Gold price to peak in Obama tenure?

Democrat Barack Hussein Obama II has been elected to become the forty-fourth President of the United States of America.

And some gold bugs couldn’t be happier.

Why?

Because the biggest gold bull market in modern history peaked amid a political landscape that is now similar to today’s.

Gold and Politics

The political balance of power in the United States has regularly tilted back-and-forth since the country was first founded 232 years ago. This state of constant change can not be said about gold prices.

Between 1792 and 1971, gold prices were set in the U.S. by the federal government at a fixed price. This fixed priced was changed only three times in the 179-year history of federal gold price fixing.

On August 15, 1971, Richard Nixon unilaterally canceled the Bretton Woods system and stopped the direct convertibility of the United States dollar to gold. As a result, the U.S. dollar was decoupled from gold, and gold prices could fluctuate like any other commodity.

So the data is very limited when comparing the performance of gold prices as they relate to the political affiliation of the President of the United States. However, there are some striking similarities between the performance of gold prices during the great gold bull market of the 1970s and today’s gold bull market and how the Presidential political affiliation was and is tilted.

Take a look at the chart below. It shows the inflation-adjusted average annual price of gold as they relate to presidential political affiliations.

Republicans Richard Nixon and Gerald Ford controlled the US Presidential office during the first half of the great gold bull market of the 1970s. During this time gold prices increased a modest 217% as the value of the US dollar dropped and gold’s investment appeal heightened under their administrations.

During the first half of today’s gold bull market, Republican President George Bush has controlled the Oval Office. During this time gold prices have increased approximately 204% (to date) for the exact same reasons.

The similarities here are extraordinary to say the least.

The Final Peak of the Great Gold Bull Market of the 1970s

In the 1976 presidential election, Democratic Governor Jimmy Carter defeated Republican incumbent Gerald Ford with a campaign promising comprehensive government reorganization.

During Carter’s tenure as President, the great gold bull market of the 1970s peaked. Gold prices climbed as much as 526% in Carter’s first three years in office.

So, with a new democratic President will today’s gold bull market peak while Obama is in office?

Unfortunately, there’s no surefire way to tell. But if prices were to increase as much as they did while Carter was in office, gold could almost reach a whopping $5,000 an ounce.

Obama is a recession. McCain is a depression

Reprinted from Business Times

Paradigm change, Clintonomics redux, or just muddling through - the shape of things to come

WALL Street may have suffered some sense of anxiety in the aftermath of Barack Obama's presidential victory with the Dow Jones falling more than 300 points. That nervousness seems to fit with the conventional wisdom that Wall Street has traditionally preferred Republicans in dealing with the economy.

But interestingly enough, the Democrat Obama has been more successful than candidate John McCain, the representative of the pro-business Republican Party, in collecting election campaign contributions from leading members of the American financial industry.

Mr Obama also performed better than Mr McCain in New York, New Jersey and Connecticut where Wall Street investors make their home.

In fact, most investors were rooting for Mr Obama. According to renowned financial commentator Jim Cramer: 'Obama is a recession. McCain is a depression.'

Mr Obama has also gathered heavyweight advisers such as two former Clinton administration Treasury secretaries, Larry Summers, the former Harvard president, and Robert Rubin, the Wall Street investor, not to mention former Fed chairman Paul Volker and, yes! Warren Buffett.

But even if one applies the best-case scenario in predicting the effect that an Obama administration would have on the economy, it's clear that the president-elect has his work cut for him.

And while he will take office only on Jan 20 next year, he is expected to select his top economic advisers, including his Treasury secretary, as soon as possible and direct them to cooperate with President George W Bush's economic team during the transition period.

Political and economic pundits speculate that either Mr Summers or a former deputy of Mr Summers, Timothy Geithner, the president of the Federal Reserve Bank of New York, would be selected as Treasury secretary.

There is also some talk on Wall Street and in Washington of bringing back Mr Rubin or keeping current Treasury Secretary Henry Paulson.

The other question is whether the new president would follow in the footsteps of the last Democratic president, Bill Clinton, and pursue his kind of centrist economic agenda that enjoyed the full support of Wall Street, or whether Mr Obama would embrace a more progressive and left-leaning economic policies.

Will Obamanomics remain committed to free-market principles that encourage economic growth, including reducing the deficit and liberalising global trade, or will it move in a more populist direction by placing an emphasis on social spending, redistributing wealth and 'protecting' US jobs from foreign trade?

During the election campaign and especially in the aftermath of the financial meltdown on Wall Street, Mr Obama did use a populist rhetoric, blasting President Bush and the Republicans for failing to create well-paying jobs and provide workers with medical insurance.

He criticised incredible high compensations granted to top business executives while the wages of the ordinary workers remained flat.

'The Bush tax cuts give those who earn over US$1 million a tax cut nearly 160 times greater than that received by middle-income Americans,' Mr Obama said.

And the Democratic candidate proposed to replace the laissez-faire policies of the Republicans in favour of increasing government intervention in the economy - more regulation of the private sector, more spending on ambitious domestic programmes, including a new government-mandated healthcare system, and on subsidising the creation of new 'green' jobs, and more reassessment of current and future trade deals, including the existing Nafta, as part of an effort to protect workers and the environment.

But the expectation in Washington and on Wall Street is that the new president is going to refrain from articulating what would amount to a coherent and ambitious economic doctrine - along the lines, say, of FDR's New Deal.

Instead, they expect Mr Obama and his advisers to invest most of their energy on muddling through the current financial crisis and on applying a mishmash of fiscal and monetary policies, to renew trust in the financial system and re-energise the American economy.

It will certainly be very difficult for critics to accuse Mr Obama of pursuing a 'socialist' agenda and of trying to use government to intervene in the economy, after the Republican Bush administration ended-up nationalising several huge financial institutions and promoted a large government-backed economic stimulus plan.

In fact, this Republican White House has presided over the most dramatic shift of power from Wall Street to Washington.

This has made it easier for any successor to use to continue using government power to shape the American economy, including by expanding the deficit.

Among the steps that the Obama administration is expected to take in the next year will probably be a new economic stimulus package of US$50 billion to jumpstart the economy and a new tax relief effort to help the strolling middle class.

