Global Stock Market BLOG - Mike Burnick

Crude Oil Bubble Trouble

Last week crude oil traded up to yet another record high price above $145 a barrel. Black gold is living up to its nickname, having jumped more than 72% over the past 12-months alone – and up a stunning 631% since the end of 2001!

There’s been much speculation of late about whether or not oil prices are in a “bubble” that’s destined to burst just like China last year, housing a few years before, and internet stocks before that. There are good arguments both pro and con to the oil-bubble notion. Let’s take a closer look…

Fundamental Imbalances Leading to High Prices

There’s no doubt that supply-demand imbalances are playing a very big role in oil’s meteoric rise. Decades of under-investment in new oil production and refining capacity when crude oil prices were low, over the last two decades set the stage for today’s energy crisis.

And many years of above-trend global growth this decade led to a sharp increase in demand from the emerging world. Meanwhile, global production capacity just hasn’t kept pace with the world’s growing thirst for oil.

More recently supply disruptions in Nigeria and Iraq and falling output from Russia, Venezuela, and Mexico – among others – has resulted in very tight global supplies.

Meanwhile, strong demand growth in emerging markets hasn’t let up, partially due to widespread fuel subsidies in many developing nations.

Signs of Excess Speculation in Bubbling Crude

Still, fundamentals may not account for the entire rise in oil prices. According to data from the Commodity Futures Trading Commission (CFTC), speculators have increased their share of outstanding futures contracts to about 70% of the total, up from just 37% in 2000.

Commodity index funds and other pooled investments have poured about $250 billion into commodity trading strategies over the past five years alone. In other words: the hot money is chasing performance in one of the best performing asset classes this decade.

To be sure, some of this increase comes from diversified investment strategies adding commodities to enhance returns. And some of the increase in oil market speculation includes investment firms involved in hedging strategies (going both long and short) for their clients, according to the CFTC.

However, several analysts caution that a big share of the recent run-up in oil is pure speculation, and that prices could correct sharply, closer to the marginal cost of oil production... that’s about $65 to $70 a barrel!

Congress Debates Tighter Regulation, Higher Margin Limits

Now Congress, feeling the heat of higher energy costs, is proposing that the CFTC rein in oil market speculators by, among other things, suggesting a huge increase in margin requirements.

Currently, many investors in crude oil futures get away with putting up initial cash collateral (margin) of just a few percent of the underlying position value.

A $500,000 purchase of crude contracts on margin might cost just $25,000 to $50,000 in cash up front. In the stock market, a trade of similar size would require initial margin of $250,000 in cash.

And that’s exactly what Congress is talking about, raising margin requirements to 50% on futures! They’re also looking into barring pension funds from investing in commodities altogether.

As this debate rages on, one thing is certain, high energy prices are already resulting in “demand destruction” in the U.S. and other developed economies.  In fact, the domestic slowdown already underway will reduce crude oil demand by 240,000 barrels a day this year.

The battle between the oil bulls and bears is really beginning to heat up. It ought to be a good fight with lots of "fireworks".

There are some interesting energy-sector bets you can make that should pay-off in big profits - even with crude oil prices falling. I’ll give you more info in Monday’s blog, so stay tuned.

Have a happy July 4th holiday weekend!

Will the 'Cold War' Against Inflation Heat Up?

Another Federal Reserve Bank official said in a speech yesterday that he is: “taking the recent inflationary pressures very seriously,” and that “Policy needs to react decisively” to keep expectations of higher inflation in check.

So is this just more lip service from the Fed in an attempt to jawbone inflation (and perhaps support the dollar)? Financial markets aren’t so sure, as Fed funds futures continue to price-in a Fed rate hike sometime this year.

The major economies of the developed world are experiencing a sharp slowdown in growth, and bracing for recession. In fact, the U.S. economy expanded at a feeble rate of just 1% in the first quarter.

And we may have already entered recession, when data for the second quarter ended June finally gets reported.

But even as the economy slows, consumer price inflation in the U.S. rose to 4.2% in May, while wholesale prices rose 7.2%.

Meanwhile, emerging market economies continue to enjoy very robust economic expansion, expected to average 6.7% this year. That compares quite favorably to growth estimates of just 1.3% for developed countries including the U.S. and Europe (the U.S. will grow just 0.5%).

While inflation is running above the Fed’s comfort level in the U.S. (and the ECBs target in Europe), inflation in the emerging world has become an even bigger threat. In fact, inflation exceeds double-digit rates of 10% or more in 50 economies around the world, nearly all of them emerging markets.

This is an economic environment that looks shockingly similar to the “stagflation” era of the 1970’s and early 1980’s.

Famed investor Warren Buffett highlighted the dueling threats of slower growth and faster inflation recently saying: “I think the ‘flation’ part will heat up and I think the ‘stag’ part will get worse.”

While the Fed continues waging its war-of-words on inflation, the ECB gets to act on it tomorrow. Stay tuned.

Inflation or Deflation... Pick Your Poison

The U.S. economy, and most other developed nations continue to be squeezed between two opposing economic threats.

Commodity-price inflation and asset-price deflation are creating havoc with financial markets, while global consumers, businesses, and central bankers are caught in the cross-fire.

The U.S. Federal Reserve appears to be caught like a deer in the headlights, unable to reach consensus last week about the correct monetary policy prescription for dealing with the twin flations. The FOMC decided to hold-the-line, keeping the fed-funds rate steady at 2%.

By contrast the European Central Bank (ECB), confronted with the same economic data as the Fed, has reached the opposite conclusion. The ECB is threatening to raise interest rates at its upcoming policy meeting.

Data out today shows Eurozone inflation ticking higher to 4% - the highest ever. It seems this pretty much seals the deal for an ECB rate hike.

Of course this makes life difficult for the U.S. dollar. There is the slight matter of “yield differential”, which my friend and colleague Jack Crooks has discussed at length.

The dollar “yields” just 2% (the Fed funds rate) while the euro already yields 4% (the ECB benchmark rate) and is likely to go up at least another quarter-percent this week.

That’s why Treasury Secretary Paulson is in the middle of a four-day, whirlwind tour of Europe today, trying desperately to talk ECB finance ministers into a less-hawkish stance on inflation.

