In the economy, money is the fuel that powers all consumption,
investment, and growth.
Likewise, in
nature, energy is the currency that drives all combustion, movement,
and change.
Each is essential
to our very existence. But BOTH are ratcheting higher in cost.
The cost of
money (interest rates) has risen to the highest level in four years
… while the cost of energy (especially crude oil and gasoline)
has catapulted to the highest level of all time.
This unique
convergence of events is not some past scene depicted in a History
Channel documentary. Nor is it some future scenario painted by CNBC’s
talking heads. It is happening RIGHT HERE AND NOW. And it’s
striking with gale force.
Take a brief
tour to the central focal points of these markets and you’ll
see exactly what I mean …
The Surging Cost of Money
Your first stop
is the Eccles Federal Reserve Board Building in Washington, D.C.,
on Constitution Avenue between 20th and 21st Streets, NW.
Just
three weeks ago, the Fed governors met here and raised their key
Fed funds rate from 2.5% to 2.75%; and just four weeks from now,
they will do it AGAIN, possibly at an even faster clip.
Already, this
puts the Fed funds rate at nearly TRIPLE its level of just a year
ago. And already, other interest rates — on 30-year fixed mortgages,
credit cards, auto loans, and commercial loans — are rising.
But
this is just the beginning.
At the steps
of the Fed building, you run into a former governor of the Federal
Reserve Board, one of the nation’s foremost experts on interest
rates.
Unlike the chairman,
he is willing to talk freely. So you ask him how high he thinks
the Fed funds rate can go in the near future.
“You want
to know how high they can go?” he says with a chuckle. “Then,
for starters, just take a glance — back in time — to see how high
they came from.”
“Back
in time? How far back in time?” you ask, grasping for any
clues. “To the 1980s?”
The former Fed
governor laughs with a snort and then responds. “No, no. You
don’t have to look all the way back to the 1980s. You don’t
even have to refer to the 1990s. Just plot the Fed funds rate starting
from, say, January 2001.”
“And then
what do I do? Draw some trendlines? Calculate the next Fibonacci
number?” you ask, demonstrating your technical sophistication.
“No, no,
no! None of that crap. All you have to do is print the damn thing
out. Then you paste the damn thing on your door. And then you just
look at it.”
“OK.
But what will I see?”
“You will
see the Fed funds rate going down … and then you will see the
Fed funds rate starting to come back up.”
“Is that
it? What’s so significant about that?”
The
former Fed governor pauses and looks past you toward the fountain
near the Southeast corner of the building. Then, counting on his
fingers, he explains …
“First,
the magnitude! The decline was from 6% to 1%. That’s
FIVE full percentage points. But the rise is just from 1% to 2.75%.
That’s only 1.75 percentage points or about one THIRD the
magnitude of the decline — SO FAR!
“Second,
the timing! The decline started only about four years ago.
So we’re not talking about a long-ago historic period when
the structure of our economy and financial markets were radically
different from today.
“Third,”
he says, raising his voice and cradling his middle finger in his
left hand, “the CONDITIONS! Think back. What were
the conditions back then which corresponded to the 6% Fed funds
rate? Was the federal budget deficit going haywire?”
“No,”
you respond.
“Was the
nation’s trade deficit going berserk?”
“No.”
“Were
oil and gasoline prices surging to their highest levels in the history
of mankind?”
“Of course
not.”
“But they
are today, right?”
“Yes,
they are.”
“And the
deficits?”
“Going
berserk,” you respond humbly.
“Then
with all this going on, how in the hell can anyone in their right
mind justify the Fed funds rate sitting all the way down here at
2.75%? How can you have them at less than HALF the level they were
at just four years … despite the fact that all the pressures for
higher interest rates are FAR more powerful today than they were
four years ago?”
You nod. Then
you go back to your opening question. “So how high can they
go?”
“Before
you ask how high they can GO, you should ask how high they should
BE right now.”
“OK. How
high should they be right now?”
The former Fed
governor smiles. “The Fed funds rate should be at least DOUBLE
today’s level. At five and three quarters percent. And I’m
not talking about next year. I’m not talking about next month
when the FOMC meets again. I’m talking about TODAY!”
“Five
and three quarters percent? How do you get that figure?”
“First
you take the current inflation rate,” he says, again counting
on his fingers.
“That’s
3%, right?”
“Right.
Then you tack on to that the average historical difference between
the inflation rate and the Fed funds rate — 2.75 percentage points.
Add those two and what do you get?”
“5.75%?”
“Exactly.
Just like I said — more than DOUBLE today’s rate. But that’s
just your STARTING point. On top of that figure, you have to add
on a couple of percentage points to cover any worsening
of inflation … a few percentage points to account for the burgeoning
money demand from the Treasury to finance its deficit … and still
more points to help offset any further decline in the dollar due
to the trade deficit.”
“Conclusion?”
“Don’t
you see? Interest rates could fly out of control. They could go
up so fast, it will make your head spin. They could make previous
spikes look tame by comparison.”
“Can you
give me an idea of exactly what that will be like?” you ask.
The
former Fed Governor lowers his voice. “I don’t have
to. Just go to New York City — where they’re trading gasoline
and crude oil futures. That will give you a good sneak preview of
the kind of spikes you can expect in ALL markets driven by inflation
— especially interest-rate markets.”
The Surging Cost of Energy
It’s
Friday afternoon, April 1, and you tell your taxi driver to take
you to the New York Mercantile Exchange building — the one with
the checkerboard of glass and steel overlooking the Hudson. You
wish you had taken a boat. You’re stuck in traffic on the
East Side Highway.
