drillers, and Australian Small-Cap Investigator. But now that oil's a rogue commodity, you'll need to hear regular bits and pieces from him. We'll keep you updated on the basics. Be prepared to read more on the topic soon.

    "Origin Energy (ASX:ORI) stepped up to the pulpit yesterday and delivered its six-month report for the second half of 2007. The company preached a glorious sermon of imminent profit growth, inspirational gas exploration, and general electricity retailing salvation.

    "The congregation burst into rapturous applause, pushing Origin up 8% after a week-long losing streak. The company's operating profits in the period were actually down 3%. But it's been growing market share. A lower price strategy usually does the trick there. It means giving up a little bit of short-term gain for a longer-term benefit: more customers.

    "Al, you're just been yammering on about the high oil price. Now you're talking about growth at Origin. What gives? Shouldn't the high oil cost cut into energy retailers' margins?"

    "Ah yes, you're spot on. It should. But the nice thing about Origin, and most other Aussie retail energy investments, is that they focus on natural gas and oil extraction. By that... we mean they rolls up their sleeves, clench their jaw, then go out and darn well finds their own fossil fuels. Hallelujah.

    "So Origin is really a producer and retailer at the same time. The higher oil is, the bigger profits are. This move in oil is good for the retail side of Australian energy."

    -- Back in South Africa, we are just catching up with the rest of the news and have had our first black out of the day. Our host Annabel assures they don't happen often, but we are running on generator power now, so we have to save our work often.

    -- We're putting the finishes touches on the latest issue of the Australian Small Cap Investigator, due out early next week (as long as the power holds out). In this issue we'll look at why a particular base metal that's lagged all the others the last three years may finally be due for a break out.

    -- But before we go, in no particular order, here are some observations from our travels yesterday.

    Australia is a really big country. And very dry, except for the parts of Queensland that are flooded.

    99% of taxi drivers are impatient crooks. But you still want them on your side. The other one percent is very lonely. And very talkative.

    Most cab rides from a major airport to a city centre cost about 50 units of whatever the local currency is. With inflation, you may have to ad a zero in some countries.

    From seat 54k of a 747 at 10000 meters up, the Straits of Malacca look like a Los Angeles freeway at night. Talk about peak traffic. You can have a lot of fun trying to guess what's contained in that endless line of freighters. Middle East oil to Japan and China. Plastic ducks. Wheat from someone who has it to someone who doesn't.

    Moving something from somewhere where it's plentiful and cheap to where it's scarce and dear is a simple idea. Why don't more people do it?

    Never eat an airline breakfast omelette. Ever.

    What if the breakdown in quantitative risk models is just beginning, and not ending? Quant hedge funds were the first and worst hit last year as things they neither expected nor modelled happened. But are some of our even larger financial models-like debt-based money-even more flawed?

    When the sun rises behind you as you race over the Indian Ocean at 5 in the morning, it looks a lot like an Edward Hopper's 1929 railroad sunset painting, which we had in the bathroom of our first apartment in Washington, D.C. as a student. It's a nice way to wake up.


    Four Questions to Answer
    Before You Begin Trading

    Trading is an excellent way to supplement your investment income and even make big returns quickly.

    But if you don’t begin with a solid foundation, it will cost you money instead of delivering an extra benefit to your portfolio. Before you plunge in to your first trades, there are four questions you must answer to make your trading better and more profitable.

    In the latest issue of the Australian Small Cap Investigator you’ll learn all about these four questions. Not a subscriber to Australian Small Cap Investigator, no worries! Simply click here to accept our trial offer and get instant access to the latest issue.


    And now over to Bill Bonner in London, England:

    Oil held at $99 yesterday. The Dow dropped 9 points. And the dollar fell to its lowest level ever against the euro. If you want to buy a euro today, it will cost you $1.51 cents.

    Gold shot up too - another $12, bringing the price to a new record of $961.

    Why is the dollar falling? Why is gold going up?

    You already know the answer, dear reader. Because the people who look after the dollar want it to go down. They're doing all they can to make sure it loses its value. And so far, at least at that, they're succeeding.

    "Dollar hits low as Fed chief hints at rate cut," says the Financial Times. "Bernanke says bank will act to support growth."

    The Fed is caught in the same crossfire as everyone else. On one side, housing prices are dropping... consumers are running out of money... and banks are afraid to lend. On the other, the supply of paper money is soaring... forcing up prices for just about everything that isn't a financial asset.

    Oil... gold... copper... wheat... tractors... farmland - they're all being pushed up by inflation.