After all, higher Euroland rates could send the dollar plunging further, which in turn will lead to even higher commodity-price inflation. A vicious cycle if ever there was one.

The dilemma for central bankers around the world is trying to figure out which is the greatest threat to economic stability at present: 

A. The threat to growth from deflation in real estate and equity market values amid the housing recession and credit crunch.

OR

B. The threat to purchasing power that results from accelerating inflation rates around the world.

The Fed has focused more on the de-flation threat, while the ECB is more concerned with in-flation at the moment - and financial markets are caught in the cross-fire! Stay tuned...

Fun Facts on Inflation: Or, Why $140 Oil Looks Dirt-Cheap Compared to Other “Necessities”…

Investors are fretting over $142 a barrel oil this morning, and gasoline is well above $4 per gallon, but a recent story on CNBC.com shows how the high price of crude really stacks up against several other “necessities.”

The conclusion… oil’s actually pretty cheap at these levels... so quit complaining.

In fact, a trip to your favorite neighborhood sports bar will really give you sticker-shock. A barrel of Budweiser beer will set you back $447.25.

Would you like some Tabasco hot sauce for your chicken wings? That’ll cost you $6,155.52 a barrel! Hmm…I’ll take mine mild.

Switching to water to quench your thirst instead of beer won’t save you much either.

A barrel of Perrier will set you back $300.61 per barrel.

How about a trip to your local neighbor Starbucks instead? Cost: $954.24 a barrel – that’s only IF you take your coffee black.  Adding milk will cost you another $163.38 a barrel. 

Of course you can always just stay home, and drown your inflation sorrows in a pint of Ben & Jerry’s New York Super Fudge Chunk instead; cost: $1,609.44 a barrel!

Clearly it’s belt-tightening time for the average American amid these soaring prices for everyday “necessities” – just cut back on the luxury items and you'll be ok. After all who can afford Chanel No. 5 at a cost of $1,666,560 a barrel?

My wife will just have to do without!

Ben Bernanke and the Honey Pot

When my two girls were a few years younger, they were huge fans of Winnie the Pooh, one of the true children’s classics. At bedtime I would read them episodes from Pooh’s adventures in the hundred-acre wood nearly every night. They just couldn’t get enough.

One Pooh story in particular comes to mind this week. In this tale, Winnie the Pooh is so intent on licking the last drop of honey out of the pot that he gets his head stuck in the jar.

Ben Bernanke apparently never heard this story as a child – or certainly didn’t take the lesson to heart. That’s because Bernanke and the Fed are now “stuck.” It’s an unenviable position, but it's of their own making.

The Fed has been all over the map in response to the credit crunch that began last year. First they ignored it in the summer of 2007, keeping rates steady at 5.25%, while saying the fallout from subprime would be limited.

Later, after $400 billion in Wall Street write-offs, the Fed decided to slash rates to the bone, and bail out Bear Stearns with $39 billion in taxpayer money.

More recently, inflation is the Fed’s main concern. The Fed hinted strongly that rates must go higher to backstop the value of the slumping U.S. dollar, and to keep inflation in check. Yesterday, however the Fed did nothing, leaving rates unchanged. More empty talk from the Fed.

In its official policy statement the Fed said on the one hand: “Recent information indicates that overall economic activity continues to expand...”

But on the other hand: “uncertainty about the inflation outlook remains high...” due to “increases in the prices of energy and some other commodities.”

So in conclusion: “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.”

Bernanke’s in a box. The Fed is stuck in a honey-pot of indecision while the twin threats of asset-price deflation and commodity-price inflation take a heavy toll on the economy.

When you net out all the Fed’s double-talk, they appeared to adopt a tightening bias yesterday, but of course didn’t raise rates. So the worst of all worlds continues: stagflation!

In a TV interview yesterday Warren Buffett shared his views on the economy and inflation. He said: “I think the `flation' part will heat up and I think the `stag' part will get worse.”

When asked what he’d do if he were in Bernanke’s shoes he said: “I'd probably offer my resignation.”

Hog-Wild Grain Prices Putting the Pinch on Livestock Farmers

Iowa livestock farmers aren’t living high on the hog these days.

Recent flooding in this key section of America’s farm belt dealt yet another blow to farmers who are already in a bind due to sky-high feed costs and low livestock prices.

“Livestock farmers and meat producers across the country have been dealing with soaring feed costs for nearly two years,” explains a recent Wall Street Journal article.

“Now, heavy flooding in Iowa is sending corn prices even higher. Thursday, the corn futures contract for July delivery closed at $7.27 a bushel on the Chicago Board of Trade, up about 13% from two weeks ago.”

Livestock prices just haven’t kept pace with other soaring commodities, including the grain that's used to fatten them. Both farmers and meatpackers are seeing their profits squeezed as a result. In response, some big processors are liquidating their breeding herds, and family farmers are calling it quits.

“Shaun Greiner, a 39-year-old hog farmer in southeast Iowa, says he has been losing money selling his pigs since November.” It costs him over $170 in feed and overhead expenses to fatten a 15-pound piglet into a 280 pound whole-hog that’s ready for market.

The trouble is he can only fetch about $150 apiece when it's time to sell the animal at current market prices. That math just doesn’t compute.

Still, Mr. Greiner remains cautiously optimistic: “The wheel's going to turn and things are going to get better, and when they do it's going to be like shooting fish in a barrel, but I don't know when that's going to happen.”

We’re in the midst of a long-term bull market in commodities. In this kind of cycle, all commodity prices eventually soar to record highs, but performance is uneven from commodity to commodity.

While everyone is focused on soaring crude oil prices, some of the best values in commodity markets are in the agricultural sub-sector – especially livestock prices (lean hogs and live cattle).

According to my colleague Eric Roseman: “Over the last six years, live cattle and lean hogs have gained just under 30% in nominal terms, or up barely 4% adjusted for inflation.”

Livestock has essentially been standing-still compared to soaring grain and energy prices. In fact, over roughly the same time frame, crude oil is up over 600% in value!  Corn prices (a key feedstock for livestock) are up 120% in the past year alone!

