Thursday, December 04, 2008

Dear ArkBuilders,

Everything is unfolding now, exactly as we predicted many years ago.

The pessimists from before are now the realists.

The optimists from before are shifting to the side of reality now that they hear more and more of the realist view on mainstream TV news.

Depression... Crash... Hyper-inflation... Police State....

Up next: oil-to-food related breakdown of industrial agrictulture and all of the predictable results that breakdowns of society include.

ArkBuilders were way, way ahead of the game but that doesn't meanwe get hit any easier. We have to continue to use this time to prepare.

Gold, gardens, guns.

Away from paper, away from global-industrial structures, back to family, community, barter systems. There is no big secret here. We were over-reliant on a dwindling resource and we are trending back financially, with food, with jobs, with lifestyle... as we were for millions of years pre-oil, so we will be again. Agrarian lifestyle, here we come!

Cheers, Tate


Peak Oil, Cars, and Depressions
by: Jim Kingsdale November 16, 2008 | about stocks: CBAK / HEV / OIL / SQM / USO

Jim Kingsdale
As the global economy heads into terra incognita and the stock market tries to prove it has seen the worst my thoughts, for whatever they are worth, are:

1. Some economic observers such as John Thain, the CEO of Merrill Lynch, and JC Penney’s CEO Mike Ullman are saying the current economy is comparable with the Great Depression. We need fiscal stimulus (since we’re nearly out of gas in terms of monetary stimulation potential). How much? If we’re going into a depression the quantity of fiscal stimulus needed to reinvigorate consumer spending on housing and discretionary items may be too great for any government to contemplate or have the courage to implement. Paul Krugman addressed this point on 11/14 and 11/10; he estimated that $600B of U.S. stimulus will be needed. Even if such stimulus were to be attempted once Obama is in charge, the time needed for it to be effective is so great that we are still in for at least 12 - 18 months of increasing weakness and thus probably 6 - 12 months away from a market bottom.

The next shoe to drop is clearly going to be car company re-organizations either within or outside the bankruptcy laws. I happen to agree with those who think the U.S. government should structure a sort of pre-packaged bankruptcy program with GM that combines management and systemic changes with sufficient financing to put the company on a sustainable course forward. The obvious question about that: who can be found to guide the company in a new sustainable direction? This issue may well be the first indication we will see of whether Obama is as smart as I hope he is and whether a new administration can actually make an important positive difference. I discuss this in more detail below.

2. With regard to energy:

A. Natural gas will be dead money unless the U.S. government decides to push NG-powered automobiles. That is a longshot but not impossible since apparently Rahm Emanuel is a fan of the concept.

B. All prior discussion of oil supply, demand, and pricing has been trumped by the economic sledgehammer that is killing the global economy. I still believe oil supplies will begin to peak in a few years. But the amount of oil used in the meantime will be far less than had previously been estimated and will result in a fair amount of spare capacity being generated. The additional spare capacity will be available to mitigate the early years of the eventual decline of old oil fields. So oil pricing may not recover rapidly as the previous megarprojects analysis suggested, more detail below.

I suspect that recent and future OPEC supply cuts will be unable to lift oil prices much or at all because market participants understand that oil withheld from the market by OPEC or Russia simply increases the amount of spare production capacity that exists. Greater spare production capacity is almost as much of a cause of lower oil prices as greater current supply is.

C. Meanwhile the present and continuing delay in new oil exploration and recovery projects will ultimately result in an even greater supply crunch once the global economy does recover, as numerous observers have recently opined. The timing of future oil shortages is uncertain; my guess is that it may begin in 2011 and become acute by 2014. The advent of economical and scalable oil substitutes like cellulosic ethanol, perhaps from algae, could be a game changer. But we won’t know that until we really, truly do know it, i.e. the timing and impact of new technologies are unknowable.