    Central bankers don't normally reduce interest rates in the face of rising consumer prices. But our poor Bernanke-led bank consortium feels it has no choice. The cannons of deflation to the left of them... the artillery of inflation making louder noises to the right - they'll attack on the left!


    Two reasons. First, they believe they can lick inflation any time. That was what Paul Volcker showed them 25 years ago. Inflation can be beaten by clamping down on lending... raising interest rates... and tightening up on the money supply.

    But deflation? The present generation of the world's central bankers watched Japan struggle for 18 years. They think they learned something.

    The Bank of Japan has economists too. They read the same economics textbooks. They attended the same prestigious universities. They believed the same claptrap theories of dead economists. They cut rates down to "effectively zero" (monetary policy)... and they spent more on useless government projects than any government had (fiscal policy). What more could they do?

    (Well, Anglo-Saxon critics said they were wimps, unwilling to let the big banks fail, so the economy could get back on its feet. More on that later.)

    Central bankers are more afraid of deflation than they are of inflation, in other words, because they find it a harder disease to cure.

    The second reason why the Fed is attacking deflation and not inflation is purely political. "Change" may be something every candidate promises, but it is something no candidate really wants... at least, not the sort of change that Mr. Market is sending their way. After a huge boom... Mr. Market is delivering a correction. That is just the way he does business. Boom... bust... and boom again. But neither the voters nor the politicians are very keen on the bust part. And they all think they can... and should... do something to prevent it. Hence, the Fed fights deflation... and leaves inflation alone, since they believe that inflation instigates growth (and is often mistaken for growth by casual observers).

    But it looks to us as though BOTH deflation and inflation are becoming more dangerous.

    "Inflation may be worse than we think," says a Wall Street Journal article. Yes, we wouldn't be surprised.

    One thing that is definitely going up fast is the price of gasoline. Per gallon, drivers are paying 19 cents more than they did just two weeks ago. Some experts think the price will go to $4 per gallon before the summer comes. This is very bad news for the consumer.

    "You're adding an oil shock on top of a crunch on credit and a housing collapse," said Nigel Gault, an economist at Global Insight. "Even the U.S. economy cannot withstand all of that at the same time."

    As anticipated, consumers are doing the only thing they can do, they're spending less money:

    "Retail earnings dive," reports the New York Times. What happens to a consumer society when consumers stop consuming? Ah, dear reader, you know the answer to that too - it shrinks.

    *** Our first extra thought is that we should move more money out of the dollar. It just keeps going down against the euro and gold.

    Our second thought is that we don't have a second thought. So we'll go back to the first thought.

    The problem with this thought is that it is too obvious. The world's governments are flooding the planet with paper money. Gold is a kind of Noah's ark. It can preserve our capital until the excess liquidity dries up. No wonder everyone wants to get on board.

    In the United States, as we keep pointing out, the supply of paper money is rising three times the speed of GDP growth. In places like Russia... it is growing five or six times as fast as GDP. China's inflation is at an 11-year high... and at more than 7% is becoming alarming. Don't expect Chinese exports to hold down prices in the United States anymore... now they're just another inflationary pressure.

    Meanwhile, the masses are deeply in debt. Their major asset is what they live in, and house prices are about the only thing going down. Their only other major resource is their own labor - which is overpriced in global terms. Inflation will bring it down to more competitive levels.

    The government is deeply in debt too. It has let out notes it can't pay... sold bonds it can't honor... and made promises it can't keep. Inflation, there too, would reduce the burden.

    What's more, the custodians of America's paper money - as we point out above - are desperate to avoid price stability. They want the dollar to lose value; they see it as the only way they can prevent Mr. Market from doing what comes naturally.

    And we will add one extenuating circumstance just to thicken the plot: the great dollar-based empire is probably peaking out. Since WWI, America has been the world's hegemonic power. Since WWII, the dollar has been the world's hegemonic currency. And since 1971, the hegemonic money has been on its own... unsupported by anything harder than cellulose. But nothing lasts forever. China, India and Russia have come into the global market. They're shaking things up... growing fast... and offering U.S. business more lower-cost competition than they've ever had to face before. Wealth and power is being blown across the Pacific with the trade winds... from North America to Eurasia.

    All of this signals, to us anyway, a cheaper dollar and a lower standard of living - relatively - in America. In terms of gold, we expect the dollar to be worth less. Then again, since all currencies are now in competition with the dollar... we expect gold to go up against them all.