You might say Eric is hog-wild for livestock, and I believe he’s right on the money.

Something’s got to give. Livestock farmers are already thinning the size of their herds, or calling it quits altogether, in response to soaring grain prices. Inevitably this results in reduced supply amid growing demand... sound familiar?

The next big round of commodity market gains are likely to come on the hoof.

Holding the Line…

Will they or won’t they? That seems to be the hotly-debated question as the Federal Reserve wraps-up a two-day policy meeting today.

There’s already some dissension within the rate setting Federal Open Market Committee (FOMC) with some members voting in recent meeting to hold the line on further interest rate cuts, or even talking about the need to raise rates to combat inflation.

Inflation worries are leading to lots of lost sleep these days for global central bankers. In fact, the European Central Bank may actually raise rates at its July meeting.

The trouble is, higher interest rates don’t do much to combat this kind of inflation, which involves mainly soaring food and fuel costs.

Headline inflation in food and energy prices has so far not spilled over into rising wages, the biggest input cost for most businesses. The reason is a globalized economy that has made labor markets much more flexible.

In fact, employment in the U.S. is already on the decline. Consumer and business confidence in both the U.S. and Europe has already fallen to the lowest levels in years, if not decades.

The Fed must continue to “talk tough” on inflation, if for no other reason than to keep the dollar from free-fall. The U.S. dollar is down about 40% this decade alone against a basket of world currencies. This fact has as much to do with rising oil and other commodity prices than global supply-demand imbalances.

Talk is cheap, but I expect the Fed to stick with a war-of-words against inflation – rather than a major policy shift. The latest housing data show foreclosures up over 40% last month – with bank repos of now abandoned homes nearly doubling.

With continued pressure on housing, consumer confidence at record lows, and employment falling, the Fed is not likely to begin raising interest rates.

I expect the FOMC to hold the line on interest rates today, but continue to talk tough about inflation. The Fed’s bark is worse than its bite.

BRICs Crumble Under Threat of Inflation

Don’t look now... but the BRICs are falling! The group of fast-growing emerging market countries which includes: Brazil, Russia, India, and China are facing their biggest economic challenge this decade. Inflation is accelerating in the BRIC economies and central bankers are responding by raising rates and tightening monetary policy.

While these moves may be necessary to combat inflation, tight money policies are usually a very unfriendly environment for stock investors.

India is the latest BRIC under fire. With wholesale price inflation running at 11% – the highest level in 13 years and climbing – the Reserve Bank of India responded last week by raising its benchmark lending rate to 8%. Global investors are signaling a vote of “no confidence” however, as they send Indian stocks plunging.

India’s currency, the rupee, is also under attack, having lost 8% of its value against the dollar this year – the worst performance for the rupee since 1993.

Inflation Looms as Biggest BRIC Threat

Spiraling inflation has reached a tipping point, where rising import prices (particularly food and energy) are hammering consumer spending power. The result has been a dramatic reversal of fortune for India, including an erosion of investor confidence in its currency and its capital markets.

Overseas fund managers were big buyers of Indian stocks in recent years, but have turned into net sellers. After $19.5 billion flowed into Indian stocks and bonds last year, foreign investors yanked $5.3 billion out of the country’s exchanges so far this year.

India is in the riskiest position among the BRICs in this environment of soaring commodity inflation. That’s because India is a net importer of most resources, including 75% of its oil.

Brazil meanwhile is a leading exporter of agricultural products and metals, And thanks to a growing energy industry and new offshore oil fields, Brazil should become energy self-sufficient this year.

Russia of course is one of the world’s largest oil producers, so it too enjoys a favorable trade balance. And China has a record $262 billion trade surplus, in spite of the fact that it too is a net importer of just about everything. Also, China has the world’s largest currency reserves at $1.7 trillion and growing at nearly $2 billion a day.

Is India an Early-Warning Sign for the BRICs?.

Still, the BRIC economies are all under serious threat of seeing their economies crumble under the threat of runaway inflation. India’s troubles are perhaps just an early-warning sign. Inflation in China is running close to 8% in spite of several interest rate increases last year. Inflation just topped 15% in Russia. Brazil, which suffered a painful hyper-inflationary past, recently raised interest rates after inflation crept up to 5.4%.

Stock investors, seeing this threat on the horizon, have been busy pulling money out of the BRIC markets. China’s CSI 300 Index is down over 50% from its 2007 high, while India’s Sensex Index has plunged by one-third in value. Share prices in the first two markets of the BRIC alphabet, Brazil and Russia, have so far held up well. This is due in no small part to their favorable trade terms. 

All of the BRICs are threatened by the risk of inflation. As an Indian government official put it, “Until inflation slows, this crisis is only going to widen.”

America’s Alternative Energy Future is Blowing in the Wind

Florida Power & Light (FPL) has a fight on its hands. The largest electric generating utility in one of the country’s most populous and fastest growing states is fighting for Florida’s alternative energy future.

FPL wants to place six wind turbines on land it already owns at the St. Lucie Nuclear Plant and nearby state owned land on Hutchinson Island. The wind turbine project is a key element in providing alternative power generation in Florida, where rising fossil fuel costs and hot weather are combining to push utility bills much higher.

FPL is the nation’s leader in wind energy generation. It operates 55 wind farms in 16 states, generating more than 5,000 net megawatts of electricity.

The firm has proposed a $60.8 million investment in the St. Lucie Wind project, not far from where I live. FPL wants to build nine wind turbines capable of generating enough juice to power nearly 3,000 homes in the area.

Public hearings haven’t even begun on the project and already local politicians and activists are lining up to oppose it… not in my backyard!

Wind Power is Here to Stay

The true irony is that the most of the land FPL intends to use for this wind power project is property it already owns… at the St. Lucie nuclear power plant here. Let’s see, if I had my choice between nuclear and wind, I know which I’d pick.

The reality is that wind power is here to stay, not just in Florida, but throughout the U.S. That’s because it’s a reliable, low cost alternative energy source. New U.S. wind power installations totaled more than 16,800 megawatts in 2007, up 45% last year!

That’s enough power to light-up about 4.5 million average homes. Wind energy is generated in 30 different states. Leading locations include Texas, California, Minnesota, Iowa and Washington.

