Monday, March 7, 2011


by Cullen Roche

Despite lopsided balance sheets and near record levels of household debt the Fed appears to have succeeded in convincing American households that it is wise to begin re-leveraging.  The Fed’s latest consumer credit report showed broad improvement in consumer credit trends (via Econoday):
“Consumer credit outstanding in December rose $6.1 billion showing, for the first time in the recovery, gains for both revolving and non-revolving credit. Revolving credit, up $2.3 billion, rose for the first time in 27 months. Non-revolving credit, reflecting strength in vehicle sales, extended its run of strength with a gain of $3.8 billion. Looking ahead to January’s number, there may be some modest help from motor vehicle sales which edged up 0.6 percent for the month but the amount boosting consumer credit will depend in part on the share split of sales to consumers and to businesses.”
As I’ve previously mentioned, this is great news for the near-term economic outlook.  A re-leveraging consumer means  more spending, higher corporate revenues, etc.  My hope was that a 10% deficit would result in consumers continuing to de-leverage, however, that looks like wishful thinking.  Instead, the combination of easy money and no loser capitalism appears to be setting the foundation for another debt binge.  At a level of 115% of debt:income this trend is clearly unsustainable, however, the American public appears intent on sustaining its fiscal imprudence.  In short, enjoy the growth, however, once the deficit shrinks or another asset bubble pops the air is going to come out of the debt bubble once again and the upside down US consumer will again be exposed as the imprudent consumer that he/she is….

See the original article >>

Meat - and oil - to lead climb in US food prices


The US is to follow many crop importing countries in seeing a jump in food prices, as competition for meat – and energy – feeds its way through into consumer's bills.
Food prices may, after "two years of very subdued inflation", rise by 4.2% in 2011, the Food and Agricultural Policy Research Institute (Fapri), a leading agricultural academic body, said.
The growth, from a rate of 0.8% last year, will be lead by costs of meat, as strong demand allows producers to pass through the higher grain costs which are swelling feed bills.
"Since the percentage of corn and many other feed grains consumed directly is small, higher corn prices mostly affect consumers when it comes to buying meat and dairy products," Fapri said in a report to US lawmakers.
Inflation ingredients 
However, the institute also flagged the impact of rising energy bills - swollen as economic revival stokes demand, besides the threat Middle Eastern unrest poses to oil supplies – and of rising wages.
"Commodity costs will take much of the blame for expected higher food prices in 2011 and 2012, but the farm value of food accounts for only about 15-20% of the finished product in the US," Fapri said.
"The largest category of costs associated with final food prices is labour", with energy costs rated "very important" through their role in raising costs throughout the food chain, from farming to processing to distribution.
Many poorer countries have already seen a surge in food prices - which have hit record highs at a global level, according to the United Nations - because of their greater reliance on local, non-processed foodstuffs, exposing their consumers more directly to the jump in agricultural commodity values.
'Profitability outlook bright' 
Among the meat groups, poultry would see the weakest price growth, with consumers expected to pay an extra 5.2% for a broiler this year.
"Just as chicken prices did not suffer as much as other meats due to the economic weakness in 2009, they are not expected to benefit as much from economic recovery as higher-cost beef and pork," Fapri, an offshoot of the University of Missouri, said.
Pork prices are expected to grow most, by 10.7% at the retail level, ahead of beef with 7.3% inflation, although it was cattle farmers that the institute was most optimistic for in profit terms, especially longer term.
"The profitability outlook is bright, beginning in 2012, as economic recovery continues to propel beef demand," Fapri said.
While US beef export, up nearly 1.5bn pounds in five years, are poised to slow, this is only because of the competition for production constrained by a long-term decline in herd numbers.
"In the next few years… domestic consumers will be bidding against those in other countries for limited supplies of US beef."

End of tax perk to tip corn ethanol into decline


Leading academics have called time on growth in the US ethanol industry, forecasting that the sector will contract next season, in a report pegging the country's corn crop lower than official estimates.
The run of uninterrupted growth in consumption of US corn for making ethanol, which has grown from 996m bushels seven years ago to approaching 5m bushels, will end in 2011-12, the Food and Agriculture Policy Research Institute (Fapri) said.
The institute, in a report to the US Congress, forecast corn use by ethanol plants falling to 4.6bn bushels, a decline of 5.5% on its own estimates.
Growth thereafter would be pedestrian, growing by an average of 100m bushels a season to 2020-21, a level "modest compared to recent history".
The outlook is considerably more downbeat, for the short-term, than that of the USDA itself, which last week forecast ethanol use of corn growing next season to 5.0m bushels.
Waning growth 
Fapri's projection assumes an end to US tax credits on biofuels which were, for bioethanol, renewed for this year against significant political opposition, and which hardened this year as the industry was blamed, amid record food prices, for taking acreage away from edible crops.
Broker US Commodities noted two weeks ago that "even the strongest ethanol supporter, Senator [Chuck] Grassley from Iowa, indicated he would vote for a balancing of the [US] budget versus supporting biofuels".
The tax assumption "matches that" used by America's independent Congressional Budget Office, Fapri said.
They also signal weaker returns for ethanol producers, with net operating returns from wet mills, in which water is used to break down corn kernels, by 21% to $0.29 per gallon.
Dry mills - typically smaller operators, which account for a minority of ethanol consumption - will see returns fall by 10% to $0.38 per gallon.
Stocks to rebuild
The forecasts came as Fapri unveiled crop forecasts for the next decade, including estimates for corn of 91.0m acres in sowings, 1.0m acres below USDA estimates.
The harvest will come in at 13.76m bushels, 125m bushels shy of the official forecast, Fapri said, terming the harvest yield "critical to world markets".
"The unexpected drop in US corn yields in 2010 is a major reason for higher world grain prices," Fapri said.
Nonetheless, with ethanol use slowing, the institute forecast ending stocks rising to 1.25bn bushels aty the end of 2010-11, significantly higher the USDA estimate.
Upbeat wheat outlook
The institute estimated soybean sowings at 78.0m acres, in line with the USDA figure.
However, it pegged harvested wheat acres, at 49.6m acres, 2.1m acres above the official forecast, saying "projected net returns to wheat producers remain strong enough to maintain wheat acreage above the 2010 level".
The US wheat harvest this year was estimated at 2.22bn bushels, 140m bushels higher than the USDA estimat

See the original article >>

End Of The Secular Commodities Bull Market?