D. The transition to electrification of cars and substitution of trains for trucks that must ultimately occur will not begin around 2010 as I had thought. The delay is of course due to the lack of any economic incentives given low oil prices and the continuing high cost of battery technology. So investments based on plug-in hybrid electric cars will not be viable for some time. That would include battery companies like HEV and CBAK and “green electricity” investments. It also implies SQM’s lithium future could be delayed, but lithium is used in many other products and its demand will grow with the recovery of the global economy before it is used to power cars.

E. The exception to the above timing guesses is that whatever the Obama administration decides to do may make a difference. For example, if Obama decides to invest heavily in electrified light rail transport systems, that might create some viable investment concepts. Similarly, if he decides to push natural gas powered cars (a longshot), that would obviously put the gas producers into play. Ditto if he takes control of GM and pushes electric cars, perhaps in concert with the electric utility industry, which would like to see this happen. So we will have to wait to see how that unfolds.

3. I have changed my investment posture. I still think energy is a key trend going forward, but times have changed in various ways so the “EIS” Porfolio can no longer be purely an energy related portfolio

A. More cash is needed since the direction of the global economy is toward slowdown and since there is no way to know how long or how deep that process will go. I think 3 - 5 years of cash, at a minimum is prudent. For the non-cash part of the portfolio I want to shift into securities with defensive characteristics, so high-dividend stocks in recession-resistant fields such as mid-stream energy distributors and convertible bonds.

B. Peak oil is now universally understood and energy is no longer the investment secret it was when I started this website about 18 months ago. Energy is still important but when you have so much company in a given sector you can not be too focused on it. Also any investment tsunami, whether a macro-economic one such as peak oil or a social and/or technological tsunami such as manufactured homes or cable television in prior periods or more recently the internet, biotechnology, or demographic trends are all trumped by a global economic meltdown like the present one. At such times a growth oriented investment strategy will be killed. Therefore, in self-defense, I have decided that the “Energy Investment Strategies Portfolio” - a real portfolio that is important to my financial wellbeing and which I have displayed on this site - will need to become far more diversified.

4. I have taken down the information relating to the “EIS” portfolio since my web site is about the confluence of energy and investing and since the “EIS Portfolio” will no longer be illustrative of that concept. I could have split the portfolio into segments and continued to have one segment be devoted only to energy investments. But at times that portfolio might be very small, and frankly it would be more work than I am willing to undertake.

I intend to follow energy investing news closely and I will make note of specific investment ideas - and investing in general - in these occasional newsletters. I’ll report on how my investing concepts have fared, but not in great detail. So my site will continue to be a repository of information that I find potentially useful in keeping track of the energy markets and energy investments. It is essentially my own file cabinet which I make available to the public in exchange for any ideas or feedback that people care to share with me.

5. To the extent I was invested in the energy area, the month of October was one of underperformance in a very bad market The “EIS” portfolio (my worst performing account) was down 26% or 43% YTD. It is now largely in cash. I continue to own small quantities of stocks I have favored: SQM, RIG, DO, TBSI.

While the portfolio is positioned even more defensively as discussed above, I would note that some very sophisticated investors are now bullish. Moreover, a lot of charts have taken on very distinct “bottoming” characteristics over the past 45 days as exemplified by the S&P 500:

A different way to look at this chart: the past 45 days represent a “bounce” from a 45% market decline since last December, but the bounce has been sideways, not up, because this market is so weak that it can’t even go up on a bounce. The current 45-day range might then represent the half-way point in a total drop which would put this market in the category of the 1929 - 1930 decline.

One rule that has proven itself in spades during the present downturn is: “the trend is your friend.” That is the rule behind some people’s insistence on using trailing stops which take you out of a stock if it declines from its peak by a specific percentage. In some markets - 1975 - 1982 comes to mind - such a rule would have you getting whip-lashed constantly. But in this market it certainly would have helped immeasurably. My friend Harry Newton and the people who listen to his advice have benefited from following it.