Florida too, with its warm steady onshore breezes could be an ideal location… if locals can get over the NIMBY syndrome.

U.S. Becoming Largest Wind Market

The U.S. as a whole is moving toward wind power in a big way. In fact, we are set to overtake Germany as the world’s biggest wind market in 2009, as an investment boom in alternative energy spending transforms the industry.

While Europe had been the “hot spot” for alternative energy initiatives, especially wind power, that mantle is now shifting to the U.S.

In fact, European energy giant Royal Dutch Shell just sold its stake in a local offshore wind farm, “saying that Europe had been ‘built out’ and wind’s future was in North America”, according to an article in the Financial Times (FT).

Wind power produces only a bit more than 1% of total U.S. electricity now, but according to the U.S. Department of Energy (DOE), this could rise to 20% within the next two-decades. The DOE estimate takes into account electricity demand growth of nearly 40% over this period too.

Cost Effective Energy is a Breeze

The cost of wind power has already come down with today’s high-tech wind turbines. “Unsubsidised wind energy costs 8-10 cents a kilowatt hour,” according to the FT article, “while coal, gas and nuclear are in the 5 cents to 10 cents range.

The beauty of wind power is its ultra-low operating cost. The wind is free (at least for now), and maintenance costs on most wind farms is minimal.

That gives wind a big competitive advantage over coal, natural gas, and even nuclear power plants – where fuel must be continuously replenished to generate power. As we’re all painfully aware, the cost of these fuels has been escalating rapidly, even while the cost of wind and solar power technologies has been falling.

It’s clear that the soaring demand for energy, not just in the U.S. but around the world, can’t be met by dwindling fossil fuels alone – something’s got to give – ushering in age of alternative energy… even in sleepy, Florida coastal towns like Hutchinson Island.

It’s Put-Up or Shut-Up Time for the Kingdom

The scuttlebut is that Saudi Arabia may be set to announce an increase in oil production at this Sunday’s special meeting of OPEC members in Jeddah.

So will they or won’t they? The drama is almost as good as watching Top-Chef. A better question to ask is... can they raise production in a meaningful way?

The Saudis are clearly the big-dogs on the oil-block. It’s the only producer that can substantially increase – or decrease – crude production at will... or so they say.

Many oil market analysts, who roll with the “peak oil” crowd have grown highly skeptical of the Saudi’s claims – so this weekend’s meeting could prove to be an interesting showdown. I’m all in!

You Gotta Believe...

Let’s look at the stats: the Saudis produce about 9.5 million barrels of oil a day (mb/d). They “claim” they have the capacity to push production up to 11 mb/d or more. They further “claim”  they have discovered another 80 fields that haven’t even been tapped yet.

The Sheiks of the burning sands say: “leave it in the ground, with grace from God. Our children need it.”

Others, aren’t so sure about Saudi Arabia’s “claims”. The problem is that none of the Saudi oil production or reserve data can be independently verified.

The state-owned oil firm, Saudi Aramco, is the only game-in-town. No other western oil firm has been able to poke around since the late 1970’s.

So, as Jim Rogers says: “you either you believe them or you don’t.”

A growing legion of oil analysts simply don’t believe them. At a price of $140 a barrel, why wouldn’t the Saudis pump more oil. Holding out for $150, or $200 maybe?

Production Slump Fuels “Peak Oil” Fears

In fact, the Saudis helped put us in this pickle in the first place by cutting crude production from 9.6 mb/d in early 2006 to just 8.5 mb/d in April 2007. The Kingdom has boosted production again since then, but the damage is done.

Less Saudi oil on the market – combined with falling production from Mexico, Venezuela, Nigeria, and others –  led to a loss of almost 1 million barrels a day in global crude oil inventories last year!

Something has to give, and soaring crude oil prices are now biting into global growth, especially in developed countries; less so in some emerging markets where fuel prices are heavily subsidized (see yesterday’s blog article).

High Oil Prices Making Consumers Change Their Ways

But one thing is certain: sky-high oil prices are pushing up inflation around the globe. Consumers and businesses are feeling the pinch. According to the latest data, American drivers are cutting back big time in response to high gas prices.

Total miles driven by Americans since November 2007 has plunged by 30 billion miles, according to the Federal Highway Administration. That’s the biggest slump in road-trips since 1979... when the Shah lost his oil fields in Iran and Americans lined up at filling stations!

Faced with data like this, maybe the Saudis are beginning to change their tune. They should be worried about falling demand amid sky-high prices and slower global growth. That’s because people are changing their driving habits.

Trading in Hummers for Hondas... and Vespas

At our Soverign Society offices we now have two intrepid people who motor-scooter their way to work just about every day... with a third member of our staff thinking seriously about taking the Vespa plunge too (he already got his scooter license).

Habits are hard to break, and once you change them you’re unlikely to go back to your old ways anytime soon.

Once you’ve pushed your gas-guzzling Hummer into the river and start driving a Honda, you aren’t getting back behind the wheel of an SUV again anytime soon.

The Saudis realize this too, and the potential for a permanent slump in oil demand worries the Kingdom, as the world embraces alternative fuel instead, or simply figures out ways to cut back.

This brings us to Sunday’s special OPEC meeting, called unilaterally by the Saudis. Might a policy shift be on the way – a willingness to open the spigots and let more oil flow?

Is a Meaningfull Oil Output Hike in the Cards?

Again, the scuttlebut says the Saudis may boost production by at least 200,000 b/d, which is only a drop-in-the-bucket. A more meaingful increase however, in the 500,000 to 750,000 b/d range, might really make a dent in oil prices.

To avoid greater “demand destruction” for oil, it makes sense for Saudi Arabia to increase the flow of oil – at this point it’s in their best interests. The real puzzle is CAN they do it. As just about everybody’s mother used to say: where there’s a will, there’s a way.

The Saudi’s may have the will, but do they really have the excess capacity necessary to boost production in a meaingful way?

The oil bulls say the Saudis are just bluffing... and they can’t wait to call that bluff. If they’re right, crude prices could keep right on shooting higher this summer.

But if the Saudis are holding a full-house, then it could mean a decisive break for the bubble-like spell oil prices are under.