Exponential global trends in population, consumption and debt, crunching with peak resources, climate change and falling biodiversity. "Unsustainable" sums it up, and hence no shortage of analysts forecasting imminent hyperinflation, currency collapse, one-way commodity prices or total system breakdown. In short, "this time it really is different". But is it, or rather, is it yet?

On current trends we are heading for peak total energy by 2025, significant water scarcity by 2025-2030, debt to GDP levels averaging limits in major nations by 2030-2035, cross-eco system collapses by 2035-40, serious climate change disruptions by 2040-45, and human population at the Earth's carrying capacity by 2045-55.

It may be that we push out these limits through changes in global policy or, more likely, through technological paradigm shifts in the areas of nanotechnology, alternative energy, artifical intelligence, geoengineering and biotechnology. But assuming no avances in these fields (which is improbable, based on exponential technological evolution trends), note that from the above timeline we are not yet at crunch points, just further down the road. So whilst I concur with the unsustainablity, I make the case that we "have room" for another secular stocks bull and secular commodities bear lasting perhaps 15 years, in line with historical swings. Indeed, the secular stocks bull is likely to be defined by technological paradigm shifts from the areas above, which should in turn create more space, time-wise, before commodities roar again.


Below I provide reasoning for why a secular inversion from hard assets to paper is likely to occur within the next 3 years, and that this final phase of the commodities secular bull should provide great returns. It is a time to hold gold, silver, oil and agri until the flags go up. But beware "commmodities to the moon" or "commodities only just getting going" calls., US real estate, and ALL other previous booms turned out both price-capped and time-capped, and I indentify such caps for our current commodities boom below. Timing an exit is critical, as sharp falls will follow.

1. Take a look at the last two secular commodities bull markets. They share a similar chart formation to each other: a launch, a running correction, a massive leg up, a sharp retreat and a final push to a higher high (a close fit with the philosophy of 5 Elliott waves):

Underlying chart source: Steve Saville / Nick Laird

Our current secular commodities bull market began in 1998/2000 and looks familiar: a launch, a running correction, a massive leg up, a sharp retreat and just recently a push to a higher high. Note I am using the CCI index as it is equally weighted and equivalent to the old CRB.


This formation repetition suggests that we are in the final phase and should expect a secular commodities bull end between 2011 and 2014. It's important to note from the historical chart that a new secular commodities bear is likely to be overall sideways at permanently ratcheted up price levels, so don't imagine years of falling commodity prices, but rather stocks being in favour.

2. Ten year rolling returns for stocks and commodities suggest that we are close to a secular inversion any time as of 2010:

Source: Barry Bannister, Stifel Nicholaus

Source: Data from Prof.Schiller via Traders Narrative

3. Relative asset prices paint a picture of gold and oil now relatively expensive compared to stocks and real estate, which also adds weight to the notion of approaching a secular inversion.


Source: Approximity


4. Homing in on the the severe commodities fall of 2008, comparable commodity downlegs from history within similar cycles occured in 1921 and 1949. Following the downleg commodity prices resumed their advance and topped out in 3 years 8 months and 2 years respectively. A similar repetition would give us a secular commodities top between March 2011 and November 2012.

5. Comparing durations of previous secular commodity bulls:
1906-1923 (16 years)
1933-1953 (21 years)
1968-1982 (15 years)
1998 (measured by oil) or 2000 (measured by gold) to the current day: 11-13 years so far.
A similar duration to previous bulls would give us a commodities secular bull end between 2013 and 2020.
However, comparing previous Kondratieff winter cycles (our current K season, in which gold leads assets) an extended Autumn gave rise to a shortened winter, implying our current secular gold bull should end towards to the earlier part of this window.

6. Looking at previous secular commodity bull price peaks:
April 1920
Jan 1951 (30 years and 9 months after the last)
Nov 1980 (29 years and 10 months after the last)
The approximate 30 year cycle between commodity price peaks which would give us a commodities price peak between September 2010 and August 2011.

7. Solar cycles suggest accelerating inflation into 2013 then a recession. This would suggest an up-move in commodities into 2012/13 before either a period of remaining elevated or the secular commodities end.

8. By dollar cycles, and based on the dollar's inverse relationship with commodities, a price peak or secular top in commodities is forecast for mid-2012.


9. Based on historical asset booms and bubbles, including gold's own last secular bull, gold would accelerate to its peak by 2012.

10. Fundamentals: China's breakneck growth and industrialisation is one key driver, underinvestment in commodities supply in the 80s and 90s is another.

Historic comparisons suggests that China is likely to be derailed at some point, before growth resumes. Bubbles and structural imbalances would be common causes, and China shows such signs. Were China to derail, the fundamental story for commodities would significantly weaken.

1. China has large excess raw materials capacity - overproducing cement, steel and more.
2. China has an excess of 3.3 billion square metres of floor space - there are whole cities lying empty or near empty.
3. Property prices are at bubble levels - the average price-to-rent ratio of China's eight key cities is 39.4 times, compared to 22.8 times in America just before its housing crisis. Chinese investment in residential property accounted for 6.1% of GDP in 2010, again a similar level to that in the USA pre-crash. Japan's real estate bubble collapsed at 8% of GDP, but on another measure China is similar to Japan's peak: the value of housing stock is set to exceed 350% of GDP in 2011.
4. China's artificial currency peg to the dollar, to keep exports competitive, is creating an inflation problem.

