January 11, 2007 – The sharp decline in energy prices in 2007 and the decline in gold has a lot of people running for the hills, including many hedge fund managers who don’t want to become the next Brian Hunter of Amaranth. I’ve stated this before and I’ll state it again. Precious metal ETFs and commodity futures are great for hedge fund managers but terrible for the average investor because hedge fund managers, for the most part, only care about trends and profits in their own wallet (but who doesn’t, right?). But by being able to buy and sell precious metals via ETFs, ETFs have increased volatility in these markets exponentially.
Why? Before, if a fund manager wanted to purchase gold, he or she really had to know what they were doing. All gold stocks are not created equal, and even among the majors, during bull markets, the returns have differed by as much as 200% – 300%. You won’t see a difference of 200% – 300% in returns between British Petroleum and Exxon stock over a period of five years but this type of difference has appeared between major gold stocks. So if a hedge fund manager wanted to buy gold, his or her options would be to truly learn to understand gold markets and buy gold stocks, buy gold coins (still requires a certain level of understanding) or buy physical gold bars ( a hassle, not to mention expensive storage fees).
With the introduction of gold and silver ETFs, hedge fund managers don’t have to understand precious metal markets at all anymore. Instead, ETFs allow hedge fund managers to just play trends, and since precious metals have always been volatile markets with very steep and rapid rises as well as corrections, after hedge fund managers saw what happened to the Amaranth hedge fund managed by Brian Hunter, at the first sign of weakness, they skittishly dump all their positions. Thus, having a bunch of fund managers that don’t understand anything and play trends subjects us, as individual investors, to much more volatility in these markets than we deserve.
If you don’t believe that the actions of hedge fund managers can unduly influence precious metals markets, the aforementioned Brian Hunter of Amaranth hedge fund lost somewhere in the range of $5-6,000,000,000 in just several weeks making huge, speculative bets in the energy markets that were wrong (and yes the amount of zeros are correct). Obviously hedge fund managers are dumping huge amounts of money in speculative bets that influence the prices of various commodities. It was alleged that Mr. Hunter had to hire bodyguards after losing all this money for investors, and no other hedge fund manager wants to have to hire bodyguards for fear of physical harm or worse inflicted upon him or her. So that explains the current skittishness as well.
In any event, for this latest correction in gold, I see about $604 as a possible bottom in gold prices, but if it breaks through this point, we may even see gold test $580 again before starting a historic run higher. In any event, since gold recently hit $609, which is pretty close to my $604 call, if it keeps rising higher, this might be it for the bottom. On the other hand, if it continues retreating then I would look to the $604 mark as key to see if it stays above this or breaks down below it.
If you check out my previous blog about dollar behavior and the next blog entry next week that will follow about gold behavior, you will see charts that illustrate exactly at what points last year I predicted down legs and up legs in these two asset classes and how each time, my predictions preceded such actions with strong accuracy. Again, it is using the long tail of investment analysis that enables me to do this, but soon enough, I will no longer be blogging about where gold and the dollar are heading. It’s quite easy to learn how to do this yourself, so I recommend that if you wish to make a lot of money over the next several years, that you take the time to learn some long tail investment strategies and analysis techniques. It will be well worth your investment.
But back to energy. As I’ve blogged previously, it’s much better to become a master of a few assets rather than a generalist in many. As a generalist you’ll never build wealth, but as a specialist you will. I want to clarify here that I haven’t applied my proprietary long tail investment analysis techniques to the energy sector, and oil and natural gas are not one of the asset classes where I’ve chosen to become an expert, so consider my ramblings here on energy more of my opinion than any analysis I’ve conducted through my proprietary long tail investment analysis techniques.
Although record warm winter temperatures all over North America and in parts of Europe have undoubtedly contributed to downward pressure on crude oil and natural gas futures, I’m not buying at all that this is solely responsible to the downward pressure as all mass media is reporting. The buildup in natural gas and crude oil reserves have changed significantly in the past without the impetus of abnormal weather temperatures and are also open to manipulation by the cartels and governments that control them. Just as the media always simplifies the dollar- gold relationship as the dollar goes down and gold goes higher, they simplify all economic relationships to black and white all the time. This is what people understand and this is what sells, even when it is far from the truth. There will come a time when the U.S. Fed raises interest rates, and gold will still continue to rise. It’s happened before for periods of time and it will happen again.