The new administration could also decide to invest in the manufacturing sector and create new green jobs, to support small businesses and new programmes to repair the nation's infrastructure, and to raise the minimum wage.

With a clear Democratic majority on Capitol Hill, the Obama administration will almost have no difficulties getting its economic policies approved by Congress.

But a Democratic Congress could also put pressure on Mr Obama to 'get tough' with America's trading partners, and especially with China that has been blamed by many lawmakers for securing a competitive trade position vis-a-vis the US by maintaining the value of its currency artificially low.

But Mr Obama's advisers insist that notwithstanding his populist rhetoric during the campaign, the president-elect remains committed to free-trade principles and is not expected to initiate any new policies to 'punish' China or other trade partners.

But Mr Obama is also unlikely to move in any dramatic fashion to revive the global negotiations on liberalising trade.

Instead, as he focuses most of his effort on saving the American capitalist system, the new president will probably place the global trade issues on the policy back-burner.

Rome is not build in a day; neither is a house build in a day

The federal government has tossed hundreds of billions of dollars at the various problems that ail the U.S. economy, but housing, the root cause of the crisis, will require more time than money to heal.

Despite the best efforts of the Treasury Department and the Federal Reserve, banks' wariness about consumers' financial health has become so dramatic, that even the unprecedented measures taken by authorities over the past few months to spur lending and boost the economy will take a good deal of time to have a measurable effect.

The government seems to be using all the tools in its arsenal to tackle housing from all ends. On the lender side, the Treasury Department has agreed to buy up to $500 billion worth of banks' bad loans; invest $250 billion in preferred equity stakes in banks to spur new, better lending; and engineered the rescue of several companies that were crumbling under the housing catastrophe.

On the borrower side, the Fed has drastically lowered key interest-rate targets in an attempt to make loans more affordable, and Treasury and other agencies have aided efforts to alter distressed borrowers' mortgages to keep them in their homes.

Despite those efforts, mortgage rates have spiked higher, home prices have continued to plunge and delinquencies and foreclosures have climbed at a steady pace. Those factors, combined with weak economic growth and rising unemployment, have led banks to tighten lending standards further. While loans represent a key business, banks aren't eager to dole out cash to people who may never pay it back.

"There is still a core of quality borrowers with good credit, who are still having opportunities to receive good, cheap financing," says Keith Gumbinger, vice president of HSH Associates, a firm that tracks the mortgage market. "But those seeking jumbo loans, or those who are not credit worthy, can't document their income, or have excessive debts -- they're going to have to get used to hearing 'no.' "

Stringent standards have further whittled down the pool of eligible borrowers, while high down payments and far-from-lucrative mortgage rates have made them less eager to take on new debt. No borrower wants to put down 20% on a $200,000 home if he thinks it will be worth far less next year.

For now, the lack of confidence is keeping lenders and borrowers on opposite sides of the ring. Unfortunately for the feds, confidence isn't something money can buy.

"The problem we've been dealing with is not really liquidity -- we've been knee-deep in liquidity," says Vicki Bryan, a senior analyst at GimmeCredit. "It's a problem of confidence."

Some say the Treasury's plan to inject capital and buy bad loans is a necessary step to rebuild the system's cornerstones of confidence by removing uncertainty from the market. Fears that any bank might collapse on any given day exacerbated the crisis and helped lead to the demise, bailout, buyout or restructuring of some of the country's largest and most respected firms, including Bear Stearns, Fannie Mae Freddie Mac , Lehman Brothers, AIG , Washington Mutual, Wachovia, Goldman Sachs and Morgan Stanley.

But while the capital infusions will help restore the financial system and the broader economy, a massive housing bubble that took years to create will not correct itself as quickly as it burst.

"What [the government is] really trying to do is build confidence in terms of saying, 'We're here; we'll protect these loans; we'll protect the banks that make the loans," says Latha Ramchand, an associate professor of finance at the University of Houston's Bauer College of Business. "But the banks that are making the mortgages are still worried about risk. So whether it actually percolates down to more mortgages being made, that's going to depend on the grassroots confidence."

One positive takeaway will be a reversion to more prudent standards of the past: It's not a bad thing that buyers must document income, hold a job, provide a significant down payment and generally be able to afford the home they want to buy. But it holds a negative connotation, since the shift from no-doc and no-down-payment mortgages to full-doc and 20% down was so rapid and dramatic.

"If you look at today's lending standards and compare them to the 80s and 90s, or 70s and 60s, it's the same thing: Borrowers have to have good credit," says Gumbinger. "If you're on the risk-management side of the coin, the prudent-lending side of the coin, the side that tries to keep people from overextending themselves, is it a good thing? Yes. It's absolutely beneficial in the long-run."

One group that is primed to take advantage of the housing downturn is first-time buyers, who may also provide the ammunition for a recovery. First-time buyers don't have homes to sell, allowing transactions to occur more quickly, with fewer strings attached. They also tend to be young, which means more appetite for risk and less vulnerability to economic downturns than older peers -- who have kids to put through college, cars and vacations homes to manage, or retirement funds to worry about.

"First-time homebuyers haven't been hurt by the stock market because they're already broke," says Dave Luczkow, vice president of business development for OptHome, a Web site that offers housing advice.

Luczkow, a former manager of a Fannie Mae mortgage-security portfolio at Morgan Stanley, says first-time buyers have been hoarding cash and waiting for the right opportunity. Recent upticks in home sales provide evidence that prices have fallen far enough -- at least in some foreclosure-stricken markets, like California -- for a national turnaround to take shape in the not-so-distant future.

Still, housing transactions and mortgage revisions take months to complete and banks still have years' worth of bad real-estate inventory to sell. But the silver lining in the murky clouds of the housing implosion is that while a full recovery will not be speedy, measures have been put in place to get it under way.

"Real estate is local," says John Jay, a senior analyst of financial services at Aite Group. "So what you see in California is not what you're going to see in Pennsylvania. But to the extent that the government is putting capital into these institutions, at some point they really are incentivized to lend. That is their business."