Either way, it should be a great side-show on Sunday, full of interesting drama. I may have to TiVo Top-Chef just to watch the OPEC outcome unfold live on CNN this weekend.

We Are Paying the Price for Emerging Market Subsidies

Yesterday morning during my morning commute, I heard an story on the radio that’s a sobering sign of the times. As I was blowing cash out my tail-pipe on my nearly 40-mile drive to the office, a guy on the radio described his own plight. He’s in worse shape than me.

At least my 6-cyclinder Chrysler Sebring convertible gets decent gas mileage for my long commute. The guy on the radio talked about how he was “stuck” in his Ford Excursion – unable to afford to fuel it up, but unable to trade it in for a reasonable price either.

My other car, the “family truckster” is a 2005 Ford Explorer. It’s bad enough on gas mileage, but is a necessity for my wife, two kids, dog, and various friends and teammates from my kids’ soccer and volleyball teams.

But the Ford Excursion is two heavy-metal models up from my Explorer. It’s a big, hulking vehicle, built on a heavy duty truck frame, with a big-block engine that measures gas mileage in gallons-per-mile instead of the other way around. My Explorer looks positively anemic in comparison.

Well, this guy interviewed on the radio has an Excursion, which he likewise needs to tote his kids (he has 4!) and assorted friends, teammates, etc., etc… around town. I already empathize with this guy big time.

Gas-Guzzlers Getting Priced Out of U.S. Resale Market

It seems he tried to trade in the Excursion at a local car dealer, hoping to at least downsize to a slightly more fuel efficient mini-van, still big enough for the kids, etc. But even though the Excursion’s book value is close to $20,000, the dealer would only offer him $8,000 for the gas-guzzler.

The reason: the dealer told this guy that big SUVs just aren’t moving. The dealer already had dozens on the lot (at a list price of $20,000) but they just weren’t selling with gas above $4 a gallon. At least this is an example of free-market forces at work.

Drivers in many emerging market countries just aren’t feeling the same pain, which is a big reason why oil and gasoline prices remain so high. That’s because many foreign nations subsidize the price of gasoline at the pump, as well jet-fuel, and other fossil fuels. In China for example, the government has a cap on gasoline prices.

As a result, drivers there pay about half of what Americans do at the pump. Beijing also subsidizes electricity rates, in a desperate (and misguided) attempt to keep a lid on consumer price inflation, which is already running at 8% annually. Imagine, how high inflation would surge if the gas-caps were scrapped?

Fuel Subsidies Thrive South of the Border

In Latin America, the situation is just as bad, if not worse. Most Latin American countries, including oil-rich nations like Venezuela and Mexico, are “shielding motorists from the impact of higher oil prices” through generous subsidies, according to a recent Financial Times article.

Chile just promised to add $1billion to its “fuel price stabilization fund.” Argentina has $11 billion worth of fuel oil subsidies in place now, and its expected to rise “much further this year” along with the soaring price of crude.

In Colombia, truck drivers went on strike this week over high fuel prices. The government’s solution: “raise taxes on private oil companies to finance increases in its $3 billion petrol and diesel subsidy.” Yeah, that’ll work, NOT!

Even in Mexico, which is a big crude oil exporter, a lack of refining capacity means they impart much of their gasoline. So Mexico City is paying $19 billion this year to maintain gasoline price subsidies – that’s four-times more than last year.

$100 Billion in Global Fuel Subsidies is NOT Money Well Spent

Note to Mexico: Perhaps that $19 billion would be better invested in new oil & gas well technology to reverse declining production rates at PEMEX!

Overall, global fuel subsidies will cost as much as $100 billion in 2008 – that’s twice as much as last year – according to data from the International Energy Agency. That’s money better spent on alternative energy development, or at least conventional energy production.

It’s no wonder oil prices are so high. Most of the world’s developing nations simply haven’t felt the “pinch” of higher prices yet, like we have. The U.S. and other nations went down this crooked path of price controls three-decades ago in an ill-conceived response to the energy crisis of the 1970’s.

It didn’t work then… and it won’t work in emerging Asia and Latin America now.

Worse yet, when these ridiculous subsidies are finally scuttled, then the lid on inflation will really blow-off, and these nations are likely to get hammered with crippling hyper-inflation.

Something’s got to give… hopefully sooner rather than later.

Oil-Mania Has Reached Tech-Bubble Dimensions

Crude oil prices touched another record high of $140 a barrel early this week before retreating a bit. Are simple supply-demand dynamics to blame; or is plain-old speculative fever in the driver’s seat now?

To be sure, the long-term driver of higher oil prices is crystal-clear. Slowing supply growth just hasn’t kept up with surging global demand – especially in fast-growing emerging markets.

As a result, global economies face a deficit of about 2 million barrels of crude per day! Meanwhile, subsidized fuel prices in many developing countries keep demand robust.

In China for instance, fuel prices at the pump are kept artificially low, and electricity rates too are subsidized. With no economic incentive to conserve, Chinese demand for oil, coal and natural gas are soaring.  As a result, China’s oil imports have soared 27% year over year.

So supply-demand imbalances continue to play a big role, to be sure, but speculation juices seem to have taken over at this stage of the game.

According to one hedge-fund insider, investors have stashed about $250 billion in cash into commodity index funds since 2003. Even traditionally conservative institutions such as public pension and college endowment funds are flocking into commodity investments – which have essentially become the only game left in town.

Bubble, Bubble…

As a result, crude oil prices have more than doubled over the past year. “I don't know if you can classify it as a bubble or not,” says hedge fund manager Michael Masters “but there is no question that investor demand is having an effect on price.”

Even if he’s not willing to do so, I’m happy to call it a bubble.

Oil has set 28 new record highs this year alone – and has more than doubled in the past 12-months. In fact, crude oil prices have soared 697% since late 2001 – the best performing global asset class by far since then.

The last time I saw an asset class turn in this kind of performance was the bubble in technology shares – leading up to the dot-com bust in 2000. In fact, the parallels are eerily similar (see graph above).

The Nasdaq Composite Index gained 640% from about 1990 to 2000. Like crude oil over the past year, the Nasdaq more than doubled in value during the last 12-months of its run-up. And then the tech-heavy index plunged 80% over the next 3 years!

