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Its giving early investors an opportunity to add to their winning positions. Its providing latecomers with an opportunity to jump on board. And its helping to shake out the weakest players, paving the way for the next, robust rise. Most important of all: This correction has done nothing to change the powerful fundamental forces that have been and will continue to be driving the energy sector higher:
My view: Before we can begin to talk about an equilibrium between supply and demand, oil prices must get back up into the $90 – $100 range. And by that time, there are bound to be more pressures from demand and from overall to push prices even higher. My forecast: $130 oil sometime next year. My recommendation: Hold all your energy and natural resource positions, and wait for my signal to buy more. While this weeks decline in oil and energy stocks has all the earmarks of a temporary correction, the decline in the Dow Jones Transportation Index is another story entirely. Thats why, in my Energy Options Alert, I told subscribers to expect a big plunge in the Dow Jones Transportation Index as profits got clocked by higher energy costs. Plus, I went one step further: I told them to buy a put option on the index an investment that helps you actually profit from the decline.
Now, however, the decline I was anticipating has finally begun: In just the last two days of trading, nearly all its recent gains have been wiped out. Plus, in the next few days, the index looks like it could plunge through its September levels — and beyond, to a new, 4-month low. No, energy prices arent high enough yet to make a significant dent in demand. But theyre certainly high enough to trim profit margins and stock values in these energy-dependent companies. And this is just the beginning of the damage that I see to a wide variety of companies in virtually every sector. Thats why four months ago, I issued an even broader warning to my Real Wealth Report subscribers. My headline was: I told my subscribers that key sectors of the U.S. economy would soon look like an orange that had been sliced in half and squeezed in a juicer. Now, the Big Squeeze is here. Its not a temporary phenomenon. Nor is it caused exclusively by surging energy costs. Its also the result of too much debt … too little personal savings … surging prices from other basic materials … and rising interest rates. Its why corporate profits are starting to slump and why companies like General Motors, Ford, Northwest, Delta and many more are in shambles. The decline in the stock market yesterday was your first wake-up call. The news from General Motors was your second. GM is setting aside up to $800 million from its balance sheet. Plus, its selling its remaining stake in Fuji Heavy. These are signs of a company in the first phases of serious distress. Look at it this way: If giant GM lost $2.5 billion in the first half of the year … is restating the value of its balance sheet by $800 million … and is selling off what was once considered a valuable asset … then you can be pretty sure there are dozens, perhaps hundreds, of other companies that are facing similar, or worse, troubles. So I hope youve listened to my recent warnings and have most of your money safe, in a short-term, liquid, money market. And I hope youve also taken seriously my recommendation to limit your stock holdings mostly to natural resources, which should continue to do well. Black Gold vs. Yellow Metal
As the torrid pace of events accelerates over the next few months, heres one fundamental issue you should always keep in mind: The gross undervaluation of gold. Consider, for example, the relationship between the price of gold bullion and crude oil. Historically, an ounce of gold usually bought between 11 and 15 barrels of oil. Today, an ounce of gold buys only 7 barrels. Since its unlikely that oil will fall much from current levels, that means the yellow metal is dirt-cheap compared to the price of black gold. So lets do the math … Say the price of oil stays at its current $64 a barrel. For gold to get back to even the lower end of its purchasing power vis–vis oil (11 barrels of crude), that would mean gold would have to rise to $704 an ounce. And for gold to get back to the upper end of its historical valuation relative to oil (15 barrels), it would have to soar to $960 an ounce. That sets the parameters very clearly: Gold will have to trade between $704 and $960 per ounce. And all this assumes no further rise in oil prices. At $90 or $100 oil, gold will have to go much higher. Unrealistic? I dont think so. Indeed, gold today is essentially just as undervalued as oil was in 2001, when it was trading at just $17 per barrel. So when gold springs to life and starts adjusting to the loss in the purchasing power of the dollar over the last 20 odd years, it too will explode higher, just like oil has. I repeat: Gold is extremely undervalued. I fully expect it to reach $1,000 an ounce. Meanwhile, select gold shares those that do not hedge the price of gold could double and triple from current price levels. No, thats not going to happen overnight. And like oil, gold and gold shares are also subject to downdrafts and price pauses. Dont let them bother you. Instead, keep the big picture in focus. That way, you can ride these trends for their full glory. What are the most likely triggers that could set off the next explosive rally in gold? There are several: First, general inflation. Its rising, just as Ive been predicting for over three years. And, right now, its going to start rising much more quickly. The most immediate reason: The $200 billion in paper money that the government is going to have to print and borrow in order to rebuild the Gulf … plus, lax monetary policies in virtually every corner of the globe. Second, rising social and political stress. Unfortunately, the