American Bankruptcy vs Chinese Bankruptcy

First, Tao Shoulong burned his company’s financial books. He then sold his private golf club memberships and disposed of his Mercedes S-600 sedan.

And then he was gone.

…As more factories in China shut down, stories of bosses running away have become familiar, multiplying the damage of China’s worst manufacturing decline in at least a decade.

Let's not condone disappearing bosses who run off with whatever cash remains and leave behind unpaid employees and suppliers, but there is a simple beauty and efficacy to this process. Capacity is immediately taken out of the market.

Entering this global downturn, it is clear that many industries are suffering from an excess of global production capacity given declining demand. One of the things needed for the global economy to find some support is for production capacity to adjust lower to meet the new lower demand. Basically, factories need to be shut down, and the sooner the better. The fact that Chinese capacity can disappear overnight is actually a good thing for rebalancing the global economy, especially since much of the excess capacity that was built in recent years was built in China.

When these Chinese bosses disappear and their factories are shut down, that production is gone. Contrast that with the typical U.S. corporate bankruptcy. In the U.S., a troubled company files for bankruptcy “protection” and continues to produce. Typically, the stockholders are wiped out, and the bondholders are given new equity in the company in exchange for their debt. Then, the company emerges from bankruptcy, often with a production footprint not terribly different from its pre-bankruptcy days.

So, not only is it likely that zero to modest capacity was taken out of the system, but now the remaining competitors in that industry are facing this “new” old competitor which has a clean balance sheet and can more aggressively compete on price. This puts added pressure on the “survivors” who may have been fairly conservative and done everything right, but nevertheless now face a stronger competitor that would have been liquidated in a true free market. There’s probably no better example of this than the U.S. airline industry.

We can bad mouth the Chinese bosses who are leaving their employees and suppliers in a bind, but at least they’ve found a way to quickly address the excess capacity overhang.

How CDS kills AIG

We start with a simple loan: a lender passes money to a borrower, receiving an IOU in return.

(In the real world, the IOU is a corporate bond, or possibly a collection of debts called a Collateralized Debt Obligation.)

Len is taking some risk, because Barb may not be able to repay the loan. Len shells out some money for a guarantee from his buddy Sid:


Sid says to Len, “If Barb doesn’t pay your money back, I’ll step up and pay you the money Barb owes.” Sid is like a co-signer, except he isn’t Barb’s uncle. Sid is doing this as a for-profit business. He hopes to collect the CDS fee without ever having to make good on the loan.

To some folks, it sounds like gambling on Barb’s finances. I’ve heard people say that shouldn’t be allowed. (They probably don’t like craps, either.)

Here’s the benefit: Len can be more liberal in his lending because of Sid’s guarantee. Len does not have to study Barb’s finances in detail. If Barb is borrowing from many different guys, it might be more efficient for only the one person, Sid, to check her credit quality.

The obvious risk of the CDS is that the original bond issuer (Barb in the simple explanation) cannot repay her debt. In AIG’s case, they did extensive computer modeling of this risk. They felt pretty good about the risk.

However, there were two additional risks not considered in the computer models. First, the CDS contract had provisions that could require the guarantor (like Sid in yesterday’s example, or like AIG in real life) to put up collateral. That collateral would ensure that the guarantee would be solid. AIG received several calls for collateral from its counter-parties. That placed a significant burden on its balance sheet.

The second risk was marking the contract to market prices. For the guarantor, the CDS is a liability on the balance sheet. When other folks are trading credit default swaps, they establish a market price for this liability. AIG was forced to recognize larger liabilities on its CDS portfolio, even before it had sustained an actual loss.

Imagine this scenario: you’ve done a great job assessing risk, but the rest of the market is nervous. They start pricing CDS’s as if they are very risky. You are right, they are wrong. What happens? We would like to live in a world in which the folks who are right profit, and the folks who are wrong lose money. But in this scenario, the guarantor gets in trouble even if its right about the credit risk, simply because it has to recognize losses on the market value of its portfolio, even though it has not had to actually pay off on any claims.

If the guarantor has a lot of staying power, it simply accepts a hit to its balance sheet while waiting to be proved right. As the CDS’s expire over time, it can recover the reserves it booked when it marked the liabilities to market, showing huge profits. That is, if it has staying power.

However, it that guarantor is highly leveraged, the financial losses it has to report (before it has any genuine losses) cause its own credit rating to suffer. It has to post more collateral with its counter-parties. Its borrowing costs go up. Nobody wants to do business with it anymore, because its finances are shaky. Eventually, the company goes bust. Or gets bought by the U.S. Treasury, which may be even worse. And all of this bad stuff can happen even if the guarantor is ultimately right about the risks of the borrowers it was guaranteeing.

Listen to any of the radio personal finance shows, such as Clark Howard or Dave Ramsey. They’ll tell you not to co-sign credit card applications or car loans or mortgages, not even for your own family members. If you’re a corporation with a very strong balance sheet, you can co-sign a few notes and make a little easy money. But if you start doing this on a large scale, a large enough scale that it really helps your company, then you are piling up risk that ultimately could sink your company.

There’s an old saw in investments: The market can stay irrational longer than you can stay liquid.

AIG began selling credit-default swaps around 1998. Mr. Gorton’s work “helped convince Cassano that these things were only gold, that if anybody paid you to take on these risks, it was free money” because AIG would never have to make payments to cover actual defaults, according to the former senior executive at the unit. However, Mr. Gorton’s work didn’t address the potential write-downs or collateral payments to trading partners.

AIG became one of the largest sellers of credit-default-swap protection, according to a Moody’s Investors Service report last week. For years, the business was extremely lucrative. In a 2006 SEC filing, AIG said none of the swap deals now causing it pain had ever experienced high enough defaults to consider the likelihood of making a payout more than “remote, even in severe recessionary market scenarios.”

AIG charged its trading partners a fraction of a penny a year for every dollar of credit protection. The company realized, of course, that it might have to post collateral if the market values of the underlying securities declined. But AIG executives believed that such price moves were unlikely to occur, according to people familiar with AIG’s operation.