Could a similar fate await crude oil?

The good news for oil bulls is that old familiar supply-demand imbalance at work. It takes years to locate, exploit, and fully produce a major new oil field – and there just aren’t many of those left in the world that remain undiscovered. Or as George Soros recently said: “The bubble is superimposed on an upward trend in oil prices that has a strong foundation in reality.”

Still, just a casual glance at the chart above tells me the parabolic run-up in oil looks a lot like it's in “bubble” territory already. In “reality” oil should be trading between $80 and $100 a barrel right now amid a slowdown in global growth.

Here’s one thing you can count on, the longer it takes for crude prices to return to “reality”, the more painful the inevitable correction will be for oil bulls.

Is This BUD for…Buffett?

One of the great icons of corporate America is in play – and global “value” investors including Warren Buffett will earn a tidy profit no matter the outcome.

More than a year ago I wrote that U.S. investors – attracted to fast growing global markets – should not ignore opportunities to invest closer to home. Specifically, in U.S. blue-chip shares offering healthy international exposure too (Going Global By Investing Local).

In that article, I pointed out that many big U.S. multi-national firms garner most of their sales and earnings from overseas markets these days.

Case in point: Anheuser Busch (BUD). America’s largest beer company has made several successful overseas investments in recent years, boosting its bottom-line.

BUD scored with a 50% stake in Mexico’s Grupo Modelo, the maker of Corona – one of America’s best-selling imported beers.

The value of BUD’s stake in Modelo has quadrupled in value since the 1990s. Another shrewd move by BUD was a strategic investment it made in China’s largest brewer: Tsingtao.

Combined beer volume from these two overseas investments has soared more than 60% in just the past two-years – and now accounts for over 20% of BUD’s total sales!

European Brewer Goes Global with a Buy-out Offer for BUD

Now, going global by investing local has been completely turned on its head. That’s because another leading global beverage company is making an offer to buy-out America’s biggest local brewer.

Belgium's InBev NV, brewers of Stella Artois, Bass Ale, and about 200 other global brands, has made a $65 a share all-cash tender offer for BUD. The potential takeover values Anheuser Busch at a staggering $46.3 billion. That’s a 30% premium to the company’s worth just over a year ago when I first wrote about BUD’s undervalued shares.

InBev’s buy-out, if it happens, highlights the dramatic reversal of fortune for America’s leading multi-national companies. Big U.S. brand-name firms like BUD, as well as Coca-Cola (KO), Proctor & Gamble (PG) and Abbott Labs (ABT) have seen continued strong sales and profit growth from healthy overseas markets. This has occurred even as many domestic-oriented companies in the S&P 500 suffer a sharp business slump.

However, there is a massive wealth re-distribution taking place now, due in large-part to the declining U.S. dollar in recent years. This makes Americn blue-chips look dirt cheap to other global companies – particularly those based in Europe.

Just 10 years or so ago, it would have been unthinkable that another beverage company could swallow a stock like BUD, but not anymore.

Buffett Could Play a Pivotal Role

The deal isn’t done yet. Anheuser-Busch CEO, August A. Busch IV whose family started the Budweiser brand over 132 years ago, is understandably opposed to the buy-out offer. But according to Bloomberg, “The Busch family, which has run the brewer for five generations, doesn't have a big enough stake to block InBev in a shareholder vote.”

In fact, BUD’s management owns just 4.5% of the company’s shares.  Institutional shareholders by contrast, are more likely to be supportive of this deal. InBev’s $65-a-share offer is 18% above BUD’s 2002 high price. That’s a nice profit in a difficult market.

Adding a touch of intrigue – there is also the possibility of a “white-knight” riding to BUD’s rescue. Value investor Warren Buffett owns a 5% stake in Anheuser-Busch, which he accumulated in 2005.

That makes the Oracle of Omaha BUD’s second-largest shareholder. August Busch has asked Buffett to discuss InBev’s offer with him this week.

Buffett of course is known for buying brand-name companies on the cheap – sometimes buying them whole. He has also stated that Berkshire Hathaway, due to its size, must consider doing bigger deals.

Heads or Tails Buffett Wins… So Can You with Other Leading Blue-Chips

Buffett has also helped push stocks he has owned into mergers in the past. When Procter & Gamble bought Gillette for $57 billion in 2005, Buffett was a large shareholder and director of the razor-blade maker. Buffett also avoids bidding wars, and Bloomberg quoted unnamed analysts as saying “InBev may raise its bid as high as $73 a share.”

So is this Bud for Buffett? It’s difficult to say for sure. Buffett has a long-stated aversion to “auctions” and InBev’s current offer already values BUD at a healthy premium. He may well support this deal in the end. But either way – Buffett wins!

One thing I’m sure of is you can expect more high-profile buy-outs of brand name American firms. Fast growing cash-rich companies in Asia, the Middle East, and even Europe have plenty of cash to invest, and still enjoy a favorable currency exchange rate environment.

Several blue-chip American icons come to mind including: Johnson & Johnson (JNJ), Walt Disney (DIS) – and Kraft Foods (KFT) which Buffett has also been buying recently (and my colleague Eric Roseman also favors). These companies are global in reach, and attractively valued in price – especially to cash-rich foreign buyers using stronger currencies as buy-out script.

Deflation, Inflation, Stagflation… Take Your Pick

The “official” inflation rate in the U.S. jumped 4.2% in the 12 months to May. That’s the fastest rate of price increases in more than 10-years in the U.S., driven mainly by sky-high energy and food costs – but this isn’t just a U.S. problem.

In fact, “official” inflation rates in American look positively tame compared to soaring inflation around the world.

According to a recent Bloomberg story, “The International Monetary Fund predicts the fastest inflation in advanced economies since 1995 this year even as they grow at the slowest pace in seven years.” That sounds a lot like the definition of stagflation to me.

Around the world inflation is catching hold, which is a whole new challenge for global central bankers to deal with.

Meeting in Japan over the weekend, G-8 finance ministers signaled an escalating unease with inflation saying: “Elevated commodity prices, especially of oil and food, pose a serious challenge.”