Since commodity prices took off again in 1998/2000 new supply has gradually been initiated globally, but it typically takes around 10 years for a new mine of field to come on stream. We are now entering the window whereby additional supply is coming to fruition and will increasingly do so over the next several years, which will dampen prices.

Combining China and supply fundamentals we should be alert for a commodities bull peak as of 2011.

Amalgamating all ten references, we can conclude that the secular commodities bull is most likely to peak and then invert in the window 2011-2014.

So it would appear that we are close to an end, in secular terms. But that doesn't mean we should be getting out of commodities - yet. On the contrary, the final stages of a secular bull typically produce great returns, with a parabolic ending move. The key is to hold for this move but sell before the ultimate reversal occurs. And the reversal is typically fast and severe. Following the last secular gold peak in 1980 gold dropped 43% in 2 months.

So let's turn to price targets.

The above "Going Vertical" chart suggests gold needs to just more than double from 2008-9 levels to complete its secular bull, giving us a peak target for gold of around $2000.

Silver is a leveraged gold play, and based on the chart below, the target peak price for silver is around $125.

Source: ECDeGroot

Crude oil has been in significant contango in the last 2 years, meaning the current contract price is significantly lower than future contract prices around 1 year further out. History shows that oil usually does not peak until this is reversed, implying that we need to see the current contract price run up some way until it exceeds contracts around 1 year out by some way. At the time of writing the current price is almost equal to that 11 months out, so we may need to see this advance to around $5 above or more. 


In order to crude oil to achieve that, it needs to break through the 61 Fibonacci retracement (the last Fib) of the 2008 declines, with which it did so on Friday: around $103. Assuming that Fib break holds, it is then normal for an asset to retrace 100%, meaning we have a minimum crude oil peak price target of a double top at $150.

In summary, I believe we will see a commodities price peak and then secular inversion (a new stocks secular bull and commodities secular bear) between 2011 and 2014, with price targets to hold to of around $2000 gold, $125 silver and $150 oil.

Dubai Property Market Crash BubbleOmiX Update 2011

If you drive out on the highway towards Abu Dhabi past the Jebel Ali Free Zone, look on the right and you will see, partly covered in sand, the remnants of the billboards that used to declare, “Where the Vision of Dubai Get’s Built”.

I met a guy who claimed to have come up with that tag-line. He was a young American, very nice and very-very smart, based in New York working for a big-name branding company, with absolutely no clue of what Dubai is/was about. But he was making really good money, and that’s fundamentally what everything is about, in Dubai.

That particular “vision” was going to be bigger than Hong Kong. My conversation with the nice young American was a big factor in what made me decide to “retire” the part of my business that did real estate consulting. 

Up to then I could explain what was happening and if I did a ten-year projection on the revenue stream for a shopping mall or a hotel, I’d have a pretty good chance of being within 20% on Year Ten. Starting 2007 my models broke down. The “crunch” came when I gave my “”opinion of value” to an investor on a “fantastic-once-in-a-lifetime” plot of land that was being offered at a very special price that only someone “really connected” could get, of $200 a square ft of GFA. 

I told him that was a stupid price and he should not buy; three months later he called me in a huff to complain that the land had been flipped at $300. I said “OK but you were going to develop (a four-to-five year commitment), not flip; and anyway I don’t do gambling”. That didn’t go down well and we haven’t spoken since; although I did notice his Ferrari in the long-term parking at the airport a while back, covered in dust.
Anyway, the “vision” that I’d been working with until then was the one that Sheikh Rashid told to my mate Eric Tulloch (sadly departed) in 1978.

 “I will build the infrastructure and the rest will follow”.
At some point in all the excitement, that vision got changed to:
“We will build the rest and the infrastructure will follow”.

Back then I knew nothing about bubbles but I was fascinated with Dubai and how and why the economy had more than doubled in size from 1990 to 2000, and then more than doubled again from 2000 to 2005. In 1990 Dubai was 15% the size of Singapore; in 2005 it was half its size and Singapore is no slouch when it comes to allowing free-market economics to rip, like when you start main-lining Adam Smith mixed with Speed.
Then there was the bubble, then there was the bust, and here we are.

What Next?

This is a chart that I put up in July 2009 which was when I think I finally figured out how bubbles work. I’ve updated it to my estimate of where prices are now (the Orange dot).

That orange dot is about 10% below where I predicted, I think the reason for that is I had not anticipated how much the bust would affect economic activity and also I under-estimated how much pipeline inventory there was. Although in my defence by that time I’d found other jobs for my researchers so I was eyeballing.
What caused the bubble in property in Dubai was pretty simple, (although I admit it took me about a year to “twig” what had been going on).

Up to early 2007 the price of housing (rentals and owned) had tracked the ratio of economic activity divided by the numbers of housing units, just like it does everywhere in the world. Sure interest rates are important but local interest rates hardly changed over that period. 

But there was a lot of growth in the economy, on top of that was the start of property that foreigners could own, called “freehold”, which created a bit of a feedback loop as more and more people got involved in property, and they all needed a place to live, so more and more people got involved in property, round and round.

Then people piled in from far-and-wide with money in their pockets so then there was a shortage of new places to live, and so prices got bid up, for anything that was available. That resulted in a huge discrepancy between rents/prices for new units and what tenants in the older units paid in rent (there was no market for sale in that sector since foreigners could only buy freehold), so prices of the new stuff almost doubled. Everyone was looking at the “new” prices, which reflected only a sub-section of the market, rather than the market as a whole.

The red line “Other than Market Value”, is where (in my opinion) prices ought to have gone if the market had been “efficient”, and would probably reflect the whole market of rental (practically everyone rents in Dubai), if the “older” units were included. But there are no statistics on that; in fact there are hardly any statistics on Dubai, and those that there are, are one-year to eighteen months late, which is pretty useless in a place that’s changing that fast. 

