Another Oil All Time High, Gold Forecasts, Fannie’s Surprise, Opportunity in Appalachia, and More!

by Addison Wiggin & Ian Mathias

  • Oil at another record high… what two events pushed crude to $122
  • So where’s the next stop for the black goo? Goldman says $200, The 5 thinks $100
  • Gold showing small signs of strength… Ed Bugos’ short- and medium-term forecasts
  • Fannie Mae drives into the ditch… government buys ‘em a new car and a six-pack
  • Chris Mayer with the latest natural gas boom… right in our backyard

Oil struck another high note yesterday, this time above $122.

The already jittery oil market snapped to just below its new high on escalating violence in Nigeria. Recent output statistics show the strife there is having more of an impact than expected. Nigerian production is now 1.8 million barrels a day — its lowest level since 1999.

That news brought oil to $121. Then Goldman Sachs released this statement:

“We believe the current energy crisis may be coming to a head… lack of adequate supply growth is becoming apparent and resulting in needed demand rationing in the OECD areas, in particular, the United States.”

Oil at $122 followed soon after.

Goldman analysts say a possible “super-spike” might be in the cards, thrusting oil to $200 a barrel as the current energy rally crescendos.

Where will oil settle after that? Around $100.

“It’s possible to attribute oil’s meteoric rise since early 2007 to rampant financial speculation,” writes Dan Denning, with an explanation, “But frankly, the oil price is hostage to a number of variables, many of which are not quantifiable. A fear premium definitely exists. Then there is the declining U.S. dollar. And there is the matter of investors treating oil as an asset class and as a ‘safe haven’ from inflation. The creation of sector funds and ETFs correlated to the oil price has made this possible.

“The increase in the oil price between 2001-2006 was a structural revaluation of oil’s value to the global economy. You had the Iraq war driving the geopolitical premium. Since 2003, you’ve had production peaks/declines in large fields in Mexico and Russia, persistent disruptions to Nigerian production and gradually increasing demand from emerging markets.

“And now? Well, like iron ore and coal, the oil price indicates that the emergence of China and India as productive industrial economies with emerging consumer classes is a lot more resource intensive than anyone imagined.

“The chart suggests there’s an oil bubble,” Dan says, “and that it has to correct soon. But by ‘correct,’ we mean oil between $95-105.

“In 2003, $40 became the new $20. In 2005, $60 became the new $40. And in 2008…$100 becomes the new $60.”

 

Gold rallied as high as $882 yesterday, but has pulled back to around $870 in Asian trading this morning. A quick look at the chart paints a challenging picture for gold investors:

“Those of us holding out for gold to mount another attack at $1,000 before the summer are none the better for it today,” says our gold adviser Ed Bugos. “The credibility of this short-term thesis is growing tired. The gold market has discounted a dollar bounce and commodity correction — it has been worried about these things long enough and has already moved on them.

“The medium-term gold price outlook hinges on evidence of low inflation and returning growth in the U.S. However, it is not clear how the Fed’s current policy might bring about a halt in those price pressures building up in the production pipeline.

“The most likely case is that consumer price inflation accelerates around the world, eventually forcing a round of interest rate hikes, while cost inflation continues to shrink margins in the production pipeline.

“When that happens, the price of gold will sharply rise.”

“There is a significant risk that higher inflation will become embedded in the economy,” Kansas City Fed Governor Tom Hoenig confirmed yesterday, “and require significant monetary policy tightening to reduce it.”

Hoenig went on to describe rising inflation as a “troublesome… serious” matter quickly approaching “unacceptably high levels.” And admitted soaring consumer costs “are beginning to generate an inflation psychology to an extent that… not seen since the 1970s and early 1980s.”

“Many of the steps public authorities have taken over the last year to stabilize the financial system,” Hoenig warned, “seem likely to weaken market discipline and extend moral hazard problems to a much wider financial marketplace.”

Heh… you think?

The dollar index edged up half a point on the Fed governor’s words, but still scores a low 73.

Pending homes sales fell to another all-time low in March, reports the National Association of Realtors today. Hitting its second consecutive record low, the NAR’s index dropped to 83. That’s down 1% from February… and an impressive 20% decline year over year.

March’s score is the worst of its kind since the NAR started keeping track in 2001.

Fannie Mae reported yesterday it lost $2.2 billion in the first quarter.

The government-sponsored mortgage buyer dropped truly hideous numbers on the Street. Aside from its multibillion-dollar quarterly loss, Fannie said it would be cutting its dividend and taking other measures to raise $6 billion in emergency capital.

The firm expects home prices to decline 7-9% this year. And to post another $4-5 billion loss.

Naturally, in response, the congressional oversight committee charged with regulating Fannie decided to expand Fannie’s ability to take more risks. The Office of Federal Housing Enterprise Oversight repealed growth limits placed on Fannie in 2006, when the company was caught manipulating its books… and lowered Fannie’s required capital reserves.

In other words, after reporting massive losses and a wretched yearly forecast, Fannie can borrow more and save less. Right… makes perfect sense.

For perspective, at the end of 2007, Fannie Mae and Freddie Mac held $83 billion in cash reserves… to back up $5 trillion in debts and mortgages. That’s leverage of over 60-to-1… and now Congress is suggesting they borrow more and keep even less in reserve. Unbelievable.

Together, Fannie and Freddie hold 80% of all American home loans.