6. I note that the Baltic Dry Index seems to be making a turn. Interesting.

Fitzgerald said the mark of intelligence is the ability to keep two contradictory truths in one’s mind simultaneously. If he were writing during these chaotic financial times Fitzgerald might say “multiple contradictory truths”, not just “two.”

Here are some of today’s contradictory truths:

- Many stocks seem very cheap in fundamental terms, certainly based on the “intrinsic earning power” that will pertain once global GDP growth recovers.

- But major segments of the U.S. economy are crumbling as reduced consumer spending and greater unemployment trends reinforce each other, thus destroying “intrinsic” corporate earning power.

- As income and asset values melt, investors are forced to sell stocks regardless of their “intrinsic value.”

- But all recessions eventually end.

- But the market can stay irrational longer than the investor can stay solvent.

- But there is a LOT of cash on the sidelines.

- But there is a LOT of fear among those who are still invested and a LOT further for the economy to fall before it begins to stabilize.

The upshot of these conflicting truths has been a huge amount of market volatility. The market climbs rapidly for a few days, convincing some on the sidelines with cash that the train is leaving the station so they need to get on to recover some of the losses they have already suffered. Then it takes violent downswings that eat up even more asset values. The market seems determined to destroy as much investment value as it can, a condition that will continue to exist … until it doesn’t. And when I say, “the market” I mean all stocks - because there has been no particular market segment that has done appreciably better or worse than another. It’s just the market.

Perhaps they won’t ring a bell at the bottom. But I keep thinking there may be a final capitulation, a huge sell-off to unheard of “bargain” levels marking a point of ultimate humility on the part of investors. That could be the signal of a bottom. On the other hand, the market may simply stop selling off, go into some extended trading range as it has over the past 45 days, and then gradually begin recovering.

If there is a capitulation, perhaps it will come when investors reject their underlying assumption of confidence. What confidence, you ask? I submit that most investors still hold onto the conceit that contemporary institutions are so much stronger and so much more skilled than were those of the Hoover-Roosevelt period that no Great Depression could occur again. That may or may not be true - only future events will tell us. We might or might not suffer another market like the ’30’s which ate up 90% of stock values at one point. But whether we do or not, I no longer think that such a possibility is out of the question. Here is one analysis that makes the case that conditions preceding our current downturn were worse than those that preceded the Depression.

Whether or not we do suffer a new Depression, investors may eventually come to agree with me that such a thing is a real possibility. If a significant number of investors reach that conclusion around the same time, we could see the ultimate capitulation of the market. That might mark the bottom.

What about Oil?
How naive I was to think that oil service companies would be immune to stock market weakness. They have been hurt as badly as any segment. If global economic weakness continues to deteriorate clearly some oil projects will continue for some time to be put on hold. That is already happening in Alberta. The IEA reports that it is happening throughout the world.

Clearly the amount of “spare” oil supply capacity - which was thought to be declining toward zero just months ago - is now growing rapidly as OPEC and now Russia begin to cut exports in order to control prices. My sense is that such efforts to keep oil prices high will ultimately fail; the price of oil will go lower - into the $50’s and possibly even the $40’s - until oil production itself is reduced based on pure economics, not on cartel actions. The reason: as mentioned above, every barrel of oil that is withheld from the market becomes one more barrel of “spare capacity” which also tends to reduce the price of oil.

A countervailing force is the decline rate of old oil fields which seems to be accelerating, particularly according to a recent IEA report saying old fields are declining at 6.7% per year. As the reduction in global GDP bottoms oil demand will reach a nadir and then it will begin to grow again. But the decline of older fields will exacerbate a new supply/demand scarcity, eating into the “spare” capacity much more rapidly than in prior recoveries. Much of the previously projected increase in production from new fields will be delayed by the present low prices for oil as discussed above. This is why numerous observers are now calling for much higher oil prices in the “out” years.

