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Friday, July 4, 2008

Bob Brinker Comments on Oil Prices

Bob Brinker opened the weekend (Saturday June 28, 2008) reminding listeners that he has been talking about the importance of oil prices and energy on today's economy. There is a direct correlation between rising oil prices and the economy as well as the stock market and we saw evidence of that this week as the S&P 500 closed Friday at 1278.
This commentary on Oil is an excerpt from David Korn’s June 28-29 weekly newsletter (Click for a FREE SAMPLE ) that comments on Bob Brinker’s Money Talk.
David Korn: You may recall that on January 22, 2008, the S&P 500 closed at 1310, and then reached a new low on March 10, 2008. During that time frame, and the months that followed, Bob recommended using periods of weakness in the market to buy stocks specifically when the S&P 500 was trading in the low 1300s, or any weakness below that level. Bob specifically recommended against selling any stocks at that time and, in fact, Bob said he was adding to his own positions during that time frame. With the S&P 500 now trading at 1278, Bob would seemingly be screaming "buy" again, but he didn't mention one word about that this weekend.

Brinker Comment: Oil prices spiked to a historic record high on Thursday and Friday, a little above $140 a barrel. Why is the price of oil so important? Because it has a direct impact on consumer spending and that accounts for the vast majority of the gross domestic product in the United States. Consumer spending is the engine that drives our economy. Consumers have a perception about oil prices through things like gasoline prices more so than other changes in their cost structure. For example, if your rent goes up, you will be reminded once a month that your rent went up and you have to budget for that. However, with gasoline prices you are reminded once or twice a week of how much money you have to fork over at the pump. But every time you drive down the street you see the price of gas posted and that increases the consumer's consciousness of the increased cost to drive your car. In addition to that, consumers are seeing their energy bills going up. The daily reminder of gasoline prices is really the kicker.
Kirk Lindstrom Comment: Brinker seems to be downplaying that inflation is much higher than he thought it would be when he told his listeners:
"We have always maintained that rising oil prices act as a tax on consumers, and are therefore counter-inflationary as they have a negative impact on consumer discretionary spending power."
[From March Inflation Up on Higher Energy and Food Costs]
This graph from the St. Louis Fed showing the year over year percent change in the unadjusted CPI data shows inflation is anything but low on an historical basis.

[Click graphs to see larger images]

Why is oil $140 a barrel? In Washington, they spent the week blaming the speculators for the price of oil. Bob said this type of blame is flawed. There is no evidence that the speculators are a material factor in the price of oil. Bob said at best, the speculators might cause a tiny premium in the price, but even that is not a given. Moreover, there is no way to know how much of an impact, if any, speculators are having on the price of oil.

Bob said in his opinion, any role that the speculators may have in the price of oil would be very small. There are trillions of dollars flowing through the futures markets on a daily basis and, therefore, it would be very hard for speculators to have a significant and lasting impact on the price. This is especially true of a commodity such as oil which is produced and consumed in the neighborhood of 80 million barrels a day. That is 560 million barrels of oil per week and over 2.2 billion per month, every month. To do anything in that kind of marketplace with that kind of volume would not be easy to do. For the most part, the blame on speculators is a paper tiger and simply a tactic to divert the attention of the voters. A few callers over the weekend took the side that speculators are driving up the price of oil, but Bob dismissed them saying there was no proof of that.
Kirk Lindstrom Comment: A Futures Contract is a standardized, transferable, exchange-traded contract that requires delivery of a commodity, bond, currency, or stock index, at a specified price, on a specified future date. Hedgers often trade futures for the purpose of keeping price risk in check. (See futures contract)
So what is causing the increase in oil if it is not the speculators? It isn't the increase in demand. We have seen a lot of growth in demand in China and India, but demand in the U.S. is about the same as last year. We have actually seen a decline in the miles driven by U.S. consumers in the first few months of this year. That's not surprising given how much money you have to put in the gas tank to fill up your cars.