    And since the U.S. authorities will likely struggle so hard to prevent this unpleasant change, it also seems likely that the price of gold will at least recover to its inflation-adjusted peak set in 1980. Then, gold briefly hit $850. But that was when the dollar was worth a lot more than it is today. Adjusting to current dollars, we expect to see the price hit $2,500 before this bull market in the yellow metal is over.

    The only thing that bothers us about this forecast is that it is so obvious.

    *** Finally, a milestone: William F. Buckley died. When we get around to it, we'll write up an autopsy report. Here, we give you the instant coroner's verdict: He was a handsome, well-bred, pompous, conceited and clever windbag who twisted American conservatism in such a grotesque way even its own parents wouldn't recognize it.

    [Editor's Note: Bill Bonner & Lila Rajiva's new book, Mobs, Messiahs and Markets, is now available in Australia from The Educated Investor. Order here for a 15% discount.]

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    The Daily Reckoning Presents: The current American presidential election has developed into charges of corruption. Europe is no stranger to ploitical corruption when it comes to the financial affairs of public servants. William Rees-Mogg explains...

    Indifferent Honest
    by William Rees-Mogg

    It is depressing that the American election has developed into charges and counter-charges of corruption. Senator Obama has been attacked for historic property deals. Senator McCain has been attacked for his relations with a lobbyist. There are still ancient suspicions of the Rose Law Firm of Little Rock, Arkansas, in which Hillary Clinton was a partner when her husband was Governor.

    In the United States, the main problem of finance for politicians comes from the cost of elections. The 2008 Presidential election will end up costing $1 trillion, or perhaps more. Much of the money goes on political advertising, of which the more effective half is spent on attacking the competence or integrity of the other candidates. The American lobbying system involves the lobbyists – who have their hands out for political favours – raising money from their clients to pay to politicians to spend on these negative campaigns.

    In Europe, the personal expenses of candidates or sitting Members of European Parliaments, seem to be more of a problem. In Britain, a Member of Parliament has been suspended for two weeks for paying his son out of parliamentary funds for research work he did not actually carry out. About a third of Members of Parliament use parliamentary funds, intended for their political staff, to pay members of their families. This applies to all major parties, Labour, Conservative or Liberal Democrat.

    Even the Speaker of the House of Commons has been accused of bad judgment, though not of breaking the law, for using Air Miles from official visits to pay for family travel and claiming his wife’s taxi journeys on official expenses.

    There is another and graver scandal in the European Parliament, which has produced, but not published, a report on the claims for expenses of the European Parliament itself. This includes claims for club class flights when the cheapest airlines had in fact been used, but it also includes more serious matters, in which downright fraud is alleged, and the sums involved go up to five or six figures.

    Naturally, politicians are reluctant to investigate their own, or their colleagues’, minor expenses fiddles. The judgment of a legitimate expense is usually left to the individual parliamentarian. No man should be a judge in his own cause. Many politicians have given up well-paid jobs, or even highly rewarding partnership in law firms or fund management. They know that they are out of pocket as a consequence of pursuing a public career. They may think that a somewhat inflated expenses claim is a way to redress part of their loss of income.

    It is also true that young politicians often find it hard to finance their careers. Very often the first stages of a political career are assisted by the earnings of a husband or wife. A young married couple, perhaps with children, can afford to live on two incomes after one of them has won a seat in Parliament or Congress, but may find it difficult to live on a single income while the political partner is still a candidate.

    In most countries, there are pressures to keep down the pay of politicians. In Britain, median pay of all workers is about £20,000 a year, and Members of Parliament are paid about £60,000 a year, but enjoy additional staff and other expenses of over £100,000. If one compares Members of Parliament with doctors in the National Health Service, the MPs seem underpaid. General Practitioners are the professional basis of health care; they are paid £100,000 a year, sometimes more, sometimes less. That is £40,000 more than MPs.

    There are measures which could remove some of the temptations which face even honest politicians. All election expenditure could be limited. If the nominees in the United States accept public funding, they will apparently be limited to $85 million each, a reasonable sum to spend on an election. Unfortunately Barack Obama has raised more money than anyone else, more than Hillary Clinton, more than John McCain. He will be tempted to make use of his advantage, though that would make his statements on Campaign expenditure seem hypocritical.

    In Europe, the Members of Parliaments may need to be paid more, and related to some acceptable standard of professional pay. Democracy is undermined when voters think that the politicians are on the take, and the present reliance on expenses to supplement income is a temptation for too many politicians who are, in Shakespeare's phrase, "indifferent honest.
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