Well, that sums up the problem in a nutshell: it wasn’t so much that there is anything wrong with CDS in of themselves per se, it’s that some of the people selling them were operating under the misguided notion that they were getting “free money” and would never have to raise any capital to cover the risks they were taking on. In effect they were disobeying a fundamental rule of the Insurance business, you know that rule about setting premiums at a high enough level to cover potential payouts in addition to having enough capital on hand to cover additional risks?

I guess no one ever told the folks at AIG that there was no such thing as a “free lunch”. The irony here is that if some “local businessman” came to a friend or family member of Mr. Gorton with a similar sounding get rich scheme, he probably would’ve advised them that they were being scammed.
At least I would hope so.

Reading through the article I was reminded of a quote from the TV Show “News Radio” spoken by Jimmy James the multi-billionaire owner of the radio station:

“Beth you sold something of no value that you didn’t own, there is nothing left about business for me to teach you”

After all, what else would you call AIG’s CDS business?

The fact that the regulators allowed this to happen, on top of executives turning a blind eye (as long as their bonuses were rolling in) and none of their investors and/or creditors scrutinized the books enough to raise a red flag about this issue is downright criminal.

But let’s stop kicking the dead horse with the aid of 20/20 hindsight and think about the future:

It’s becoming more and more clear that many aspects of our economy, banking system, etc, operate in much the same fashion as a Ponzi scheme. If the new administration, financial executives, etc, truly want to save us they need to start attacking the Ponzi aspects of our financial systems as if they were a cancer, and replace them with a financial system that is firmly grounded in reality.

I’m sure the above statement may sound like a mere abstraction to some, but if you think about it some of the solutions are obvious:

Regulate CDS just like any other insurance product, in order to prevent a situation where a company is selling risk protection products as if they’ll never have to cover any losses.

Make it unlawful for banks to use CDS as regulatory arbitrage to meet capitalization requirements; in fact just set higher standards for what can qualify as a Tier-1 asset so that banks aren’t using derivatives as capital.

The idea is simple you review the banking and insurance industries and work to eliminate situations where we have de facto Ponzi schemes, and/or financial systems that are a house of cards. Now I’m sure the financial industry will squawk very loudly about this, but considering that they’re coming to the Government for handouts to stay in business it should be easy to shut them up.

Short term bullish; Long term bearish

Jim Cramer outlined a plan for President-elect Barack Obama to fix the struggling economy on his "Mad Money" TV show Wednesday.

Cramer said the first steps to turn the economy around are unfortunately beyond our control. The European and Asian central banks must cut interest rates, he said, ahead of what is sure to be a awful unemployment number on Friday. Without it, the markets will undoubtedly be in for another significant slide.

As for what Barrack Obama can control, Cramer said the first step is to fix the ailing auto industry. He said a major federal bailout, similar to that of AIG will be needed.

The government should buy huge chunks of both common and preferred shares in General Motors, Ford, Chrysler to stabilize their stock prices and secure the companies' corporate debt until structural changes can be made.

Second, Obama needs to solve the country's energy independence problem. Cramer recommended relying on the U.S.'s huge reserves of natural gas to bridge the gap to renewable energy.

Obama, he said, should mandate the U.S. automakers to make natural gas vehicles and encourage the oil industry to use tax credits to open natural gas fueling stations. Natural gas, he said, is not only a quick solution but one that could create thousands of jobs.

Finally, Cramer said the country must fix the housing crisis. Cramer says the remaining $400 billion in the TARP program should be used to buy 1.3 million homes in the hardest hit areas of the country.

The government then can offer these homes to Americans for low down payments and fixed 5% mortgages. He said this strategy will stop home price depreciation cold.

With these steps, Cramer said any president could easily fix the country's problems in his first 100 days.

Unless unemployment sky-rocket

Zimbabwe hyper inflation in rampant

Zimbabwe issued three new denominations of banknotes on Wednesday, including a one-million-dollar note, as the impoverished country struggles to cope with runaway inflation.

The Reserve Bank of Zimbabwe said the new 100,000-dollar, 500,000-dollar and one-million-dollar banknotes would be available immediately.

The move comes less than a month after the central bank introduced 50,000-dollar banknotes, hoping they would be large enough for Zimbabweans to afford the skyrocketing prices of basic goods.

However, the 100,000 banknote is now worth only one US dollar on the widely-used parallel black market and is only half the amount needed to buy a loaf of bread.

Twenty-four new currency denominations have been introduced in Zimbabwe this year alone.

Once described as a model economy and a regional breadbasket, Zimbabwe's economy has collapsed over the past decade and there are now shortages of basic foodstuffs like sugar and cooking oil.

When central bank chief Gideon Gono was appointed in November 2003, inflation was 619.50 percent but as of July, annual inflation hit 213 million percent.

The southern African nation is also suffering from foreign exchange and fuel shortages and the majority of the population live below the poverty line.

President Robert Mugabe's government blames the country's economic meltdown on sanctions imposed by Britain and other Western nations, while critics fault Mugabe's chaotic land reform programme as one of the main causes.

To keep pace with the rising costs, shops sometimes change the prices of goods more than twice a day, while long meandering queues have become a familiar sight at banks as depositors seek to withdraw cash which is rapidly losing its value.

While the currency, once on a par with the British pound, is in freefall, unemployment is a staggering 80 percent.

The government has tried several measures – including price controls and even striking off 10 zeros from the country's currency – to try to rein in the galloping inflation.

WISDOM OF Warren Buffett

We could all take a leaf out of value investment guru Warren Buffett's investment book. Buffet's timeless approach to investing has made him the world's richest man in 2008, according to Forbes. Buffett is known for his strong adherence to the value investing philosophy is the purchase of stocks that are trading below their intrinsic value.

As Warren Buffett once said, "Try to be fearful when others are greedy, and be greedy when others are fearful." In essence, investors need to dare to be contrarian, and move against the tide of conventional wisdom when the times calls for it.

The EIGHT Peals of Investment Wisdom

1) Volatility is not something to fear, but something to embrace
2) Think Long-term
3) Know the difference between gambling and investing
4) Be a contrarian
5) Consider the difference between price and value
6) Be humble, the stock market is smarter than you
7) Avoid the things you do not understand
8) Understand where you have an edge, and use it to your full advantage

Crisis and opportunity go together like peanut butter and jelly. Troubles can create great buys for investors looking to profit from long-term powerful trends.