If you look at the greatest downward pressure being exerted on the energy markets, it is originating out of North America. We all know by now that inflation is multiples higher than what the U.S government reports it to be. They have two indexes they use, a core Consumer Price Index (CPI) that excludes the price of food and energy and a CPU index that includes the cost of energy. Whichever one happens to be lower is the one they use, while at the same time overweighting the cheapest components of the index and underweighting the most expensive. And even despite the lies and deception of the government, people can’t consistently be fooled by deceptive reports. You can’t keep telling people that inflation is under control at 2% to 3% if every time Joe & Jane Public looks in his wallet, he or she increasingly finds less money there every month. Eventually Joe and Jane Public are going to realize that it’s impossible for inflation to be under control if every month, they are able to save less and less money buying the same basket of goods. They’ll realize something is amiss.
U.S. Secretary of Treasury Hank Paulson and U.S. Federal Reserve Chairman have repeatedly asked the Chinese government to allow the Chinese Yuan to strengthen. If Chinese goods become more expensive relative to American goods, this helps the U.S. economy. However, the Chinese government has not bowed to strong U.S. pressure, even in the face of threatened protective tariffs, stating that they will not allow other countries to dictate their economic policy. Another tactic the U.S. government can use to stimulate its economy is to cut interest rates further. This weakens the dollar and makes American goods more appealing against a weak Chinese Yuan. But with global sentiment so negative towards the dollar now, this strategy would have far more negative consequences than the Fed probably is willing to accept at this point, even if cutting interest rates would help a faltering U.S. economy. So where does that leave them? Artificially manufacture and exert downward pressure on energy prices.
Low energy prices have always been directly correlated to increased consumer confidence. Even if winter temperatures were normal this year, I still believe that the U.S. government with the help of the Saudis, would have found ways to drive energy prices lower as this was their only viable option to achieve their short-term goals. If former Saudi ambassador Prince Bandar bin Sultan has admitted that U.S. Presidents, Democrats and Republicans alike, have repeatedly asked his government in the past to manipulate oil prices to serve their election campaigns, what would prevent the U.S. government from asking the Saudis to help their economic wishes.
However, exert too much downward pressure, and because the public masses view faltering commodity prices as a sign of a global economic slow down, not only will U.S. markets then suffer, but so will global markets. That’s why I just can’t see oil going to $30 a barrel as many are predicting now. In fact, I don’t think oil will go much below $50 even though it is descending right to the verge of $50 and many are stating that $40 oil is a given now. And where have all the peak oil enthusiasts gone now? If peak oil was a reality, how can oil be behaving like it is now? In any event, oil service stocks like Rowan, Diamond Offshore, Halliburton, Transocean and the like are all trading near 52-week lows. Because these types of companies aren’t as susceptible to faltering oil prices as oil producers, and their downside is more limited, these are the types of oil stocks I would be considering now. However, I’m not advocating buying all kinds of stocks now by any means. Just read my previous posts for my opinion on the global markets now.
Too often, investors’ psychological framework resides within the recency effect instead of the long tail of investing. I know this because while the mass media reports for the most part on what is happening right now while I report on what will happen, I believe that even with the aggregate thousands of readers of my blog and newsletter, that only a handful made some very nice profits off of my calls on the dollar and calls on gold last year. Why?
Because my calls, though far more accurate than anyone quoted in the mass media, often directly contradicted the calls being made in the mass media. People tend to make decisions only on what is being said and discussed by the talking heads on TV and in the papers. They remember exactly what is going on now but don’t take the time to dig below the surface to understand what will inevitably happen in the future. And that is how you make money.
Again, I don’t track oil anywhere nearly as closely as the U.S. dollar and gold, so consider my comments on energy more so my opinion than an in depth analysis. But even on a superficial level, I just believe there is much more at play here than just warm weather contributing to the fall in crude oil prices. And when these shenanigans end, I think we’ll see oil and energy start to recover again.
J.S. Kim is the founder and Managing Director of maalamalama, a comprehensive online investment course that uses novel, proprietary advanced wealth planning techniques and the long tail of investing to identify low-risk, high-reward investment opportunities that seek to yield 25% or greater annual returns.