war on terror is destined to continue for years. There will be social upheavals in China between the rich and the poor. And there is no end in sight to the heated ethnic conflicts precisely in those areas where natural resources are among the richest: Central Africa, Indonesia and key regions of South America. I expect all of these to escalate in the years ahead, creating acute shortages of raw materials, more inflation shocks and surging demand for gold. Third, the dollar decline. While its stable right now, the long-term downtrend remains firmly intact. The budget deficit which will now blow out to record highs due to Katrina and Rita virtually ensures a falling dollar. Added on top of that: Another $44 trillion in unfunded liabilities in this country. Fourth, dont forget … Derivatives: Derivatives are instruments used by banks, insurers, commodity producers and other institutions to help hedge against losses … and to make speculative bets on the future direction of virtually any market. Most of the players and analysts stress the hedging side of the equation. They see these leveraged bets as good insurance to help provide markets with better liquidity and investors with better protection against adverse price moves. The problem: Derivatives are designed for protection against reasonable price movements that are largely expected. They do not provide protection against dramatic changes that are unexpected. In fact, its precisely those kinds of disasters that can cause a massive blow-up in derivatives. Some examples: The 1992 currency crisis in Europe the 1994 Mexican peso crisis the collapse of Barings Bank in 1995 … the Asian Financial Crisis of 1997 … and the default by Russia on its debt in 1998, precipitating the demise of Long Term Capital Management just to name a few. Now, heres what bothers me the most about the derivatives market: Its growth is out of control, and no one has a good handle on who owns what or where the hidden risks may lie. According to the Office of the Comptroller of the Currency (OCC), the notional, or gross amount of derivative bets held by insured U.S. banks, is now $96.2 trillion. If just 1% of the $96.2 trillion in derivatives were to go bad, that could cause nearly one TRILLION in losses that would cascade through the system. What might trigger the derivatives crisis? I see three major threats on the horizon: Threat #1. Surging interest rates. The OCC reports that 85% of the derivatives are based on the direction of interest rates. That means that if Im right about oil, natural resources and inflation, and if the inflation drives interest rates up as sharply as I expect, there are bound to be a series of disasters in this sector. Reason: When placing their bets, thousands of banks, insurance companies, and mortgage lenders rely on relatively stable, or at least predictable, interest rates. If rates spike more quickly than expected, many will get caught with large losses, and some could even fail. Threat #2. Real Estate Prices. The average price of a condo in Manhattan has slumped 13% in the third quarter just ended, the biggest drop in 16 years. If Manhattan is slipping, you can pretty much assume that the hot real estate markets elsewhere are starting to crack as well. There are trillions of dollars at stake in the mortgage markets, with many links to the interest-rate derivatives I just told you about. So a sharp, unexpected decline in real estate prices could send many banks, mortgage companies and other financial institutions over the edge. Threat #3. The dollar itself. If the dollars long-term decline resumes, as I expect it will, the greenback itself could set off a derivatives nuclear bomb. How so? Foreign investors are financing up to 75% of this countrys trade deficit as well as a substantial portion of the U.S. federal deficit.
Meanwhile, the value of foreign holdings in the United States now exceeds U.S. holdings abroad by nearly $4 trillion. Thats unsustainable. At some point, overseas investors will throw in the towel on U.S. assets, and the dollar will crater, causing more derivatives bombs to go off. Update on the Gulf of Mexico … As of this morning, production in the Gulf thats still shut down amounts to over 1.3 million barrels of oil per day, or nearly 90% of the daily oil production. Meanwhile, the shut-down in gas production is over 7 billion cubic feet per day, equal to just over 71% of the daily gas production. Since Katrina hit, the cumulative shut-downs in oil production is over 46 million barrels, 8% of the yearly Gulf production; while the cumulative gas production shut-down is 226 billion cubic feet, over 6% of the yearly gas production. In short, the recovery progress in the Gulf oil and gas production is a lot slower than most analysts expected. Look at it this way: Last years Hurricane Ivan destroyed 7 platforms, 100 pipelines and ZERO rigs. By contrast, Katrina and Rita have destroyed 90 platforms, at least 5 rigs, and a still-unknown number of pipelines. Next week, Im off to Asia with stops planned in Bangkok, Shanghai, Hong Kong, and if time permits, Mumbai. Ill be reporting to you from the front lines. Best wishes for your health and wealth, Larry Edelson About MONEY AND MARKETS MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others. 2005 by Weiss Research, Inc. All rights reserved. |
The NEXT 40% Rise in Oil
I love quick market corrections like the one were seeing right now in oil and oil stocks. 
In late September, the Dow Transports defied my expectations and went up instead of down. 
Result: The U.S. has suffered a rapid deterioration in its net international investment position (NIIP). Specifically, in the past 23 years, our NIIP has deteriorated from a liability of merely 10% of GDP to a liability of almost 25% of GDP. Previous post: Surging Energy and the Big Squeeze
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