Pricing of Crude Oil

Without a doubt, crude oil has been the commodity with the most buzz surrounding it over the last three years. Every investor and analyst (especially those geniuses on CNBC) has an explanation for every single move, but more often than not they are either misinformed or lying.

The importance of crude oil to our world financial markets is very important; it affects everything from companies’ transportation costs to consumer behavior and spending habits. Being able to predict the future price or price movements would be an invaluable skill, but the question is how would an investor even go about this? I believe the basis of this unattainable skill is influenced by a wide number of factors.

After I realized that this article was quickly turning into a book and then into an encyclopedia, I thought the title may be somewhat misleading. After some more thought, I decided to break up this post into a Five Part series. On top of that, the concepts I have presented are not very in depth, but they take time and a lot of writing to put into context.

Without a general understanding of these concepts that I am about to delve into, you will not be able to fully grasp the scope of the larger concept.

Crude oil has one of the most complex and variable pricing mechanisms in the commodities market. It is even more complex than almost every other liquid asset class. Crude oil pricing is affected by a host of different factors, and it can be extremely difficult to determine which factors have the greatest impact on the actual spot price at any given point in time.

As you have certainly seen in recent months, the crude oil markets have been extremely volatile and it is possible to make or lose a large sum of money very quickly. Many investors believe that the crude oil markets are susceptible to heavy manipulation, but when attempting to present evidence, their thesis generally comes up short. A good example of this would be that these “speculators” have been net short crude oil from early March 2008.

During this time period, crude actually appreciated from the $110-$120 range all the way up to $147 even though there were heavy bets against the commodity. While I don’t believe that manipulation drives oil markets, I am not saying that manipulation doesn’t take place. Instead I would like to focus on other factors that have been affecting crude recently:

Fundamentals of Supply and Demand
OPEC
Russia
Shortages, Stockpiles, and Decline Rates
Discoveries
Currency
Refiners and the Crack Spread
Geo-political Tensions
Weather Threats
Fear and Uncertainty
Other Risks

Hopefully I can shed some light on these factors as I will be the first person to tell you that I am not a sooth-sayer. I can tell you for certain that anyone who has a prediction for the price of crude in the short term shouldn’t be taken seriously because of their arrogance and lack of intelligence on how crude oil has historically traded in terms of volatility.

While I believe no one can predict short term movements, I do believe that with a strong understanding of macro economic factors as well as supply and demand it is possible to formulate a reliable general prediction for where crude oil will be trading far out into the future, somewhere in the range of 5 years and beyond. General stock market news in general can also have an effect, but I would rather explore some of the deeper points.

Fundamentals of Supply and Demand

The most basic metric for crude pricing is the simple fundamentals behind world wide supply and demand. Obviously these two factors are not exactly known down to the barrel, but it is widely accepted that crude oil supply is around 85 million barrels per day (Mbpd) and demand is around 86.5 Mbpd.

However, during the current crunch many experts believe that worldwide demand has dropped due to the severe economic slowdown that is looming upon us and about to occur starting next quarter. With a basic understanding of economics you can understand that this discrepancy must be filled through a market clearing price. This market clearing price occurs whenever approximately 1.65 Mbpd of demand is “priced out of the market.”

This single value is the basis for crude oil pricing but by no means is the only factor. Supply and demand may be the most important factor because all of the other factors can have a direct impact on supply and demand on a daily, monthly, or yearly basis. Supply and demand is the metric that investors always will go by whenever they are interested in long term horizons, basically any time period from 5 years to 30+ years.

OPEC

The Organization of Petroleum Exporting Countries (commonly referred to as OPEC) is the world’s largest cartel. It consists of Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. OPEC has control of roughly two-thirds of the world’s oil reserves and 35% of the world’s crude production (these numbers do not include tar sands and other unconventional forms of hydrocarbons). OPEC collectively places production quotas on its nations which in turn affect world wide supply. Often times countries within OPEC ignore quotas to promote their own economic interests but the net change from the total quota generally has been minimal.

Generally OPEC aims to keep oil prices increasing steadily at a rate slightly greater than inflation but there has been evidence and accusations of manipulating the market for other purposes, particularly in terms of the United States Presidential elections.

Many industry experts believe that the Saudis (OPEC’s largest member) purposely hold reserves until around the time of the election, and either add or take reserves from the market to help push for the election of the candidate that is most likely to continue America’s reliance on foreign oil. Obviously because transparency within OPEC is microscopic at best, this is impossible to prove but there has been a history of oil price spikes and drops around the half year before the election.

Russia

Depending on which day you look at the statistics, Russia is either the largest or the second largest producer of crude oil in the world. As you can imagine this allows Russia to have a great amount of pull in the world oil markets. While I do not believe Russia is currently trying to take crude oil off of the market to cause a price spike, I do believe they are supplying less oil to the rest of the market because they are consuming more to further their economic development.

Their export numbers were down last quarter and I wouldn’t be surprised to see them hold steady or drop again when the next quarter’s numbers are reported. Russia is currently listed as having the eighth largest crude oil reserve in the world, but I highly suspect that this number is inaccurate. Because of the political and economic instability that has taken place in the region over the last 50 years, proper surveying has not been completed and it is highly likely that within the next five to ten years there will be substantial oil finds in Russia. This is especially likely in the northern portions and offshore where very little work has been completed.

Another interesting factor when thinking about the future of Russia’s involvement with the world crude oil markets will be how it uses its political power. There have been rumors that Russia is interested in joining OPEC. This would instantly transform OPEC from a semi-legitimate cartel into the premiere market maker.

While I still think this is unlikely, this type of move would be a way for Russia to take a backwards strike at the United States. Even if Russia joins OPEC it doesn’t necessarily mean that their power will increase because many of the countries within OPEC act as rogue members and do not listen to the production quotas set by the council. When a country can further it’s own economic interest, OPEC and its feelings take a back seat.

