Buffalo Jumps

In Canada, the native hunter-gatherers used to lure large groups of bison by chasing them over a cliff. That practice, in recent times, has gone out of fashion. However, Byron King points out, there is something comparable in modern times. It’s called investing on Wall Street.

About two hours’ drive south of Calgary, Alberta, there’s a place called Head-Smashed-In Buffalo Jump. It’s located in the Porcupine Hills, where the foothills of the Canadian Rocky Mountains meet the Great Plains of the North American interior.

Head-Smashed-In Buffalo Jump bears witness to a custom practiced by the native people of the plains for nearly 6,000 years. The native people were hunter-gatherers, so they understood both topography and animal behavior. And the native people killed large numbers of bison by chasing them over a cliff.

The bison used to graze on the plateaus adjacent to a deep river valley. The early human inhabitants would sneak up on the bison. Then they’d scare them with loud screams and burning torches. The bison would spook, run over the edge of a sandstone cliff and fall to their deaths on the rocks below. Then the natives would carve up the carcasses and leave the remains to the vultures and other scavengers.

People don’t herd buffalo over cliffs anymore. Smashing in the heads of large herbivores – by luring them into a deathtrap – has gone out of fashion. But still, there is something similar in our modern time. It’s called investing on Wall Street. Or so it seems.

Can you believe what is going on in the markets? Pardon me, but the markets are making almost no sense.

The future of the dollar looks terrible, yet the dollar is rising at a record-setting pace. And depletion is causing oil output in some areas to…well, fall off a cliff, if I may use that phrase. Energy and commodity stocks are tumbling like buffalo in the olden days of Alberta.

Let’s start with the U.S. dollar. It’s strengthening on world markets, but why? Is there some sort of good news about the U.S. economy we’ve missed? Is the U.S. tax code suddenly more capital friendly? Are national levels of wages and household incomes rising? Is the labor force suddenly more focused on producing goods that the world wants to buy by the boatload? Are government expenditures suddenly under control? How about none of the above? Really, where’s the good news?

Despite the lack of good news, for the past two months, the dollar has been strengthening. The euro, in turn, has been weakening as Germany and France have slid into recession. Pretty much in tandem with the rising dollar, the prices for oil and natural gas have been falling. And prices for precious metals have also been declining. It’s devastating the stocks in the Outstanding Investments portfolio.

Meanwhile, the U.S. banking system is badly hobbled. Back in January, in an Outstanding Investments weekly update, I predicted, "Three major banks will fail in 2008." Now here we are in the ninth month of the year, we’ve bagged a good deal more than three banks and the list is getting longer. (Last week, an acquaintance who works at a government agency described Citigroup to me as a "dead bank walking.")

Heck, the U.S. government just seized Fannie Mae and Freddie Mac. Don’t these firms count as major banks, what with their $5 trillion and more of liabilities? They’re both too big to fail, yet too big to bail. Really, does anyone have a spare $5 trillion lying around?

It used to be that the job of the Federal Reserve was, as former Chairman William McChesney Martin Jr. told it, "to take away the punch bowl just as the party gets going." Now it seems like the Fed is laying a direct pipeline to the distillery to keep everyone loaded. And in the process of taking over Fannie and Freddie, the U.S. government is socializing the financial side of the national housing market. The cynical view is that the federal government will loan you the money to buy an overpriced house and your local government will tax you for the privilege of living there. But where is the money coming from?

And what’s going on with the price of oil? The other day, someone sent me an e-mail asking about the "plunge in oil prices." Plunge? Not quite. If you want to see a plunge, go to Head-Smashed-In Buffalo Jump. But oil has not plunged. Or at least it depends on your time frame.

This time last year – September 2007 – a barrel of oil cost about $80, and rising. I remember being in Houston in October 2007 – sitting about 10 feet from T. Boone Pickens and his wife – when oil crossed the $90 mark for the first time. Pickens commented, "We’ll see $100 oil before we ever see $80 again."

T. Boone Pickens was right. Today, a barrel of oil is trading for about $107, or about a 33% increase year over year. That’s no plunge.