There are no shortages of gasoline like there was in 1974 when Saudi Arabia announced their boycott of shipments of oil to the U.S. We don't have price controls and we don't have windfall profit taxes or boycotts, which is why we don't have shortages. The gasoline is there if you are willing and able to pay for it.
Kirk Lindstrom Comment: I don't think Bob Brinker or David Korn answered the question "what is causing the increase in oil if it is not the speculators?" The truth is not everyone who buys a futures contract is a "evil speculator." A company like FedEx (FDX) may know they can make money in September 2008 with oil at $140 but not at $175 so they buy futures contracts for oil at prices that allow them to plan their business. If the oil sellers think oil is going to be higher, then they may ask more for the contract than the present price of oil. In short oil is going up in price because people think oil will be more expensive in the future. The price of oil thus goes up and up in a "speculative bubble" similar to a wage-price inflation spiral. To pop this speculative bubble, something has to be done to make people think prices will be lower in the future. Some ideas are
  • Drill for oil where we know there is oil, such as ANWR and off the coast of the US
  • Announce a "Manhattan Project" to develop alternative energy sources such as converting algae to fuel.

  • Convert a large part of our auto fleet to PEV (Plug-in Electric Vehicle) that charge overnight using electricity generated in new nuclear power plants.
The higher price of oil is really hurting certain industries that rely on petroleum products. The automobile industry comes to mind. Look at Detroit which is stuck with gas guzzling products and they are getting creamed.

David Korn: General Motors stock hit a 53-year low on Friday. Yup, you read that right. Shares closed Friday at $11.43 following a downgrade by powerhouse Goldman Sachs. GM is now down 70% from its level one year ago, and dropped by 13.3% in just the last two trading days. Even at $11.43, I wouldn't touch this stock right now. When you see this kind of dramatic decline, the bankruptcy wolves start licking their chops.

David Korn #2: There is also collateral damage in other companies, such as auto-part suppliers. American Axle & Manufacturing Holdings, one of GM's largest suppliers of parts for light trucks, declined 14.7% on Friday. I don't know about you, but when it cost me $65 to fill up my car on the way to Yosemite this weekend, I was fantasizing about a Prius, or other hybrid.

Brinker Comment: The airline industry is getting hammered as well. Another 100 cities are expected to lose airline service this year according to news reports out this weekend. The higher price of oil is impacting companies in this industry in a big way.

David Korn: American Airlines and its regional affiliate American Eagle are cutting 42 flights to LaGuardia alone. Although it might mean less congestion, it also means less supply and perhaps higher prices. Not to mention, the airlines are starting to nickel and dime you on your baggage now, charging higher fees for luggage every which way. There is now talk in Washington of having Congress suspend federal taxes and fees on airline tickets until March 2009 if oil remains above $100. Check out BusinessWeek's article entitled, "If We Help Save the Airlines (Again)" at this url:
Brinker Comment: The U.S. is a service-based economy which is a good thing because a manufacturing-based economy is much more vulnerable to higher oil prices. That said, the U.S. has a transportation system that is almost entirely petroleum based. The amount of non-petroleum based vehicles is simply a drop in the bucket.

Caller: What's your take on the impact of the weak dollar and the price of oil? Bob said they are linked as we pay for oil in dollars. If our dollar loses value in the international market place, which it has, then oil is more expensive for us. Our country has a strange policy relative to the dollar. Our policy is to always say that we "favor a strong dollar." That has been a mantra repeated by the Treasury Department, regardless of who has been in office. The U.S., however, has done nothing to support that philosophy of a strong dollar. We live in a country where spending is through the roof and there is no end in sight to our deficits. If there was one thing that would impress global currency investors, it would be if we operated with a balanced budget mandate. That would probably do more for the U.S. dollar than anything.

