Deal Or No Deal...The Buck Is A Bust

Oil Curve Steeper Than '99 Shows Possible Gain in '09
Jan. 5 (Bloomberg) -- The steepest plunge in crude prices on record may be setting up oil investors for a rally this year, if history is any guide.

The so-called forward curve of futures contracts traded on the New York Mercantile Exchange suggests oil will rise 28 percent to $60.10 a barrel by December. The curve looks almost the same as 10 years ago, after Russia’s default and the collapse of the Long-Term Capital Management LP hedge fund raised concerns that a global economic slowdown would reduce energy demand. Crude prices fell 25 percent in the final quarter of 1998, the steepest drop in seven years.

Bets on a recovery paid off then as the Organization of Petroleum Exporting Countries cut production 6.9 percent, causing prices to more than double in 1999. Now, OPEC is pledging to reduce supply 9 percent, companies from Royal Dutch Shell Plc to Valero Corp. are postponing new energy projects and central banks are cutting interest rates to end the worst financial crisis since World War II.
http://www.bloomberg.com/apps/news?pid=20601086&sid=a1Ab6lUay5TE&refer=news

Gas Prices Will Go Up with a Fury
An anomaly currently exists on the West Coast with unbranded independent prices for gasoline being inverted by about 20 cents per gallons over branded product. In simpler terms, branded major oil company stations, paying Dealer Tank Wagon prices fro gasoline to their major oil companies, are 20 cents per gallon below what their unbranded independent neighbors are purchasing their product for from independent rack jobbers.

Therefore, either the unbranded independent stations will have to lower their gas prices to stay competitive or the major branded stations will be increasing their pump prices.

My bet is on the latter. Exploring, producing, refining and marketing oil is a business, although many people in the U.S. seem to be under the delusion that we have some form of inalienable right to cheap gasoline. Independent and major oil companies will not allow themselves to run a deficit in order to make gasoline more affordable for all of us. Instead they will make whatever adjustments necessary until they can get a fair price for their products and maximize profits for the benefit of their stockholders.
http://seekingalpha.com/article/113157-gas-prices-will-go-up-with-a-fury?source=email

Oil settles above $48 on uneasy Mideast
SIOUX FALLS, S.D. (AP) -- Israel's ground offensive in Gaza and a dispute between Ukraine and Russia over gas imports pushed oil prices above $48 a barrel Monday, but some analysts say there's more than just unrest in the Middle East behind the rally.

Energy consultancy Cameron Hanover said some traders like to point to violence in the Middle East as a cause of higher oil prices, but the reality is slightly different.

"Any time that prices react by moving higher, in response to violence in the Middle East, particularly in non-oil producing countries like Israel or the Palestinian territories next door, it is a good sign that the market wants to move higher," the firm said in its Daily Energy Hedger report.

Phil Flynn, an analyst at Alaron Trading Corp. in Chicago, said there seems to be a mood change in the market and a belief that the economic doom and gloom has hit bottom.

"Would we really be concerned about these geopolitical issues as it relates to oil if we didn't think that the demand was going to improve somewhat in the coming year? Probably not," Flynn said.
http://biz.yahoo.com/ap/090105/oil_prices.html

Profiting From Bernanke's Super-Fed and Obama's Newer Deal [must read]
by Naufal Sanaullah
With an insolvent public and no foreign demand for Treasuries, the Federal Reserve will monetize debt to finance its continued bailouts and economic stimulus. This is purely created capital pumped right into the system. This is not anything new for the Fed-- for the past two decades, it has kept interest rates artificially low and created massive artificial wealth in the form of malinvestment and debt-financing. In the past, the Fed has been able to funnel the inflationary effects of its expansionary monetary policy into equity values with its low rates, which discourage saving, causing bubble after bubble, in the form of techs, real estate, and commodities. The excess liquidity (the artificial capital lent and spent because of low interest rates and debt financing) was soaked up by the stock market, which gave the appearance of economic growth and production. With inflation being funneled into equity and real estate over the last two decades, illusionary wealth was created and the public remained oblivious to the inflationary risk and the much lower real returns than nominal.

Now that the “artificial wealth bubble” being inflated for the past two decades is finally collapsing, one of two scenarios can occur: capital destruction or purchasing power destruction. Capital destruction occurs when the monetary supply decreases as individuals and institutions sell assets to pay off debts and defaults and savings starts growing at the expense of consumption. This is deflation and the public immediately sees and feels its effect, as checking accounts, equity funds, and wages start declining. Deflation serves no benefit to the Federal Reserve, as declining prices spur positive-feedback panic selling and bank runs, and debt repayments in nominal terms under deflation cause real losses.