By the time
you make your way to the floor of the exchange, it’s too late.
The din of trading is gone, and most traders have left for the weekend.
But
to the trained observer, the sheer pile-up of litter denotes one
of the most hectic trading days in recent memory.
A camera crew
from CNBC is setting up to interview an energy analyst from Goldman
Sachs. You get to speak to him while he’s being prepped by
a make-up artist.
“What
the heck happened here today? Did crude make new highs?”
“Yes,
it did.”
“New highs
intraday or on the close?”
“Both,”
he says while his forehead is dabbed with powder.
“What
set this off?” you ask.
“Actually,
some people are blaming me.”
“You!?
Oh, I get it. You’re the guy from Goldman that put out that
far-out forecast this week — that crude could spike to $105 per
barrel and that it could DOUBLE in price even from these high record
levels. But how can one person have such an impact on the market?”
The analyst
shakes his head. “That’s my whole point. This isn’t
me. It’s the tidal wave of worldwide demand. In fact, the
truly BIG action today wasn’t even in the crude oil market.
It was in the unleaded gas market.”
“How
big?”
“Take
a look at that monitor over there. See that chart? That’s
unleaded gas futures. Massive break-out. Through the friggin’
roof! Huge spike to $1.731 a gallon. Highest since trading began
in 1984.”
“What
does it mean?”
“It means
precisely what I’ve been saying all along — that, so far,
this is mostly demand driven. In past cycles, when it was mostly
driven by scarce supplies, you’d first see crude oil go through
the roof. Then, the higher cost of crude oil would drive up gasoline
prices. Not this week. This week, the normal sequence is reversed
— first you’re seeing gas prices surge … and then crude
is following. It’s just another telltale sign that this whole
thing is mostly demand driven.
“So …”
“So when
you finally do get a supply disruption — THAT’s when energy
prices are REALLY going to explode. That’s what will drive
crude to $105 … and gas at the pump to $4, $5, even $6 or $7 per
gallon.”
The clean-up
crew approaches with brooms, and you remember your conversation
with the former Fed governor. “But suppose interest rates
rise. Won’t that put a damper on the demand for energy?”
“Hah!
That’s what some people thought a few weeks ago. So they bid
down crude and other commodities for a while. But now look! Crude
is making new highs again, and gasoline is way ABOVE its old highs.”
“Why?”
“Because
Greenspan’s a wimp. His quarter-point rate hikes are like
corks out of a pop gun. Even if he starts firing off HALF-point
hikes, it won’t have much of an impact. Think about it. It
would take over SIX half-point hikes just to get the Fed funds back
to where they were in 2001 — not one iota higher. Do you think
energy markets are going to give a damn about Greenspan at this
stage? Do you think a couple of billion Chinese and Indian consumers
are going to care?”
Theory
vs. Practice
In theory, when
the cost of money rises, it should indeed dampen demand for energy.
And the cost of energy should decline.
But in practice,
money is still cheap and abundant. Interest rates aren’t even
close to the threshold beyond which they might restrain the energy
price surge.
This morning,
Monday, April 4th, is a case in point. Oil prices have just raced
to all-time peaks, climbing above $58 a barrel.
In response,
some OPEC producers have started talking again about a second round
of output increases — supposedly to try and hold back the price
spike. But energy traders aren’t paying any attention to OPEC.
Everyone knows that what OPEC producers really want is to sell more
oil AND get higher prices for it at the same time.
Meanwhile, U.S.
crude for May delivery on the New York Mercantile Exchange just
hit a record $58.18 a barrel, up 91 cents on the day. London’s Brent
crude traded this morning $1.14 higher, at $57.65.
And look at
this: NYMEX crude oil for September delivery — trading at a premium
to the front month — just hit $60.03, the first time ever a futures
contract has topped $60!
This is the
spike we’ve been warning you about. And this is the time the
energy investments we’ve been recommending are spiking as
well.
If you’re
already on board this energy bonanza, great. If not, it’s
not too late to join. Just be sure that you …
– Don’t
invest more than you can afford to risk. No matter how dramatic
the current rise may be, no one can guarantee the future.
– Don’t
concentrate all your risk funds in just one market. The cost of
money and the cost of energy are jumping in leapfrog
fashion. So when one is surging, the other is consolidating, and
vice-versa. If you have a nice little stake in both, you have a
much better opportunity to cash in, and a much-improved chance of
smoothing out intermediate downturns in your portfolio.
– Learn as much
as you possibly can about (a) interest-rate markets and (b) energy
markets. They will dominate the scene for many months to come. And
the more you know, the better your chances.
– Don’t
pinch pennies when it comes to buying solid, independent trading
recommendations. I am biased, naturally, in favor of our own services
…
Larry
Edelson’s Real Wealth Report for longer-term
energy investors …
His
Energy Windfall Trader for more active energy traders
…
My
Safe Money Report for interest-rate profits …
And
for some of the greatest possible leverage anywhere, my Interest
Rate and Currency Trader.
But there are
many other good sources of information as well. And if you have
the trading know-how, you probably can do quite well entirely on
your own.
Enjoy.
And remember: Don’t bet the farm.
Good
luck and God bless!
Martin
D. Weiss, Ph.D.
Editor, Safe Money Report
President, Weiss Research, Inc.
martinonmonday@weissinc.com
Martin Weiss
and “Martin on Monday” are non-partisan. Third-party ads do not necessarily
represent their opinion and should not be interpreted as an endorsement.
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