In my opinion, the lack of meaningful statistics was one reason there was a bubble, which was a classical example of “asymmetry of information”, people would look at the newspapers, they could see that an apartment could rent for say $25,000, and that the nominal yield was say 5%, so it made sense to pay $500,000.

But the “assumption” they made was that the price they could rent-out a new unit for today was a reflection of what the whole of Dubai was paying, on average. And as we all know, “Assumption is the Mother of all Frappuccinos”. 

Then, the big-name branded real estate consulting companies who didn’t have any more of a clue of how Dubai worked, than the nice American branding expert; piled into town, and they got paid big bucks “facilitating” the new-boys-in-town bankers like RBS and Deutsche Bank to lend $100 billion to developers based on “sure-fire” RICS valuations; plus a total misunderstanding about how the constitution of the UAE works, as in “sorry sweetheart, Uncle Abu Dhabi is not your fairy godmother”.

But that was good money if you could get it, and if you had the ethics of a sewer-rat and if you didn’t mind your customers leaving their Ferraris at the airport. 

Anyway just as the new-kids-in-town declared that 2009 was going to be an “even better year than 2008”, the penny dropped. Or more precisely the demand for the sub-market of hugely over-priced property started to get satisfied by new inventory, and then there was the “pop”.

The pop was helped along by a decision to make it more difficult for people from non OEDC countries to get visas, which was a factor feeding the market. But “visas” were not the cause of the bubble; up to 2006/7 the market had been driven by “fundamentals”, which included people who live behind the barbed-wire fence that separates the rich nations from the threat of influx from poor nations.

There’s nothing wrong with that; Dubai works, first because it has modern infrastructure including reasonably good standards of the rule of law (at least compared to its neighbours, and sure the courts are not Dubai’s strong-point), it is safe, and outside of the “vision” thing, there an absence of petty corruption that is endemic in the “Third World”. Second it’s open; anyone who has money can come to Dubai and set up a business (that often does not do any business in Dubai). 

As in the line from Confucius on how to get a city to prosper, “Make the local people happy, and attract foreigners from afar”, which is something China has been very successful at doing.

Dubai was then, and still is, the best place to base a business for 2,000 miles in any direction; and now that property prices have come down from where they were when everyone was having “visions”, it’s even better.

The black dotted line that dips down to 150 was the prediction that I made in July 2009 about where the bottom would be, although you would have had to be pretty quick to catch it, and it was pretty “theoretical” because there were practically no transactions. 

The thing about Dubai is that there isn’t a proper law on foreclosure so when you take a loan, you just write a hundred post-dated cheques, and if the cheque bounces, you go to jail, or you run away before your name is posted on the computer at the airport.  Foreclosure takes a lot longer, so the market didn’t exactly “clear”, it just stopped.

But I know of some transactions that followed that path; a friend of mine wanted to buy on the Palm in early 2009, and he asked for some free advice. I said “if you want to live there” (I couldn’t imagine why anyone would want to live on the banks of an algae-filled canal), “then now is the time”. He was offered a “standard” villa for $1.75 million; I said “grab it”. 

But my friend is real-smart which he says explains why he has much more money than me. My theory by the way is that’s more to do with my deep vein of human kindness, as in giving free advice to people who can afford to pay, and if they did pay they might be more inclined to take it. Anyway he told me, “I Never Accept the First Offer”.

So he messed around looking for a better deal, and what he did was typical Dubai; instead of trusting the agent he was using, he went to see ten other agents. And every one of them found the same property, and they all told the owner they had a “cash buyer” in their pocket. So he figured that with ten “cash buyers” in the market he was going figure a way around whatever it was that was forcing him to sell at that juncture, and he put the price up, so my mate was gazumped by himself (as in “shoot yourself in the foot”). Nowadays you won’t find a unit like that for less than $2.3 million, which pretty much fits the curve.

Right now (in my opinion) the price of property in Dubai more or less reflects the fundamental of supply and demand.

Prices are down on pre-bubble (say January 2007) because there has been a lot of new inventory (and there is more to come), and also the amount of economic activity has gone down (a bit) in nominal terms since then (my opinion also).

That explains why a temporary 40% over-pricing ended up in a fairly short-lived 60% decline; that subsequently bounced (a bit).

Where Next?

No one with any brains is building new property in Dubai at the moment; unless they managed to get some really cheap land (construction costs are rock-bottom), but most good land is tied up in litigation and has a half finished building on it; all that’s happening now is that some of the half-competed units are slowly getting finished. 

One of the things about Dubai was that many developers (not the ones I advised mind), forced contractors to take risk and signed lump-sum contracts rather than taking the risk of price changes in steel,  concrete and MEP during construction themselves; now those owners are crying.

What will drive the future now, is the rate of growth of the Dubai economy.

Of course, no one really knows what the size of the Dubai economy is, since there is not really any tax and so there is no direct way of measuring it. And the valiant efforts to estimate the size of the economy (typically done by benchmarking some not particularly reliable proxies), are a year to eighteen months late.
But you can build pretty good models if you know your proxies; here are some that I use: 

That data is all “public-domain”, as in you can look it up on the net or in the Dubai Chamber of Commerce Library. Of course if you know your way around and you pay a bit extra, you can get it in “real time”, but then that’s not “Official”, and if something is not official in Dubai then it’s a rumour; although in some cases even if it’s “official”, it’s a rumour too. I hope that’s clear!

Anyway, sticking with the “public” stuff; my comments are as follows:

1: Net Airport Arrivals: That’s the numbers who came into Dubai Airport less numbers who left and it’s a pretty nifty way to get to population. Although not all of the people passing through the airport live in Dubai, and Abu Dhabi Airport is catching market share, but for the first time in many years, in 2009 more people left Dubai Airport than flew into Dubai Airport.