Defying logic once again, “investors” bought up shares of Fannie on the news. FNM jumped 9% following the “earnings” announcement.

Wachovia unveiled a nasty earnings report of its own yesterday
.

The bank lost $708 million in the first quarter — double the losses Wachovia analysts predicted in preannouncement expectations. Despite recently raising over $8 billion by selling WB shares, Wachovia said it would likely lose another billion or so in the second quarter.

So… traders bought Wachovia, too. The stock finished up 1%.

Baltimore’s own Legg Mason reported its first quarterly loss in company history this morning. The super-sized fund manager lost $255 million during the quarter. Legg said it would soon sell 20 million preferred shares in a desperate attempt to raise about a billion bucks.

Still, the stock market rallied. Never mind Fannie or the rancid earnings report from UBS…forget D.R. Horton… and Wachovia…. and Legg. Disregard record-high oil prices… and a sagging dollar. Cisco and Disney had great quarters! Buy!

For the day, the Dow finished up 0.4%, while the S&P 500 and Nasdaq gained 0.7%.

“Appalachia is exciting and full of opportunities,” writes Chris Mayer looking elsewhere than Wall Street for opportunities. Recent estimates for natural gas reserves hidden in the Appalachian Basin, not too far from our offices here in Baltimore, have showed that the basin might contain 225 trillion cubic feet of natural gas. That’s about 15% of the estimated recoverable unconventional resource base in the U.S.

“The reserves lie in tight gas sands, shale and coal bed methane reservoirs. Historically, these areas have been more difficult to reach. But new technologies and higher natural gas prices — and the decline of the easy-to-get-at conventional wells — mean that it’s open season in Appalachia.

Adding a natural gas play to your portfolio is probably a smart thing to do. Chris suggests you check out Appalachia. We recommend you read the latest Mayer’s Special Situations.

U.S. gasoline prices held steady overnight despite run-ups elsewhere in the energy sector. The national average gallon of the cheap stuff still costs $3.61, a cent below its all-time high.

The national average for a gallon of gas will peak around $3.73 sometime in June, the Energy Department forecast yesterday. That’s the height of the “summer driving season.” For the year, quants at the Energy Department expect gas to average $3.52… 71 cents higher than 2007.

“Let’s talk about the gas problem,” writes a reader. “In my humble opinion, there is a simple solution that most of our population will not consider. That is: PARK THE FAMILY VEHICLE/S and either walk, take public transportation or stay home. Sounds pretty simple, but I guarantee you that upward of 75% of our population would rather pay $4 or even $5 for gasoline than put their overweight bodies to the test of not driving (where possible) or staying home, when the commute makes walking impossible.

“Heck, most of us (and I include myself in this) will drive all around the mall looking for the closest parking space, rather than parking more that 100 steps from the entrance. We have become an overweight and lazy society.”

The 5 responds: Heh. History shows people don’t change their behavior until they’re forced to.

“As I recall,” responds another to our discussion of the Laffer curve, “all eight Reagan budgets were submitted to Democrat-controlled Congresses. They proclaimed each year that the budget was “dead on arrival,” and then proceeded to significantly increase spending. It would be instructive to total up these increases in spending for these eight years and adjust the deficit totals by that total. That would be a much more accurate way to assign blame for that period of deficit spending.

“It bears out your point that spending must decrease, something completely lost on the Democrats in those years. The increases in defense spending during those years was either completely or almost completely covered by the increased revenues, and the deficits were from domestic spending.”

The 5: If we don’t move beyond “assigning blame” for deficits… the unborn will pay for our trespasses. Following the Saturday evening screening of I.O.U.S.A., a young gentleman approached me… and after a short conversation about the themes and aims of the movie, followed up with this comment by e-mail about stale political ideals:

“The film, obviously, has the power to raise awareness and start a conversation. By leaving out (intentionally, I’m assuming) some details or not taking it one step further, the audience are allowed to search for solutions on their own. Now, generally, this seems to be the aim of a documentary, but people are so uninformed and unimaginative on these issues that they will inevitably search for solutions through the same broken frameworks (i.e., the New New Dealers and Lafferites, as you mentioned) because these are the only ones they are aware of.

“I can understand that, but I think that there are some things that could be said, that really need to be said, without necessarily losing the audience, specifically regarding basic economics, taxes, and the Fed.

“Not criticizing here, really just venting and seeking your thoughts, as I’m sure you’ve been over these issues countless times in producing this film. It was difficult to sit in the theater and not comment while some audience members implied the obvious and singular solution is raising taxes, not to mention listening to Sarbanes and the politicophiles behind me whispering, ‘That’s SENATOR, not mister! Don’t you know who that is?!? That’s a former senator! That’s Sen. Sarbanes!’ because Mr. Creadon, God forbid, didn’t instantly recognize a former senator.

“Maybe that’s part of the problem…we look at our elected officials as near royalty; better and smarter than us, rather than representatives for us.”

The 5: You’ve hit the nail on the head with respect to some of the frustrations of both making the movie and trying to engage a wider audience in a very important conversation. People, even among the crew that made the movie, give in easily to the “same broken frameworks.” At that point, rational thought seems to end… and then, mindless emotion carries the day.

But we’re just getting started. The film has been accepted into the Impact Film Festival, which will take place during the circus surrounding both the Republican and Democratic national conventions. Then we’ll see about broken frameworks.

Regards,

Addison Wiggin
The 5 Min. Forecast

rspertzel

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