Analysts are debating whether speculation was behind the great rise in oil prices. I don’t think there is a definitive answer to that question. The way I’ve started to think about the problem is that there are only two conditions for the price of oil: plenty and scarcity. When there was plenty (prior to 2004, other than during the two 1970’s Middle East crises) the price was set at the marginal cost of production. When there was scarcity (after 2003), the price was set by the marginal rate at which required demand destruction would occur. But in both cases there is, was, and will be some speculation that can move the price temporarily around the fundamental requirements.

Right now we are in a period of plenty. Whatever the marginal cost of production may be is being discovered in part by speculators. The conditions that will change the world into a period of scarcity are discussed above.

Cars Are the New Canaries
For many months I’ve been harping on the idea that consumers have little reason to buy a new car. Most purchases of new cars in recent years have really been made out of boredom or excess cash facilitated by easy credit, not out of a real need for transportation. Cars are now made to easily last for ten years, yet many people have gotten in the habit on replacing them every 2 - 4 years, aided by easy credit. But with a lot less spare cash around and the hierarchy of needs tending toward food and shelter rather than entertainment, people no longer buy cars so much out of boredom. And with new engine technologies on the drawing board and nearly in the showroom, there is a further reason to wait to see what comes next. To top it all off, the U.S. manufacturers do not make the best quality products available and their dealer networks SUCK.

Thus it was not hard for me to predict a while ago that two or three of the Big Three U.S. makers might be headed for bankruptcy. This is clearly a landmark in our journey through economic chaos. It will be interesting to see how the Obama folks and Congress handle the challenge. I tend to agree with those who favor letting the market mechanisms take their course. The U.S. car industry is not as vital as it once was. Foreign makers are increasingly doing their manufacturing in the U.S. And the legacy health and welfare contracts that hold down U.S. makers need to be changed.

But a simple hands-off posture toward a GM bankruptcy in the face of overwhelming consumer nervousness would help crash the economy further by giving people the idea that there is simply nobody in charge (which is the actual case, of course, but people don’t want to think that). In normal times a bankruptcy gives a company the opportunity to step back, refinance, and move in a better direction or slowly go out of business in an orderly fashion. Today’s economy, credit constriction, and the size of the auto industry make that option non-feasible for GM. Therefore I think the U.S. government needs to step up with financing and a new managerial structure to help the company come out of a bankruptcy. In other words, a government-assisted pre-packaged bankruptcy program.

Two months ago I wrote a piece called “Is GM Building a Dream Car or a Bankruptcy Case?” I stand by my conclusion that the only advantage that the Volt offers GM, and the only reason they have been spending millions to advertise the car, is as a social-benefit case for the U.S. to finance GM’s emergence from bankruptcy. I also continue to believe that GM could (but will not have the guts to) sell the Volt in small quantities during its initial productions runs (the only quantities that will be available) at rather high prices, say $39,000 per car, and there would be enough people who would buy them at that price, partly as a luxury curiosity and partly because it will be a really neat car with a lot of scarcity value. So I don’t think GM must lose a lot on the Volt. But GM’s unimaginative management can only see the car as a loss leader priced much lower. Are you listening, Mr. President-elect?

There is more about cars here from John Mauldin’s 11/7/08 email:

“I now drive a 4-year-old Cadillac Escalade (I am a Texan, after all!) and it has 65,000 miles. I have a friend with an identical car that has 270,000 miles on it, and it is still running fine. My car could easily last me another four years, as could the cars of many people who bought new ones in recent years.

Basically, automobile manufacturers, in their drive to sell as much as possible, “brought forward” future sales of cars and, as a side effect, put lots of still quite good used cars on the road. New car sales are likely to be depressed for some time. It is somewhat like the housing problem. There is just too much inventory on the road that will have to be worked through. When Detroit gives me a real reason to buy another car, like an electric-powered vehicle, I will. And a lot of Americans, with a need to save money for retirement, are going to feel the same way.”

Enough. Good luck to us all.

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