Notice how it’s gone down quite dramatically, like 17%; the last time that happened was in 1998 when they had a purge on the “illegal” immigrants (people who had over-stayed their visas). Those all came back the next year, but the ones who left Dubai in 2009 and 2010 probably won’t come back, unless they want to subscribe to Dubai’s unique guaranteed sure-fire weight-loss program, as in debtor’s jail.

2: Occupied housing units are from DEWA; anyone who does not have an electricity connection in Dubai is “not economically active”; so that’s a good benchmark. Interestingly those were still going up in 2009, probably reflecting migration of people with jobs in Dubai from next-door Sharjah.

3: Light passenger vehicle registrations are a reflection of how much money is being spent (new-car sales). Although there is a complication there because many cars are re-exported from Dubai which affects the ratio of new-buys, and to get to the bottom of that you have to look closely at that which is really tedious; big picture, that flat-lined in 2009; reflecting a drop in economic activity (the amount of money being spent).
4: City Deluxe Hotel Lodging Revenues used to be one of my favourite proxies (goes to business travellers who relate to the way Dubai’s economy works), but when occupancies go over 90% annually there is price elasticity; plus I suspect the property bubble migrated into that market, people who think they are rich when in reality they are not, spend big on luxuries like first-class hotels.

5: GDP is a bit of a mystery, up to 2006 that was published promptly (i.e. never more than nine months late) by the highly efficient and very professional, Dubai Municipality. Then that job was transferred to the newly formed Dubai Statistics Centre, which only recently published the outcome of it’s deliberations for 2006, 2007 and 2008, so now it’s running two years late.  

What’s interesting is that the numbers put out by Dubai Municipality (before) used to be posted on their website, but now they are not there any more; as if they have been “expunged”. That’s quite a mystery; a possible explanation is that the people putting the new numbers out were at the time, very much into the “new” vision of Dubai that you can see on the road just past Jebel Ali. Plus of course when you are having a conversation with the guys you owe $100 billion to, $90 billion GDP has a better ring to it than $60 billion.

The Future

The ultimate driver of economic activity in Dubai is the price of oil and the price of oil has gone up and is going to go on going up.

Dubai hardly has any oil; revenues are about $2 billion a year out of $91 billion GDP claimed “officially” in 2008; but it services a region that is full of oil; which is why it works.

Now that the “visionaries” have run out of foolish bankers to lend them money so they can create housing bubbles and clog up the roads with their Ferraris, the rest of Dubai can get back to what it did before, with the bonus of a great infrastructure, a pretty decent government (particularly after the re-shuffle), and very cheap property prices relative to anywhere within 2,000 miles (for the same quality).

Insofar as property is concerned, as I said, prices are on the “fundamental” now; they may go down a bit as the last of the developments get finished which will drive the fundamental down (that could take another one or two years, realistically). After that, prices will start to rise, albeit quite slowly.

After so much “vision”, it’s nice to get back to reality.

Is QE2 an Unmitigated Disaster?

There was a debate recently between Rick Santelli of CNBC and James Bullard, President of the Federal Reserve Bank of St. Louis regarding the inflation effects of the QE2 initiative. 

Bullard, the economist, cited the core inflation rate, and even the headline inflation rate as illustrative of a lack of serious inflation pressures in the US economy. Santelli, on the other hand, talked the trader's perspective of inflation wanting to use the CRB Index (Fig. 1) as a true indication of inflation effects since QE2 was brought up at Bernanke’s Jackson Hole Speech in August 2010.

So let us compare two scenarios and ask ourselves would the US economy be doing better without the QE2 initiative?

Pre-QE2 Prices:

  1. 2.50-2.70% 10-Year Treasury Yield  
  2. $2.64 US Gasoline Price (August 2010)  
  3. Cotton Prices at $85 (Contract Size 50,000 pounds)   
  4. S&P 500 Index 1100   
  5. Copper Prices $3.25 a pound  
  6. US Dollar Index at 83.00  
  7. Lumber Prices at $200 (Futures Contract –Contract Size 110,000 board feet)  
  8. Sugar Prices at $17.50 (Futures Contract-Contract Size 112,000 Sugar #11)  
  9. Cattle Prices at $92 (Futures Contract-Contract Size 40,000 pounds)   
  10. Milk Prices at $14 (Futures Contract-Contract Size 200,000 pounds Class III)
QE2 Effects So Far:
  1. 3.50% 10-Year Treasury Yield  
  2. $3.50 US Gasoline Price  
  3. Cotton Prices at $215 (Futures Contract -50,000 pounds)  
  4. S&P 500 Index 1320  
  5. Copper Prices $4.50 a pound  
  6. US Dollar Index at 76.40  
  7. Lumber Prices at $303 (Futures Contract)  
  8. Sugar Prices at $30 (Futures Contract)  
  9. Cattle Prices at $114 (Futures Contract)  
  10. Milk Prices at $19.50 (Futures Contract)
About That Unemployment Rate...

This just gives a snapshot of some of the inflationary effects for the US consumer.  I cannot think of any argument where higher interest rates resulted from QE2 are good for the housing sector, which is the most troubled part the US economy.

Nevertheless, I must add that the unemployment rate is better, and we have created more jobs since QE2 but with a highly fluctuating job pool where workers give up looking and leave the labor market it is hard to gauge the real unemployment numbers.

Plus how much of the job creation is due to other factors like more business friendly policies from the Obama administration, a Republican Landslide in the Midterm Election, and the extension of the Bush Tax Cuts and a reduction in the payroll taxes for businesses?

Equity Gains Don’t Mean Much

The S&P 500 is 230 points higher which can be argued is good for the “wealth effect” but stocks usually have a year-end rally so some of these gains probably would have occurred even without QE2.

Clear Present Danger – Inflation
There are some substantial price increases in a lot of these inflationary metrics for both businesses and the US consumer, not to mention the reduced purchasing power of a much lower US dollar (Fig. 2).