OK, I know what people are talking about. Back in the spring and summer, oil ran up in price. Oil crossed $100 early this year and kept rising. By July of this year, oil traded for over $147 per barrel. At the time, I said that oil was "rising too far, too fast." I said that a lot of things in this world stop working when oil gets to about $130 per barrel. And I also said – on Fox Business News one early morning in June – "Oil OUGHT to pull back to around $100-110 per barrel." In the past two months, the price of oil has fallen by $40 or so.

That is, oil is down close to 30% from its recent high. But that’s after more than doubling in the past year. So the recent price retreat is not a plunge. It’s just a correction within a long trend of rising prices for energy.

Meanwhile, almost all of the world’s largest oil fields were discovered over 30 years ago and have been lifting crude oil for 30, 40 or more years. So crude oil output from many of the world’s oil fields is either flat (such as in Saudi Arabia) or falling (such as in Mexico).

Even Russian oil output is dropping this year. No less an authority than the head of Gazprom recently stated that oil should sell for $250 or more per barrel.

Closer to home, let’s take a quick look at Mexico. Crude output from Mexico’s Cantarell oil field – the third largest in the world – is falling at its fastest pace in 12 years. For the past two decades, Petroleos Mexicanos (Pemex) has badly underinvested in field upgrades and new exploration. So Cantarell oil output has fallen 34% within the past year.

Indeed, Mexico may cease to be an oil exporter as early as 2010 and, in all likelihood, no later than 2012. In all candor, even the "lack of investment" argument holds a large element of spin. It may well be that no amount of new investment can reverse Mexico’s oil output decline.

Along these lines, I surely do not envy the next U.S. president. One of these days, the morning National Intelligence Brief will begin, "Mr. President, we have some really bad news about Mexico’s oil exports to the U.S. Pemex told us that within the next two months, it just can’t deliver the oil that we’re expecting. And none of the other oil suppliers in the world can begin to make up the difference."

Yet in the face of all this, the market is currently selling off oil and other energy players. The market is selling off oil field service companies, infrastructure companies, precious metals companies and even basic metals.

So how do we deal with this? I hate to see what’s happening to the Outstanding Investments portfolio. It’s painful to watch such great companies decline in value. But I also have to keep my eyes on the future.

And what does the future hold? The dollar will weaken, what with all the new credit being created to bail out banks, and probably the automakers, and everybody else with a hat in their hand, it seems. And the energy and resource plays are going to stage a comeback. Of that I am convinced.

For now, just be careful when you walk next to any cliffs. Remember what happened with those buffalo out in Alberta.

Until we meet again…

Byron W. King
for The Daily Reckoning
September 17, 2008

P.S. Here’s what I’m going to do for my Outstanding Investment subscribers. Soon, I’ll be publishing a list of the "10 Screaming Energy and Resource Buys" in this market. You can use that list as a starting point when you decide that it’s the right time to go shopping.

Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments, and editor of Energy & Scarcity Investor.

Yesterday, we didn’t know where to begin our reckoning; we were spoiled for choice. Today, we have no choice at all.

"Insurance Giant AIG to get $85 billion Loan from Fed," is the headline story.

Ah yes, dear reader…the land of free markets and free men has become the land of the free lunch. Wall Street hustlers can make billions in bonuses – when the sun shines. As soon as it begins to rain, the losses are handed out to the general public. What kind of capitalism is this?

Oh, but you will say…AIG is "too big to fail"…that if it were to collapse, it might take the whole financial structure down with it.

You might be right. AIG is a major financial player…and, specifically, a major player in the Credit Default Swaps market…said to be worth about $60 trillion. No one knows – the CDS market is not regulated or monitored. And no one knows what would happen if it went kafooey. But no one wants to find out, either.

Yes, again, dear reader…we’ve come a long way from when Andrew Mellon was Secretary of the U.S. Treasury in the late ’20s. When Wall Street cracked in ’29, Mellon had the solution: let it happen!

"Liquidate the banks, liquidate the farmers, liquidate Wall Street…" Mellon was ready to let the chips fall wherever they might.