Purchasing power destruction is much more desirable by the Fed. Its effects are “hidden” to a certain extent, as the public doesn't see any nominal losses and only feels wealth destruction in unmanageable price inflation. It breeds perceptions of illusionary strength rather than deflation's exaggerated weakness. The typical taxpayer will panic when his or her mutual fund goes down 20% but will probably not react to an expansion of monetary supply unless it reaches 1970s price inflationary levels. In addition, the government can pay back its public debt with devalued nominal dollars, which transfers wealth from the taxpayers to the government to pay its debt. Inflation is essentially a regressive consumption tax, which the government wants and the Fed attempts to “hide”. Not only is the Treasury's debt burden reduced, but the government's tax revenues inherently increase.

The Fed, in an effort to minimize inflationary perception, has for the last two decades supported naked COMEX gold shorts to keep gold prices artificially low. The Fed, as well as European central banks, unconditionally supported these naked shorts to deflate prices and stave off inflationary perception, as gold prices stay artificially low. This caused gold shorts to be “guaranteed” eventual profit, by Western central banks offering huge artificial supply whenever necessary, causing long positions in gold to be wiped out by margin calls and losses.
Now that the economy is contracting, the Fed won't be able to funnel the excess liquidity into equities or other similar assets. It also can't allow the excess liquidity of today, which is different in both its size (already $1.37 trillion) and nature (it is printed “counterfeit” money and not malinvested leveraged and debt-financed capital), to be directly injected into the economy. That would prove to be immediately very inflationary, as more than three times the money is chasing the same amount of goods, technically leading to 300% price inflation. These figures are strictly based on monetization of the Fed's current liabilities, not including any future deficit spending (which is sure to dramatically increase, especially with Barack Obama's policies), the American external debt, or unfunded social programs that need payment as Baby Boomers retire.

In order to funnel the excess liquidity into a less harmful asset, the Fed appears to be abandoning its support for gold naked shorts, causing shorts to suffer their own margin calls and cause rapid price expansion in gold. On December 2, for the first time in history, gold reached backwardation. Gold is not an asset that is consumed but rather it is stored, so it is traditionally in what is called a contango market. Contango means the price for future delivery is higher than the spot price (which is for immediate settlement). This is sensible because gold has a carrying cost, in the form of storage, insurance, and financing, which is reflected in the time premium for its futures. Backwardation is the opposite of contango, representing a situation in which the spot price is higher than the price for future delivery.

But why would the Fed abandon its support for naked COMEX shorts? What makes gold such a desirable asset to attempt to direct excess liquidity into? The unique nature of gold and precious metals provides its desirability in this Fed operation. Gold has little utility outside of store of value, unlike most commodities (like oil, which is consumed as quickly as it's extracted and refined), so its supply/demand schedule has unusual traits. Most commodities and assets go down in price as the public loses capital, because the public has less to consume with and that is reflected in demand destruction that leads to price deflation. Gold is not directly consumed and its industrial use and consumer demand (jewelry) is at a lower ratio to its financial/investment demand than almost any other asset in the world.

As a result, gold is relatively “recession-proof,” as evidenced by its relative strength in 2008. Gold prices rose 1.7% last year, which is quite spectacular considering equity values went down 39.3%, real estate values went down 21.8%, and commodity prices went down 45.0% in the same period (as determined by the S&P 500, Case-Shiller Composite, and S&P Goldman Sachs Commodity Indices, respectively). Because gold is not easily influenced by consumer spending, highly inflationary gold prices don't do any direct damage to the public and are a good way to funnel excess liquidity without economic destruction.

Federal Reserve Chairman Ben Bernanke is a staunch proponent of dollar devaluation against gold and is very supportive of President Franklin D. Roosevelt's decision to do so in 1934. In the past, manipulating gold prices to artificially low levels was beneficial because it prevented capital flight into a non-productive asset like gold and kept production, investment, and consumption high (even if it were malinvestment and unfunded consumption).

Bernanke's continued active support of gold price suppression would lead to widespread deflation that would collapse equity values and cause pervasive insolvencies and bankruptcies. Insolvency in insurers removes all emergency “backups” to irresponsible lending and spending, which would surely ruin the economy. Bernanke's plan seems to be to devalue the dollar against gold with huge monetary expansion, causing equity values to rise and economic stabilization. I've heard estimates of 7500 and 8000 in the Dow Jones Industrial Average as being minimum support levels that would cause insurers and banks to realize massive losses, causing widespread insolvencies in them and other weak sectors like commercial real estate that would irreversibly collapse the economy.

This gold price expansion, set off by the massive short squeeze, will continue until gold prices reflect gold supply and Federal Reserve liabilities in circulation. The “intrinsic” value of gold today (called the Shadow Gold Price), calculated dividing total Fed liabilities by official gold holdings, is about $9600/oz, compared to around $865/oz today. This gold price calculation essentially assumes dollar-gold convertibility, as is mandated by the US Constitution and was utilized at various periods of American history. The near-term price expansion in gold, mainly led by abandonment of gold shorts and the first traces of inflationary risk, should show $2000/oz by the end of this year. As the leveraged deals from the pre-crash credit craze mature, with the majority of them maturing in 2011-2014, there will be more monetary expansion for debt repayment, which will structurally weaken the US Dollar (which is inherently bullish for gold) and will also provide new excess liquidity to be funneled into precious metals. This leads me to believe gold will be worth $10,000/oz by 2012.
http://seekingalpha.com/article/113169-profiting-from-bernanke-s-super-fed-and-obama-s-newer-deal?source=email

Karl Denninger (Market-Ticker): GMAC’s “money-losing strategy” makes no sense
“The government ‘buys’ preferred equity that pays an 8% coupon. GMAC must pay that 8% coupon (9% if the government exercises the warrants).