More importantly, inflation data utilized by the core and headline rates are behind the curve of futures prices by anywhere from 3-6 months so the true inflation pass through effects of these higher input prices at the futures level have yet to be realized in the Fed`s measures of inflation data.

For example, gasoline prices at the pump probably lag the futures prices established by the RBOB contract by 20-30 cents. Likewise, the full effects of higher cotton prices will take much longer to work their way through the supply chain to consumers at the retail level for clothes they purchase. It may take another six months for the damage that has already occurred at the futures level to be fully experienced by consumers of cotton products, which would lead to an underestimate of the current inflationary effects in the economy.

Biflation at Work

It should be noted that parts of the economic data are deflationary in nature like housing and wages, which serve to artificially keep the inflation numbers utilized by the fed down--the biflation phenomenon--I previously discussed

And if you add in the 6 month lag factor for inflation effects to pass through to the data, a completely different inflation story starts to emerge.

Wanted – Lower Inflation & Interest Rate

However, this still misses the important barometer for analyzing QE2 which should be the following question: “Which scenario is better off for the US economy?” and not any argument of what the current inflation level is in the economy.

This assumes that some inflation is better than no inflation, and I would argue that being able to finance a home mortgage at 100 bps lower, and a dollar per gallon cheaper gasoline is better for businesses and consumers, and that this scenario is far better for fostering sustainable economic growth than the current scenario of QE2 and its effects.

Really Better Off with QE2?

So the question for Bullard misses the mark if one argues with him what the current or even future inflation effects are for the economy due to QE2. The real question for Bullard is would the US economy be performing that much better without QE2? If you add up all the pros and cons of QE2, guess which scenario would 9 out of 10 independent economists pick for an environment that fosters economic growth?

It seems regardless of what the inflation data says is the overall inflation rate in the economy, QE2 gave us all the negative, anti-growth, lowered standard of living type of inflationary effects that act as a major tax and headwind for both businesses and consumers going forward, and very little of the much needed “Record GDP Growth” and “Eye-Popping Job Creation” bang for our costly buck.

Right Back Where We Started

It seems we pretty much could have gotten this same level of current GDP growth and job creation without massively devaluing the dollar in the process. Sometimes a little patience goes a long way, and if the fed would have waited until the November elections where both the business climate and economic data were improving all on their own we could have had the best of both worlds with a low inflationary price stable environment, and a slow but steadily improving employment situation.

The real fear and irony is that once the full effects of QE2 are realized in the US economy, that we start reacting to said inflationary effects both through tightening monetary policy and consumer/business behavioral changes, and the US starts giving back some of its recent economic gains, and becomes vulnerable to the very scenario that the fed was trying to avert in the first place--a double dip, deflationary downturn--in the economy.

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Hyperinflationary Deluge Is Imminent

Tyler Durden writes: A deluge of an unprecedented magnitude is both inevitable and imminent. The consequences of the economic and political mismanagement will have a devastating impact on the world for a very long time. And the consequences will touch most corners of the world in so many different areas; economic, financial, social, political and geopolitical. The adjustment that the world will undergo in the next decade or longer, will be of such colossal magnitude that life will be very different for coming generations compared to the current social, financial and moral decadence. But history always gives us lessons and the one that is coming will be necessary and eventually good for the world. But the transition and adjustment will be extremely traumatic for most of us.

We have reached a degree of decadence that in many aspects equals what happened in the Roman Empire before its fall. The family is no longer the kernel of society. More than 50% of children in the Western world grow up in a one parent home, either being born by a single mother or with divorced parents. Children are neither taught ethical or moral values nor discipline. Many children consider attending school as optional and education standards are declining precipitously. Most families do not have a meal around the dinner table even once a week. Sex and violence are common place on television and in real life. Both press and television create totally false values and ideals. Everyone must be young and beautiful often enhanced by surgical or digital means. Old people have little value and their wisdom is not benefitting the younger generations.

The Golden Calf or materialism is the ultimate value that is worshipped and no means are eschewed to attain material goals. Since most of the prosperity that has been achieved in the last 40 years is based on printed money and debt, it is totally false and unsustainable. A major part of the Western world has improved their living standard, by exchanging services and swapping houses at ever rising prices financed by printed paper and credit. The perceived wealth that is created out of this is illusory and ephemeral. We have created a world economy which is based on debt and thin air.

Most countries are already running major deficits which will increase dramatically in the next few years. The banking system is bankrupt and is only holding together due to false valuations of toxic debt and derivatives. This is done with the blessing of governments since virtually no major bank could face an honest valuation of its assets. Unemployment and especially youth unemployment is currently a problem worldwide and it will get much worse. In 2010, the US government spent 60% more than its revenues. In order to balance the budget individual and corporate income taxes would have to double.

Never before in history has the world run out of real money as well as (affordable) food and fuel simultaneously. But his is exactly what is happening now and it will get substantially worse in the next few months and years.

Financial misery, famine and high unemployment combined with governments that will not be in a position to give real help are a recipe for disaster that will lead to social unrest and revolutions not only in developing countries but also in the West. Hungry people are desperate people and desperate people do desperate deeds. We could see already in 2011 food shortages, and riots both in Europe and in the US.

Finally we are again quoting von Mises who clearly understood that “le déluge” is inevitable:

“There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises

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By Guest Author

As the markets tremble at the massive changes now sweeping the energy-rich Arab world, once again we are reminded that the supply of energy is not something to be taken for granted. Clearly, a continued march upward of oil prices above $100 per barrel threatens an already tepid US economic recovery.

The US (and the rest of the world) needs an energy policy. But what should it be? In my opinion as a free market economist, current policies are a disaster. Note I do not pretend to be an energy expert. But basic economic principles underlie all economic activity.