“Official” inflation in the U.S. is already far above the Fed’s comfort zone. What’s worse, inflation expectations are on the rise: A recent survey shows Americans expect 3.4% inflation over the next five years.

But even the understated “official” inflation numbers are now well above that mark, indicating more upside to inflation.

The European Central Bank (ECB) has a stated goal of keeping inflation in check at 2% or less. But inflation is soaring at a yearly rate of 3.7% -- the highest in nearly 20 years. Since prices are rising at nearly twice the ECBs target rate, there’s a growing likelihood of rate increases, perhaps as early as July.

Central bankers around the globe have been busy raising rates in the face of higher inflation. The Wall Street Journal reports that "inflation rates are soaring in many developing economies" (see graph above). In fact, inflation has quickly become the biggest threat to emerging markets.

Two of the world’s fastest growing economies – China and India – are struggling to reign-in what looks like runaway inflation – up 7.7% and 8.8% respectively over the last 12 months alone.

In China, inflation is nearly 8% year over year – and that’s after the central bank raised rates six times last year. Accelerating inflation pushed the Reserve Bank of India to begin hiking rates again just last week.

Inflation is running at annual rates of: 7.5% in Singapore, 9% in Argentina, 10.4% in Indonesia, 10.5% in Saudi Arabia and a whopping 15% in Russia! Brazil’s central bank, which has done a great job bringing inflation rates down substantially during the last decade, recently raised rates to combat inflation now at 5.4% and rising.

So what’s the solution to high global inflation? A stronger currency might help. That’s what Federal Reserve and Treasury Department officials have been saying lately, talking tough on inflation - by talking UP the dollar. So far, this is just a war of words, but dollar-sentiment is shifting.

Last week, Ireland rejected yet another attempt at a European Union treaty (see Bob Bauman's blog). As a result, global currency investors are beginning to question the stability of the EUs monetary union.

Institutional investors this year have switched from sellers, to buyers of the buck. Even dollar-bears like Jim Rogers admit the buck has room to bounce higher this year because sentiment is so one-sidedly negative.

The dollar had its biggest weekly gain in three years against the euro and the yen last week – can this reversal of fortune for the buck continue? A rising dollar may be one of the few ways out of this inflationary spiral. Either that, or much higher global interest rates. Stay tuned.

Election Year Politics Means Business as Usual for Congress and Big-Oil

America’s energy policy suffered another setback this week as partisan squabbling in Congress resulted in a missed opportunity – and may result in a major short-fall of investment in the alternative energy sector.

Senate Republicans and Democrats have been wrangling over a windfall profits tax and greater regulation of energy markets. On Wednesday, Republicans successfully stalled a bill that would have taxed big oil for their “excess” profits (whatever that is).

At the same time the Republican move will keep Congress doling out huge tax-breaks for big-oil companies that really don’t need such taxpayer-sponsored charity with crude oil above $130 a barrel.

The Senate proposal “would have imposed a windfall profit tax of $10 billion to $12 billion this year on oil companies,” according to a Bloomberg story. “It also included new margin requirements on oil-futures trades, and aimed to outlaw price gouging as energy prices have soared to records.”

Those “evil” speculators are to blame, and they must pay!

Tax Breaks for America’s Most Profitable Industry

Big-oil firms together made $36 billion in the first quarter of 2008 alone. But several forward-looking firms including Chevron and BP are already investing significantly in alternative energy sources.

Exxon Mobil, by contrast, spends very little of its record $40.6 billion in profits on alternative energy research & development.

In my view, redistributing oil company profits by Congressional mandate doesn’t seem like a smart way to go.

But neither does granting lavish tax-breaks to big-oil companies that are already flush with fat profits. Part of the bill defeated in Congress this week would have rolled back generous tax breaks and other subsidies expected to save big-oil some $17 billion over the next 10-years.

How about “targeting” those incentives specifically toward developing new, outside-the-box energy sources? Or at least producing conventional energy in a more efficient and cost effective manner?

This makes a lot more sense to me than just doling out $17 billion in taxpayer money to the most profitable industry in the U.S.

Meanwhile, Alternative Energy May Go Without

Sadly, Senate Republicans also successfully blocked a proposal that would have extended income tax credits for wind, solar and other alternative energy sources. These incentives take the form of production tax credits, and have been in place for years, but are due to expire – as Congress dithers – at the end of December 2008.

This program has played a key role in the viability and growth of the alternative energy industry in recent years. In fact by most accounts, these alternative energy tax credits cost little, but have had a successful impact on increased spending and investment in the sector. You might call it a “multiplier effect.”

Congress, in its typically partisan wisdom has had an on-again, off-again interest in this program. Washington hasn’t seen fit to make these tax credits perpetual, or at least choose a reasonably-long time frame (like tax cut legislation), so electricity producers can include alternative energy in long-range planning. Hello?

What is Our Alternative Energy Policy Anyway?

Instead, Congress has extended the alternative energy credit every few years. Naturally, this Short-sighted politics-as-usual attitude on Capitol Hill only hurts American businesses and citizens in the end -- as the future of our energy policy hangs in limbo.

Come January 1st, 2009, these alternative energy incentives will again expire, if not renewed by Congress. When this has happened before, it has often led to a major spending and investment slump in the alternative energy sector (see chart above).

That is something we simply cannot afford with fossil fuel prices going through the roof right now.Hopefully, the current Congress will at least wise-up long enough to extend the alternative energy incentives before this session is out.

Maybe the 111th Congress, and the next President of the United States, can put aside partisan, special-interest politics just long enough to address America’s alternative energy future sometime early next year.

Japan Surprises to the Upside... Again!

A funny thing is happening to Japan on the road to economic armageddon… the country is confounding forecasters by growing much faster than expected.

Back in May, Japan's economy surprised on the upside. The land of the rising-sun reported 3.3% annualized GDP growth in the first quarter - over three-times faster than the U.S. – and better than Europe too.

On Wednesday, Japan surprised again – adjusting first quarter growth upward to 4% due to better than expected capital investment and continued strong exports.

According to one press report “unusually brisk personal consumption and exports” accounted for the surprisingly strong expansion in Japan. Exports, especially to the rest of Asia, have in fact been booming lately.