“GMAC turns around and loans out money at 0% which it has to pay 8% to acquire, and at the same time decides that it will make loans to people with credit scores significantly worse than average, when before they would make loans only to people with scores that were slightly better than average. And we wonder how we got into this mess?

“The Federal Reserve and Treasury approved an application that contained as it’s essence an intentional money-losing business strategy, enabling the literal looting of the public treasury under the false pretense of an ‘investment’.”

Source: Karl Denninger, Market-Ticker, December 31, 2008.

Bill King (The King Report): Unlikely that ’09 will be as ugly as ’08
“2008 will be a year of historic imfamy. The S&P 500 declined 38.5%, the biggest drop since 1937. The Dow Jones Industrial Average declined 33.8%, the largest drop since 1931.

“It is highly unlikely that 2009 will be as ugly. But this does not suggest that it will be a ‘good’ year.

“Back in October we commented that the stock market is following a clear historic pattern. A summer folly rally amid a receding economy and percolating financial duress produced an autumn collapse.

“And an October panic did not generate a low for stocks because during recessions, like in 1907 and 1929, October panic lows yield to new lows in November.

“But then a yearned rally appears. This usually extends into the first day or two of the New Year. But then January turns ugly on anticipated horrid earnings reports that will appear during the second and third weeks of the month. Finally there is a performance gaming rally over the last few days of January.

“When bonds rally sharply in Q4, they tend to make a significant peak early in January. Bonds by then are extended, even ‘over-invested’, and corporations and governments tend to burst the dyke by issuing beaucoup bonds for financing needs in the coming year.

“However, this year will be tricky because Weimar Ben is monetizing everything in sight. Weimar Ben can continue to monetize everything and anything – until the market revolts. And the revolt will likely come from the dollar.

“Though Ben and US solons desire a lower dollar in the hope of papering over the US’s intractable structural problems, there is a line of demarcation for the dollar. If the dollar descents below that incalculable threshold, it’s checkmate, Ben.”

Source: Bill King, The King Report, January 2, 2009.

Financial Times: Fed pushes on with mortgage bond plan
“The Federal Reserve pushed ahead with its plan to buy mortgage bonds issued by Fannie Mae and Freddie Mac on Tuesday, saying it would start buying early next month and purchase up to $500 billion by the end of June.

“The aggressive tactics – the Fed had previously said it would buy this amount over ‘several quarters’ – highlights the central bank’s determination to hammer down the risk spreads on the mortgage bonds and thereby reduce mortgage rates.

“The Fed also announced that it had selected four asset managers – BlackRock, Goldman Sachs, Pimco and Wellington Management – to manage the process. It had agreed a ‘competitive fee structure’ but did not disclose this.

“The Fed said ‘the program is being established to support the mortgage and housing markets and to foster improved conditions in financial markets more generally’.

“The move comes as policymakers at the central bank and in both the outgoing Bush and incoming Obama administrations look to target mortgage rates in the hope that lowering them would arrest the decline in house prices and thereby support financial asset prices.”

Source: Krishna Guha, Financial Times, December 30, 2008.

Paul Krugman (The New York Times): The yield curve is wonkish
“I’m a little late getting to this, but … I see that economists at the Cleveland Fed are taking some comfort from the positive slope of the yield curve. Long-term interest rates are higher than short-term rates, which is usually a sign that the economy will expand.

“Not this time, I’m afraid. It’s all about the zero lower bound.

“The reason for the historical relationship between the slope of the yield curve and the economy’s performance is that the long-term rate is, in effect, a prediction of future short-term rates. If investors expect the economy to contract, they also expect the Fed to cut rates, which tends to make the yield curve negatively sloped. If they expect the economy to expand, they expect the Fed to raise rates, making the yield curve positively sloped.

“But here’s the thing: the Fed can’t cut rates from here, because they’re already zero. It can, however, raise rates. So the long-term rate has to be above the short-term rate, because under current conditions it’s like an option price: short rates might move up, but they can’t go down.

“Indeed, if we look at Japan we find that the yield curve was positively sloped all the way through the lost decade. In 1999-2000, with the zero interest rate policy in effect, long rates averaged about 1.75%, not too far below current rates in the United States.

“So sad to say, the yield curve doesn’t offer any comfort. It’s only telling us what we already know: that conventional monetary policy has literally hit bottom.”

Source: Paul Krugman, The New York Times, December 27, 2008.