Allow me to make some basic points:

1. Energy independence, a.k.a., energy autarky, is an impossible and undesirable dream. Every American President since Richard Nixon has loudly proclaimed that America should become “energy independent.”  However appealing this may be to the American public, energy independence hasn’t happened. For example, US petroleum imports increased steadily from 1981, slowed down only by the Great Recession beginning in 2007. Over the same period, US petroleum production has been slowly declining.

For an economist, independence and autarky amount to the same thing. Autarky means total self-sufficiency and it carries a pejorative connotation in economic texts. Since the days of Adam Smith and David Ricardo economists have held that free trade results in a higher standard of living and superior allocation of resources as opposed to autarchy.

Barring some miraculous discovery of new energy sources, total energy costs would rise dramatically if America (and most other nations) substituted much higher cost domestic sources of energy for imports to achieve energy independence.  Our ever higher standard of living and human progress in general has been driven by cheap and available energy. Dramatically increase the cost and reduce the availability of energy and the American and world economy fall into a serious recession.

2. A major objective of US (and all importing nations) foreign policy should be to secure reliable energy supplies. Is this an imperialist notion? Maybe. But I would argue that securing reliable energy supplies ought to be one of the major objectives of European, Chinese, Japanese or Indian foreign policies. All these areas are major petroleum importers. Sudden moves up to and beyond one hundred fifty dollars plus per barrel of oil will take no prisoners – they will kill all the world’s major and minor economies.

Petroleum is not a perfectly homogeneous commodity. For example, Italian refineries need high quality “sweet” Libyan oil vs. “sour” Saudi oil. But that said petroleum is homogeneous enough and its supply basically goes into one interchangeable  global pool.  And China, America, India, Europe, Japan all have the same overriding need for access to this pool.

The proponents of non-traditional alternative energy sources argue that the prices of oil and its byproduct gasoline are understated because among other things they do not include the price of supporting a global military presence to ensure the reliability of the oil. There is some truth in this for the US although the entire cost of the US military cannot be ascribed to oil security. It is less true for other countries which from the viewpoint of global oil security “underinvest” in military and “free ride” off the US. (Of course until recently when its fiscal situation began to reach the precarious state, the US may have preferred this state of affairs, especially in the case of China.)

I would argue that the US should at least get its money’s worth on its military expenditures. The US might start by trying to know what it is doing. Looked at this way, the invasions of Iraq and Afghanistan under the Bush Administration were serious errors. US military resources have been tragically squandered in this effort which in retrospect could be considered an overreaction to 9/11.  Afghanistan has no oil. It is highly debatable whether the US invasion of Iraq helped make Iraq and the Persian Gulf more or less secure as a source of oil for the global pool.  Saddam Hussein, while clearly not one of history’s “good guys”, was a secular Sunni ruling over a nation that is over 50 percent Shi’ite. Iran is Shi’ite. Saddam’s secular Sunni Iraq was counter balance for Iran. Today’s Shi’ite controlled Iraq will not be a counter balance for Iran. Iran now has much more flexibility in any attempt to undermine US influence in the Shi’ite minority kingdoms of the Persian Gulf (Bahrain, the home of the US Fifth Fleet, has a Sunni King but a Shi’ite majority). The Persian Gulf is where the oil is.

The US has drained its military, thereby throwing down its stick as in the Chinese proverb above. Now for the US apparently even organizing a no-fly zone over Libya is a military challenge akin to climbing Mt. Everest. And Somali pirates? Why are they getting away with kidnapping oil tankers? The dogs are bullying the US.

The revolutions sweeping the Arab world are the equivalent of the revolutions that swept Europe in 1848. They are major events that will change the structure of the Arab world for the next generation. Perhaps if the US had left Saddam Hussein in place, he’d be tossed out today anyway and things would be worse. Perhaps the US should only watch. But if the oil kingdoms of the Persian Gulf are allowed to fall and oil prices rocket upward, the entire world could be sent into recession or worse. Now is the time for the US to be prepared to act decisively and exercise leadership. It will have to act in concert with the other major nations of the world who have the same foreign policy objective of secure oil as the US. Given its fiscal weakness, the US will have to combine diplomacy with its diminished but still considerable military muscle.

3. The free market—not the government – should be making the choice among various energy sources. The market has every incentive to find new and least cost energy alternatives. The markets are constantly experimenting.  New ideas are tried and discarded if viewed as failures. At the dawn of the twentieth century, the gasoline powered car competed with the electric and steam powered cars. Thomas Edison put his time and money on the electric car.  Henry Ford and his gasoline car won. Without subsidies.

It is not so with government programs. Take ethanol. There is now virtual unanimous agreement that corn-based ethanol is a failure on economic and ecological grounds. Corn-based ethanol is dependent on massive government subsidies and has driven up the price of corn in a world worried about food inflation.  Is it too much of a stretch to argue that food riots in Tunisia are linked to the American ethanol program? In any case ethanol goes on. Government programs always acquire their own rent- seeking vested interests who try to perpetuate these programs no matter what. Bankrupcy – the great Darwinian grim reaper in the private sector – does not exist in the ideologically driven, vested interest-supported world of government boondoggles.

The Obama Adminstration’s policy seems to be one of discouraging domestic production of proven sources of energy like oil, natural gas, coal and nuclear and offering massive subsidies to less efficient so-called “green” energy alternatives like wind, solar, ethanol and other biomass alternatives.  As far as I can tell, ideology – not economics or physics – is driving this policy. Authors whose conclusions are based on economics and physics seem to conclude that these green alternatives are inferior with regard to energy density, power density, cost and scale. I would cite Robert Bryce, Peter Huber, George Gilder and Vaclav Smil in this regard. George Gilder by the way has been outspoken in his condemnation of the US venture capital community which has enthusiastically bought into the green energy/government subsidy program.
The socialist British Labour government in 1945 assumed control of the “commanding heights” of the economy, only to nationalize what turned out to be the industries that were most important in the past and ignoring the new industries of the future. Only in the 1980s were Mrs Thatcher and her privatization programs able to rid the UK government of these government run albatrosses that held down British economic growth for the entire post war period. The Obama Administration has tried to seize from the markets the commanding heights of US energy policy. Will the US in the years to come be stuck with the various alternative energy boondoggles?