Russia has also been slowly encroaching into other oil rich areas that tend to be part of the former U.S.S.R. Georgia has sizable crude oil reserves as well as a key pipeline that supplies Europe with a lot of energy. If Russia were to take over Georgia, either literally or through political pressure, they would have an even larger energy stranglehold on Western and Central Europe, especially in terms of natural gas supply.

Do not be surprised if you see LUKOIL, Gazprom, or Gazprom Neft expanding their territory further outside Russia’s borders with the help of Vladimir Putin. Putin is an extremely smart and thoughtful leader who understands the need for natural resources going into the future and he has determined that those who control natural resources will control the world in the future. He is also an astute student of “cold-war” type politics and has proven this through his neglect of anything the West tries to offer.

Shortages, Stockpiles, and Decline Rates

Often one of the most important short term pricing factors in regards to crude oil are shortages and stockpiles. These dynamics work in ways that are mysterious to most investors and misunderstood by many others. It is easy to understand that reports or rumors of any shortages will cause the market to price in future shifts in supply, that in-turn, will tighten the supply.

This conceptual logic also applies to decline rates. Decline rates are the rates at which oil or gas fields and wells “shrink” in terms of production. This number is generally quoted in a year-over-year metric and is a great measure when projecting and modeling future production. Decline rates are generally only issued after a well has surpassed its peak production phase, under most circumstances 2-6 years after the well has started producing oil.

Obviously different types of wells from different geographical locations have different average decline rates. Because there is a wealth of historical information available on decline rates, the market has priced in expected future supply of oil. The shifts in the price of crude oil occurs when the decline rates are either greater or smaller than expected. Obviously smaller than expected decline rates will cause future supply predictions to increase, and greater than expected decline rates will cause future supply predictions to decrease.

This same scenario is reflected when investors are looking at crude oil stockpiles. The Energy Information Agency (EIA) produces a report that is released at 10:35 AM EST on Wednesday of every week that collects data on the amount of crude that is currently in storage. Every week analysts predict numbers for barrels of crude oil, gasoline, heating distillate, and the refinery utilization rates. If these reports come out and are either above or below analyst expectations it is likely that the price of crude oil will fluctuate. (As a side note, the EIA also produces a natural gas inventory report that is released on the Thursday of every week at 10:35 AM EST.)

Discoveries

Just as shortages have an effect on the pricing of crude oil, so do new discoveries. New discoveries generally bring down the price of crude oil because investors will predict new supply coming online in future years after the new resources are tapped into. A great example of this are the new discovery announcements that have recently come out of Brazil. Petroleo Brazileiro (PBR: 30.58 +4.21 +15.97%), Brazil’s largest oil company which is partially state-owned, announced the discovery of the Tupi field in 2006 and the Jupiter field in 2008.

These are two pre-salt layer petroleum fields that contain a vast number of reserves. Current estimates are that the Jupiter field contains 5-8 billion barrels of oil and that the Tupi field contains 7-30 billion barrels of oil. When these announcements were made, the price of oil came down because of the expectation for increased supply not only from these two fields, but also from the speculation that other reserves may be found in the pre-salt layer crust level of the Earth.

Conventional discoveries have been slowing down in terms of number and magnitude as the world’s population uses all of the easily accessible oil. It is very likely that in the future discovery announcements will come in the form of unconventional sources of oil, such as oil sands, rock basins, and other sources deep under the Earth’s surface.

An excellent way to keep up with announcements of discoveries is to reference the Wikipedia Oil Megaprojects page. This website lists all of the new megaprojects, their location, their production, and their time frame. From all of my research I believe it is the most comprehensive and user friendly compilation of discoveries and megaprojects information on the internet. The link for the website can be found here.

Currency

Probably the most under appreciated determinant of crude oil prices is currency. Many investors forget that the foreign exchange markets sometimes are the entire reason for a move up or down in oil. Crude oil around the world on almost all exchanges is denominated in U.S. Dollars and a change in the base currency of an asset will cause the assets value to fluctuate in terms of other currencies.

As you can imagine the recent volatility in the foreign exchange market, especially in regards to the U.S. Dollar, have only compounded the complexity and volatility within the crude oil markets. Obviously there is no way to measure what effect a change in the U.S. Dollar against any basket of currencies has on crude oil, because there is no way to isolate currency as the only variable within crude oil pricing.

Many experts currently believe that roughly a 1% gain or loss for the U.S. Dollar Index will represent approximately a $3.00 gain or loss in the price of crude oil respectively. During this current liquidity and credit crisis it is not uncommon to see the U.S. Dollar Index move up or down 2% in one day, which would help to explain why there have been giant record setting moves up and down in crude over the last six months. This theory also happens to perfectly coincide with the rise of oil to $147 when the Dollar was appreciating and the subsequent fall back down as the dollar appreciated heavily against the Euro and British Pound over the last month or two.

During volatile times, especially currently during the massive market panic, crude oil has not traded in lock step with the United States Dollar. This is a special circumstance where multiple negatively correlated assets can trade in a correlated manner for a small period of time. In this example it would be the United States Dollar and crude oil depreciating simultaneously. The events of the last two weeks in respect to the currency and crude oil markets are aberrations and are extremely unlikely to occur again unless another similar situation arises in the distant future.

Refiners and the Crack Spread

The general misconception that the demand of crude oil is that it comes directly from “whoever pulls it out of the ground to their cars.” Unfortunately this is flawed thinking as they neglect many steps in between the first and last steps. The refiners are the ones who actually control the demand of crude oil, not the consumers. Their demand for the most part is dictated by the “crack spread.”

The crack spread is the term that refers to the profit margin of refiners. It comes from the process of “cracking” a barrel of crude oil, or refining a barrel of crude oil into a useful output. In most cases, this output is either gasoline or heating distillate, although there are many different outputs. The most common crack spread is the 3:2:1 crack spread, or 3 barrels of crude is refined into 2 barrels of gasoline and 1 barrel of heating distillate. Again, there is more than just one crack spread variation.