Also, consumption at home is picking up - thanks to the tourist trade.

Take yourself back in time for a moment... to the mid 1980’s when newly-wealthy Japanese tourists traveled by the plane-load to high-end stores in the U.S. for shopping sprees. Beverly Hill's Rodeo Drive was chock-full of Japanese shoppers with money to burn, in search of bargains.

Well guess what... now Tokyo's fashionable Ginza district is the destination of choice for newly-rich Chinese shoppers!

In fact, almost one million Chinese visited Japan last year alone. As China’s travel restrictions are loosened further, and Chinese wealth continues to grow, Japan can expect plenty more visitors… and a lot more business opportunities.

Stocks in Japan have enjoyed a strong rally the last few months. In fact, it's been one of the world's best performers so far this year.

While a broad market pullback – now underway – may cut into Tokyo’s share price gains, I remain a big bull on undervalued Japan in the long-term.

One of the Scarcest Commodities on Earth

Commodity prices have been going through the roof for years, thanks to a scarcity of supplies amid strong global demand. But forget the global food crisis and peak oil – the #1 threat to global economies may instead be a scarcity of fresh water.

Water is a precious resource that’s also in short supply globally, and there’s no argument that water is much more a necessity of life that oil.

Here in Florida, we’re on water rationing, like many other areas around the world. Even as our “rainy season” begins, I’m restricted to watering my parched front lawn to just two days per week.

That’s a very mild inconvenience compared to what’s going on in other parts of the world – and what’s likely to happen in the very near future…

Global Warming is a Dehydrating Experience

Due to global warming, glaciers in the Himalayas are melting fast. That’s bad news for emerging Asia, since a few hundred square miles of the Himalayas are the source for ALL the major rivers of Asia – home to nearly half the world’s population.

In places like Florida, where vast underground aquifers supply ALL our fresh water, rainfall isn’t enough to refill the sub-surface water tables.

It turns out water isn’t a “renewable” resource after all. Or at least Mother Nature is not renewing it fast enough to keep up with soaring global demand.

“Demand for water continues to escalate at unsustainable rates” according to a recent Goldman Sachs report.

“Globally, water consumption is doubling every 20 years. By 2025, it is estimated that about one third of the global population will not have access to adequate drinking water.”

Aging Infrastructure Leads to Short Supply

Water is fast becoming the world’s most critical and sought after commodity. It’s a valuable resource that most of us have taken for granted during our lifetimes, but is getting scarcer with each passing day.

Water is running in short supply. It’s a global issue, and it’s approaching crisis dimensions.  The facts are sobering…

• Billions of people – don’t have access to reliable fresh water supplies
• The US alone needs up to $1 trillion in new water pipes and waste treatment plants by 2020.
• Half of the world’s population - will live under conditions of “severe water stress” within the next two decades.

The growing crisis in the world’s fresh water supply means major profit opportunities are in store for companies working to find solutions. 

Part of the solution involves building out new water infrastructure in developing nations where an estimated $50 million a day will be invested on water supply projects over the next few decades. In the Meanwhile, aging water systems in modern countries are leaking like a sieve, with infrastructure upgrades badly needed.

Global Water Crisis Will Trigger a Tidal-Wave of Spending

The World Water Council estimates that developing nations alone will need $4.5 trillion in water infrastructure investment over the next 25 years alone. And this isn’t just a third-world problem...

In modern industrialized countries, municipal water systems put in place centuries ago are woefully inefficient and falling apart at the seems.

In Europe, most pipe systems date from before World War I and many haven't been upgraded since then. Studies show that between 40% and 60% of the fresh drinking water that’s produced in Europe is lost before arriving at the tap.

Contamination in Japan’s fresh water system is widespread, and becoming a serious issue in some areas of the country. In Australia, which has suffered recurring droughts in recent years, salt water is creeping into fresh water wells – a major threat to farming.

And in U.S. municipal water systems 30% of the pipes are between 40 and 80 years old… another 10% of pipes are over 80 years old. As a result, about 6 billion gallons of treated water leak from American water systems every day.

The global water crisis may soon end up grabbing the headlines away from soaring food prices and sky-rocketing energy costs. This will result in an unprecedented spending boom of more than $5 trillion over the next 20 years, according to estimates.

That’s about $250 billion in water-related spending every year – a very big opportunity to profit if you know where to invest… stay tuned.

Energy Sector Divergence: Keep an Eye on Earnings

The bulk of second quarter earnings reports are just around the corner. In fact, many Wall Street firms will be reporting over the next few weeks. Lehman Brothers (LEH) kicked off the hit-parade yesterday, by taking a major HIT to its income statement with a $2.8 billion loss.

Energy sector profit reports will be eagerly anticipated by investors this quarter. That’s because energy is now the king-of-the-hill in terms of the sectors total net income contribution to the S&P 500 Index. Financial shares used-to-be #1, but not anymore. Just a year ago, banks and brokers contributed nearly one-third of total profits for the blue-chip index.

While the financial sector is gushing red ink this year, energy sector shares quietly took the lead – kicking in 23% of total S&P 500 earnings in the first quarter.

 

Overall, energy sector profits rose 24% last quarter, after growth of 25.5% in the final quarter of 2007. Since energy firms are doing so much of the heavy-lifting, it’s easy to see why investors are nervously anticipating second quarter reports for the sector.

This time around, analysts expect 16% profit growth for the energy sector. That’s still quite respectable, but it’s a pretty sharp slowdown from 25%. Meanwhile, energy sector shares haven’t been enjoying the big rally we’ve seen in crude oil, gasoline, and natural gas prices.

Oil prices alone are up more than 40% year to date, but energy sector stocks in the S&P 500 have gained only 5.4% so far this year. And shares of the world’s largest energy firm, Exxon Mobil, are actually DOWN more than 7% since January 1st.

This divergence between energy commodity prices and energy stocks has persisted for awhile now.

Something’s got to give. If energy sector profit reports are less-than-expected (or future guidance disappoints) this divergence could grow wider still, as energy stocks fall. Stay tuned

Consumer Woes Now Weighing Down Banks

More bad news from the financial sector