A counter argument may be made that China and many other countries are throwing massive subsidies at green energy. I wrote in a recent The Dismal Optimist how China’s state directed investment system is misallocating resources. My answer: the US does not have to emulate China’s mistakes.

4.  Domestic conventional sources of energy offer great promise. There is no question that domestically produced energy is more secure than that derived from foreign sources. To acknowledge the undesirability of energy autarchy does not imply opposition to the development of non-subsidized domestic energy sources.  And the US has plenty of untapped sources that need rational regulations, not subsidies. Offshore deepwater drilling and opening up Alaska could dramatically increase US petroleum production.  The US has abundant supplies of coal. And nuclear – which has been hindered by  government regulations and irrational  public fears since the Three Mile Island incident in 1979(where nobody died and the containment system worked perfectly)—is ready for further expansion as new technology has rendered nuclear safer and more efficient. The irrational response to Three Mile Island by the way has led to a greater reliance on coal which of course is a major carbon emitter as opposed to nuclear which does not emit carbon.

In fact the private sector and technology have produced a “near-miracle” in energy production. I refer to natural gas. For many years natural gas was in short supply thanks to price controls which were only finally lifted in the first Bush Administration . (Government price controls on natural gas – another dumb government action forcing a greater reliance on coal.) Today new horizontal drilling and fracking technology are producing a quantum increase in the supply of domestically produced natural gas and a decline in its price. This has occurred not only in the US but in other areas such as Western Europe as well. STRATFOR chief George Friedman has forecast that the Russian natural gas stranglehold on Western Europe will be broken because of the new supplies of natural gas being brought forward in Western Europe by the new technology. None of this has happened with major government subsidies. It has happened in spite of governments’ attitudes.

5. So called-green energy alternatives are not necessarily easier on the environment. The public and the politicians somehow have this naïve attitude that alternative energy sources like sun, wind and biomass are “free” and involve no damage to the environment. Wrong. The damage list is a long one.

For example, wind and solar for are intermittent sources of energy. Both require substantial investments in conventional energy facilities (including carbon emitting coal facilities of course) which must be inefficiently turned on and off when “the wind don’t blow and the sun don’t shine.” Moreover both wind and solar facilities have to be located way out in the boondocks and require massive investments in environmentally dubious power transmission lines. They take up enormous swaths of land. Wind turbines are major birdkillers and make a low grade humming noise that drive their unfortunate human neighbors batty. No wonder the usually well heeled and typically liberal NIMBY (Not In My Backyard) crowd is against wind turbines being built near them.

One particularly sad example of green power gone bad is Indonesia. This story is best told by quoting directly from Robert Bryce’s Power, the Myths of “Green” Energy and the Real Fuels of the Future:

In Indonesia “the misguided quest to produce more biofuels has led to rapid deforestation. Since 1996, some 9.4 million acres of Indonesian forest have been destroyed to make way for palm oil plantations. And much of that palm oil was aimed at producing biodiesel for export for the European market. The lowland tropical forests in Sumatra and Borneo have been decimated by the quest for palm oil…as the forests have declined, so, too, have the numbers of rare endemic species such as tigers and orangutans.”(p175)

The fact is that all energy sources involved some type of environmental risk. But, intuitively difficult as this may be to grasp for some, more efficient conventional sources of energy and power may do less environmental damage than inefficient green alternatives.

6. Don’t worry about peak oil. Peak oil, according to Wikipedia, is “the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline.” Actually this definition has been tweaked to give it a geopolitical twist whereby the maximum rate of global extraction is partly a function of the fact that new petroleum reserves tend to reside in politically hostile and/or unstable countries. The peak oil concept derives from the work of M. King Hubbert who first put forth the concept in the 1950s.

Among experts there’s substantial controversy over how accurate this model is.  No matter. Reportedly there are “peak oil groupies” who spend their days worrying about the world running out of petroleum. Peak oil has become one more excuse for massive government subsidies for alternative green energy projects.

I’m not qualified to pass on the technical aspects of this except to say that in the past somehow technology and new discoveries have always shifted this peak outwards towards the future. As an economist, I’m not surprised. I remain convinced that, absent irrational constraints, a functioning free market in energy unencumbered by irrational constraints will solve any problem of petroleum supply constraints. Solutions include shifting to other economically viable energy sources. We’ve seen how technology has suddenly dramatically increased the supply of natural gas. We would see this with nuclear if rational regulations prevailed. And there is plenty of coal. The universe is filled with energy. We’re not going to run out. Higher prices for oil are a price signal for further oil exploration and technology improvements in petroleum extraction and for other energy sources. The decline in oil production in the United States is as much a function of political rather than geological constraints.

7. Increasing energy efficiency results in the use of more energy. This counter-intuitive notion was first advanced by British economist Stanley Jevons, one of the founders of neoclassical economics. In 1866 Jevons wrote:

“It is wholly a confusion of ideas to suppose that the economical use of fuel is equivalent to a diminished consumption. The very contrary is the truth.”

This idea is called the Jevons Paradox. Basically this is saying that efficiency makes energy is cheaper and when something is cheaper we use more of it.  Our economy and our prosperity depend on energy. More energy yields more prosperity, more energy efficiency yields cheaper energy, cheaper energy yields more demand for energy.

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The case for palladium


When it comes to precious metals, palladium may give investors more bang for their buck than its flashier cousins.

The often-forgotten white metal is expected to outstrip gains of both gold and silver again this year, thanks to concerns over supply disruptions and surging car sales in fast-growing Asian countries.

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