Crack spreads are always quoted using spot market pricing for the equations. Because of this, the crack spread is not always a 100% accurate indicator of refining activity. Unless a refiner is completely unhedged, their input and output prices are not going to be the same as the spot market prices. That being said, the crack spread is a pretty decent indicator of crude oil demand. The larger the profit margin is from the crack spread, the more demand there will be, and therefore, refining activity will pick up. The refiners are worried about making a decent profit margin due to the fact that they are also being squeezed by input prices (in the exact same manner that consumers are squeezed by input prices). Providing the general public with cheap gasoline is not the refiner’s chief concern.

Geo-political Tensions

There have been books of multiple volumes written on this topic, but I’ll try to keep it short and confined to only recent news. In general, geo-political tensions will cause the price of oil to go up because investors will attempt to price in the risk of potential supply coming offline in the future. This supply could be disrupted for a number of reasons, taxes, tariffs, elections, economic sanctions, embargoes, blockades, and in some cases war. A good example of this was the time period before the United States started their War on Terrorism.

Oil appreciated on the news because investors suspected some sort of slow down in productions from the Middle East. It turns out they were right as Iraqi crude production was cut down by about 45% from its peak before the war. Investors also priced in extra supply coming on in the future once the oil majors began to announce new projects that they had signed with the new Iraqi government (Iraqi production by most estimates is now above the pre-war high).

Another appropriate example is when President Mahmoud Ahmenijhad of Iran began to threaten other countries and released the photo-shopped photos of the Iranian cruise missile tests. The price of crude oil futures appreciated on the belief that there would be supply shortages from a conflict in the Middle East in the near future. Geo-political tensions have historically been what has caused some of the largest swings in crude prices and I would expect this to continue into the foreseeable future.

Weather Threats

As we have seen recently, weather threats have a severe impact on commodities (and the energy sector as a whole). Hurricanes Gustav and Ike of 2008 are examples of counter-intuitive price movements in oil because of other overriding factors that were simultaneously taking place, so I would rather focus on Hurricane Katrina of 2005.

During Hurricane Katrina oil prices spiked for a number of reasons. Firstly, production both onshore and offshore was forced off-line cutting the supply. Because supply was cut domestically, there was also an added need for imported oil which meant that demand from the United States was driving the price even higher than normal.

On top of that, crude prices were driven up because a great majority of the domestic transportation infrastructure (pipelines) in the southern United States was also offline. This event caused a panic and crude prices soared, which in turn caused many other commodity prices to soar. Many investors will attempt to price in the effects of upcoming weather events into the price of crude oil. This was seen with the run up in price before hurricanes that took place after Hurricane Katrina as investors learned their lesson.

Fear and Uncertainty

Fear and uncertainty is the worst enemy of a financial market, and if you turn on the television it is easy to see why this is the case and how it can affect the world financial markets. Within the crude oil markets, fear and panic can cause a severe move in either direction.

During this current credit crunch and liquidity crisis we have seen crude oil drop from its peak of $147 all the way down below $80 a barrel. This drop was not based on supply and demand metrics, but on investors fearfully pulling out their remaining capital from all segments of the market. Margin calls have become even more prevalent, especially when asset prices are decreasing.

This has the exact opposite effect of a short squeeze. You can read more about the affects of a short squeeze on oil in another article I have written, [5] http://www.bullishbankers.com/why-was-crude-up-huge-on-monday/. Fear will cause crude oil to be priced irrationally and it is impossible to quantify its effects on the price even though it is blatantly apparent that it exists within the market.

Other Risks

Obviously there are many factors that have a bearing on the price of crude oil; I would need to write for another year or two to name them all. The factors I have laid out are the most commonly talked about factors, but by no means necessarily the most important factors. One time events generally have an effect on the markets, as well as events that surface every so often. A good example of this is the potential problems and conflicts involving the Strait of Hormuz.

This strategically positioned strait is located between Iran and Oman and is probably the single most important geographical location in the world in regards to crude oil pricing. Because of the vast amount of crude oil production coming from the Middle East, it is estimated that roughly ~40% of the world’s crude oil travels through this strait on a daily basis. If anything were to happen to the strait, the crude oil markets would be in complete meltdown. The realization of this threat has never been real, until recent threats from Iran’s President Mahmoud Ahmenijhad mentioning sinking Iran’s own oil tankers to block the strait in order to inflict financial pain on nations who rely heavily on crude oil.

Luckily the United States has a naval fleet stationed full-time near the strait, but that does not necessarily mean that an attack could be averted. Certain special situations such as this hypothetical scenario will generally have an upward effect on crude oil.

Final Thoughts

Obviously the information presented above and in this set of articles is an extremely large collection of information that is only a relatively small piece of the entire puzzle. The market in many cases is fairly efficient and there are other factors priced into crude oil that no one can even begin to understand. As I have stated above, there is no set equation to determine what a barrel of crude oil is worth but I think it is very apparent that if there is an overriding factor, it is the all encompassing supply and demand equation. Even this seemingly simple concept is almost impossible to map when it comes to crude oil, and all of the other variables make the real equation unknown.

There are many great sources for information on crude oil, especially in terms of history, pricing, and how macro economics affect crude oil. If you are interested in learning more about crude oil and its rise I would highly recommend reading the book The Prize: The Epic Quest for Oil, Money, and Power by Daniel Yergin. This Pulitzer Prize winning book is the most accurate and in depth description of the history of crude oil as well as the macro economic ideas that are important to the past, present, and future of the commodity. The book is over 900 pages long but it is one of the best books I have ever read and for anyone invested or planning on investing heavily in energy stocks it is a must read.

I believe that there are three important things to remember: firstly, over the short term and sometimes intermediate term, the fair value for a barrel of crude oil is what the market says it is and nothing else. Secondly, the market does not always digest information in the fashion that seems the most logical. Often times new information will surface that would seem to be bullish or bearish for crude oil and the price will react in the exact opposite manner.

This may occur because there are other factors at play simultaneously: other investors do not come to the same conclusions from the same information, or for other reasons that are seemingly illogical. Finally, as much as you or I may think that we know about crude oil and its market, there is an even larger amount of information that we do not know.