Brinker Comment: Bob said he thinks the price of oil is really responding to the geopolitical concerns. The supply/demand cushion is gone, and yes demand has increased, but the kind of increases you have seen this year must be attributed to the psychology of investors who are worried over what will happen with supply. This weekend, for example, Iran has threatened to impose control of the Persian Gulf and Strait of Hormuz if they are attacked. Nobody knows how this will play out and the uncertainty is causing consternation in the markets.

David Korn: Here is a link to an article entitled, "What's Really Fueling Those Sky-High Oil Prices:

Get a FREE SAMPLE ( January 2008 Issue ) of Henry, David and Kirk's newsletter, "The Retirement Advisor."

Portfolio Performance
Long-Term "Retirement Advisor" Model Portfolio Performance
The Retirement Advisor Model Portfolio Name Dollar Value
on 6/30/2008
Bob-Brinker Portfolios
Aggressive Growth and Income Model Portfolio 1
Initial Value of $200,000 on 1/1/2007
$210,317 5.2% P1: -7.4%
Moderate Growth and Income Model Portfolio 2
Initial Value of $200,000 on 1/1/2007
$213,843 6.9% P2: -2.4%
Conservative Capital Preservation Model Portfolio 3
Initial Value of $200,000 on 1/1/2007
$221,274 10.6% P3: 1.6%

To read the table, The Retirement Advisor Model Portfolio #1 is up 5.2% since January 2007, 18 months ago, while Bob Brinker's Model Portfolio #1 is down 7.4% over the same 18 month period..

In fairness, Brinker's P3 should be compared to our P1 since both are "balanced" with 50% in equities and 50% in fixed income.

Through 6/30/08: Bob Brinker YTD Results:

P1 down 11.8%,
P2 down 10.5%
P3 down 5.8%
VTSMX down 10.91%

See "The Retirement Advisor" Model Portfolio Performance through 6/30/08 for more information.

This above commentary on Oil is an excerpt from David Korn’s June 28-29 weekly newsletter (Click for a FREE SAMPLE ) that comments on Bob Brinker’s Money Talk.


Anonymous said...

Oil priced in gold or even pre-1964 coinage is dirt cheap. Oil is not going up-- the dollar is going down, sinking like a rock. Why? The Federal Reserve guarantees a minimum inflation of 2%. That's the floor! If it goes above that, they do not seek to bring it back to that average by running lower than that for a while. Consequently, the smart money factors in that the inflation for the past few years has been at the bottom and has nowhere to go but up.

Further, the Fed uses a warped measuring stick to determine this inflation, looking at "core" inflation. Rampant inflation in food and energy does not register on the measuring stick, but it does to those of us who eat and drive. The federal government was given few responsibilities, but maintaining the value of the currency is one of them. They have been a dismal failure.

GM stock reaching a new low is bad until you realize that the dollar 50 years ago was worth 20 times what it is today. That $11 price is really 50 cents. Who would have imagined? Why did it happen? The management promised money that future managers would have to earn, and the unions took benefits that future GM would have to pay. The union bosses and management of the time both looked good, but now those chickens have come home to roost. Of course the managers and union bosses who made these agreements are long gone and we're here to clean up the mess. They did not consider competition would make those agreements so untenable. They figured their oligopoly would be able to demand ever higher prices from their customers, just like the politicians figure they can demand ever higher taxes from the public. They were both wrong.

Kirk said...

Great points!

Oil priced in gold or even pre-1964 coinage is dirt cheap. Oil is not going up-- the dollar is going down, sinking like a rock. Why? The Federal Reserve guarantees a minimum inflation of 2%. That's the floor! If it goes above that, they do not seek to bring it back to that average by running lower than that for a while. Consequently, the smart money factors in that the inflation for the past few years has been at the bottom and has nowhere to go but up.

I agree and it clearly shows in the price of Gold, oil and top quality real estate that is not going down in price despite the majority of real estate in the US is down a lot.

I hope you read DOW In Secular Bear Market When Priced in Ounces of Gold and click on the graphs there showing the ratio back to the 1800s.

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