Oil & Treasuries, Every Bubble Bursts

by John Dalt

12/29/08   

I have been watching TLT, the 20 year Treasuries ETF, currently trading at $120.75.  It is sitting at all time highs, because the FED is printing money and buying rates down.  It looks like a great short, but betting against the FED is tough.  There will be a time to play this, just not now.  It looks like a classic bubble ready to burst, but bubbles are caused by herd mentality of millions of individual buyers.  One really big buyer, with unlimited deep pockets, is causing this bubble.  Why do I tell you this, because there will come a time when that ‘big buyer’ realizes that if he does not let rates rise he will be the only buyer.  When this happens, the inevitable will occur.  The bubble will burst because rates will have to rise to keep China supporting our credit markets, but when it starts to move buyers will hold back because they know that anything they buy this week will pay even more next week, so they hold back and hold back and finally the dam breaks, the bubble bursts, the market tumbles.  If we are in the right place, we make a lot of money. 

I wrote about the problems of exporting countries dwindling reserves and increasing domestic consumption on Dec 18, you can read my take on Peak Oil.  I was reading an interview with Rick Rule.  Rick is the founder of Global Resource Investment.  Porter Stansberry who runs and investment service I really respect conducted this interview in October 2008.  Let me reprint a small portion of Rick’s comments that address the state of energy and more particularly crude oil in the near future. 

I think the oil price goes not merely go higher, but substantially higher in the five-year term.  What people are missing in particular in the oil market is that most of the world’s export crude isn’t controlled by oil companies.  It’s controlled by national oil companies.  And, it’s extremely important for people to understand this.  These national oil companies, at least to a substantial degree, are not reinvesting enough money in the oil company to maintain their current production, never mind to grow their current production.  That’s very, very, very important.   National oil companies in places like Iran, Venezuela, Mexico, and Indonesia are diverting cash flow from their domestic oil and gas industry to social expenditures.  In fact, some of the diversion is used to lower energy prices.  So they are encouraging domestic demand at the same time that they are reducing future supply. 

What’s important about the four countries I have named is in the three to five year timeframe; those countries will not be exporters.  And currently, they supply about 25% of the world’s export energy.  If you take 25% of the world’s export energy off export markets, with export demand growing at a reduced rate of 1.5% compounded per annum for five years, it is absolutely stupid what can happen to the oil price.  I won’t even venture a guess, but I  don’t believe that if all four of those countries started spending money now to increase production that they could undo the harm that they’ve done by the spending constraints that they’ve imposed on their domestic industry in the last three years. 

He covers the coming export supply shortage better than I did, thanks Rick and Porter.  Think about the way our politicians demonize big oil, they blame them for high prices while making it impossible to find more oil by not opening areas for exploration.  I was looking at the Energy Information Agency statistics and projections.  The U.S. now produces the same amount of crude as in 1947.  While production declined in 2008, they expect production to increase in 2009, for the first time since 1991.  There are three large off shore oil platforms coming on line in 2009.  This is primarily a result of off shore drilling encouraged by high prices.  Present low prices are depressing oil exploration; this does not bode well for the supply when prices begin to rebound. 

Israel took action against Hamas in the Gaza strip this weekend.  This was not one of the actions I saw as an input to higher crude prices.  I thought it more likely that Israel would take out Iran’s nuclear weapons labs before OH! BAMA! came into office, or that an Arab state (Iran) would create a conflict in the Strait of Hormuz to choke of shipping.  Long-term this weekend’s action probably won’t drive oil higher, but it reminds traders that outside forces can effect the market.  We also have Pakistan moving troops to India’s border.  There are plenty of problems in the world.  All with ramifications to the price of oil.

WARNING:    The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future. 

HOME

Back to Top