Obama wins - a better tomorrow

Cult of confidence - Wall Street needs it, Obama brings it

NEW YORK (MarketWatch) -- You have to wonder if we are too high on ourselves, that we're setting ourselves and our soon-to-be president up for a fall.

The good news is that we can worry about it later.

If you think Wall Street didn't want Barack Obama to win Tuesday, you've probably been listening to the business media too much. You've probably heard that Republicans are the real friends of business, and that the market was building in a discount because a tax-and-spend Democrat was ahead in the polls.

Well, a Republican is sitting in the White House today and business is not exactly thriving.

The bottom line is that Wall Street is really not all that different that the rest of America that voted for Barack Obama to be the next leader of this nation.

Wall Street is worrying about reform and what it might do to profit. It's worrying about preserving a way of doing business and about how the new model will work. Americans are worried about their jobs, their wealth and the direction the country is headed.

They are similar problems, but not the same. They do, however, require the same kind of candidate. It's the candidate that electorates usually choose in times of crisis: the one who best conveys strong leadership and most importantly: confidence.

Losing confidence
During the past 18 months of deep economic tumult, the ultimate cause of failures and losses in the financial world was confidence.
Bear Stearns and Lehman Brothers weren't felled because they broke some set of rules. It wasn't that they upended the investment banking business model. They collapsed because their clients, customers, investors and lenders lost confidence.

The toxic securities held across Wall Street -- the mortgage-linked derivatives that have brought storied firms such as Citigroup Inc. and Morgan Stanley to their knees -- aren't worthless because they aren't producing returns, it's because investors have lost confidence in them.
Fannie Mae and Freddie Mac. The mortgage giants were brought down by investors who had lost confidence and would no longer accept returns that the government-sponsored entities would pay on their bonds.

As the dominos of doubt kept falling we began to question one another. It was a recipe for panic. On Aug. 11, the S&P 500 Index closed at 1,305.32. Less than 10 weeks later, on Oct. 27, it stood at 848.92 - a decline of 34%.

If that's not a panic driven by a lack of confidence then there's still hope McCain can win California.

Drastic measures

Many Americans may not understand exactly why Wall Street needs a $700 billion bailout. They may not understand why its financial institutions are failing and need to be nationalized like in some Eastern bloc state in the 1950s.

But they do know that they don't have to know what credit default swaps are if they have a smart, optimistic president who surrounds himself with smart people. The thinking goes, if the smart guy is positive we can make it through this mess, then I am too.

Wall Street is looking for the same thing. Individual donors on Wall Street would not have contributed more than $11 million to Obama through Oct. 19 if they thought the guy would do them in with draconian taxes. Obama received 43% more than McCain from the securities and investment industry, according to Federal Election Commission data.

In the end, this election was about confidence. Obama inspired it. His opponent, Sen. John McCain, didn't really come close. This is no slam against the Republican nominee. Either of these guys would be an improvement on an administration that couldn't change with the times.

Neither candidate has spelled out the painful measures that need to taken to shore up the financial system. The omission is understandable. Voters don't want to hear that the budget won't be balanced or that the healthcare system isn't suddenly going to become plentiful and cheap for everyone.

That's OK. The know-how to do the job is important, but faith can move mountains.

US economy on the decline

US output of goods and services shrank at a 0.3% annual rate during the July-September period, as consumers slowed spending. The figure for the nation's gross domestic product was the worst since the 2001 downturn, according to the Commerce Department. Consumer spending, which makes up more than 70% of total economic activity, fell at a 3.1% annual rate in the quarter, the first drop in 17 years and the sharpest decline since 1980.

The figures indicate that the steep downturn which may be labeled a recession later on by the group of economists that makes such calls probably began well before September, when carnage at financial firms spurred a freeze in lending. In coming months, as tighter borrowing terms and higher rates work through the system, employers are expected to slash jobs and consumers are likely to pare spending even more.

Economists expect output in the current quarter to decline more than 3% and continue contracting in the first three months of next year. The unemployment rate, now 6.1%, is likely to top 7% in the coming months and several forecasts show it hitting 8% by the end of next year. The downturn is bad news for nations around the globe that depend on the U.S. market for their exports and on U.S. financial companies for lending.

Fed 0% interest rates in the making

Excerpt from Kathy Lien

The Fed decided to yield to popular opinion Wednesday by cutting rates by 50bp. With an economic crisis that may continue into the foreseeable future, the Fed will have less and less ammunition as rate cuts begin to draw down to the zero figure.

The amount of slack left may be insufficient as it is because recent rate cuts have only been met with tightening credit conditions. It seems that newly created Fed initiatives, like making purchases in commercial paper and buying equity in banks, will have to be relied upon more as lower interest rates begin losing their effectiveness.

We continue to believe that the market will call upon the Fed to cut rates further, as economic conditions persistently weaken. In particular, recent complications in the auto industry may set up an accelerated series of layoffs, which could have a large negative effect on next week’s employment situation.

Notice how the Fed’s rate cuts have had little effect on mortgage rates and corporate bonds rates? Thus lending credence to my theory from last year (after the first rate cut) that the rate cuts would have little impact on the credit crunch since it was a function of loan losses, bad risk management, investors losing money, derivatives abuse, etc, as opposed to being a function of high interest rates.

Taking it a bit further: you can cut interest rates to zero and it won’t change the reality of overleveraged and undercapitalized banks that are facing escalating loan losses, or a nation full of borrowers that are either overleveraged (in general) and/or struggling with mortgages they can’t afford.

Not to mention the fact that it’s illogical to think that you can solve a problem that was partially caused by low interest rates with low interest rates.

Now suppose you could interpret this to mean that things would be markedly worse without the Fed’s rate cuts. You could also say that the Fed simply misinterpreted the impact of their rate cuts on the credit crunch; after all weren’t the rate cuts supposed to make mortgage rates fall, give relief to ARM borrowers, etc?

Either way the Federal Reserve and Wall St. have both become over dependent on rate cuts as a way to generate growth, and now with interest rates at 1.0% maybe both parties will begin to focus on the economy’s actual problems instead of hoping rate cuts will magically fix things.

US is a nation of analysts, pundits, politicians and policy makers who can’t seem to tell the difference between a root cause problem and a symptom.