But four score years later, the chips are held up…cushioned…and caught by public nets by officials pretending to labor in the name of the public. Whether it is good or bad, we have no opinion. But it is certainly different. And it recalls to us that we were right about a number of things.

Ten years ago, we began to see a certain parallel between the United States and Japan. The latter was in a terrific slump…and American economists thought they knew why: the Japanese refused to let their big banks fail. Instead, they were propped up…causing the correction to happen in slow motion. Even today – 18 years after the Nikkei Dow collapsed – Japan has still not recovered. You can still buy stocks at 50% – 80% off!

We thought we saw the handwriting on the wall (in Japanese no less! We couldn’t actually read it, but we thought we knew what it said…): This shall be your fate too.

And here we are. Rather than allow the correction to take its natural course – and get it over with – the feds are doing all they can to prevent it. The risk of "systemic failure," is too great, they say.

They must have stolen those words directly from the Japanese. That’s what they always said. And so the Japanese hunkered down and stretched out their recovery so long that people gave up on it altogether.

What will be the result of this big bailout of AIG? We don’t have to guess. We just have to look across the broad Pacific – at Japan.

If the Japanese model is what we think it is, the bailout – along with all the other props and cushions provided by the feds – will simply delay the inevitable. Stocks will sink. Smaller companies will go broke. Property prices will fall. Consumers will stop spending so much and begin saving.

That is what we expect for the United States too. But there is a major wrinkle; the U.S. can’t afford a Japan-style slump…and neither can your portfolio. There is still time to protect your hard-earned money – and still turn a nice profit…while everyone else are losing their collective shirts (and minds). Get all the tips your need on how to weather this financial disaster in the Strategic Financial Survival Library.

Stay tuned…

*** The Dow bounced yesterday – predictably. Oil fell $4 and change – to $91.

(We must admit…we’re feeling rather content with ourselves. We warned that oil would correct to under $100…and so it has.)

Gold, too, has corrected all the way to $742 (more than we expected…but at least our well-earned humility is intact.) And the euro lost a little ground yesterday. It now trades at $1.40.

*** Inflation is retreating…deflation is on the march. Food prices were increasing at about a 10% annual rate in July. In August, the increase slowed to 7%. The whole world economy is slowing down. And the bubble system – in which exports of borrowed consumer cash from the United States resulted in huge piles of capital overseas – is slowing down.

So far, everything is happening more or less as it should. The credit bubble has burst. The feds are trying to reflate it. But asset prices are sinking anyway…and so is the rate of consumer price inflation.

The Treasury market reflects the shifting fortunes of inflation and deflation too. Yields on the 10-year note fell to 3.4% this week, which means bond prices are going up. The smart money is said to be rushing into Treasuries to protect itself from falling stock prices, bankruptcies, defaults, derivatives, junk debt and other dangers.

Should you follow the smart money? We don’t think so. It may be true that Treasuries will do well during this phase. But there is no margin of safety. At 3.5% yield, you are earning at least 200 basis points less than the rate of consumer price inflation. And when this phase ends, bonds will collapse too. When it will happen, we don’t know…but sooner or later, it seems inevitable.

No, dear reader…we’ll stick with our formula: Sell stocks on rallies. Buy gold on pullbacks. Gold is a good buy right now. Stock up on the yellow metal now – with change you find between the couch cushions.

*** Our office in Paris has moved three times. We started out in a bohemian part of town, with many bars and geriatric prostitutes. Then, we moved to a chic part of town – near the Madeleine – with high rents and fine restaurants. And now, we are in Belleville – an "ethnic" neighborhood.

"When I was growing up," said our new friend Jean-Paul, a Frenchman who has lived in Australia for the last two decades, "this was an Arab area. Now, I’m surprised how many blacks there are."

Our new office is almost next door to the Communist Party headquarters. It is not a fancy area, but it has it charms.

"You filthy son of a b****. You rotten ***. You’re a miserable *****."

We were having lunch in a local restaurant on Friday. All of a sudden we heard shouts and saw chairs flying. A fight had broken out at the bar. Two men were pushing at each other. One took a swing and hit the other in the mouth. The one who had been hit began a counterattack…but he was stopped by the barman and the waitress…who held them apart.

Both men had a vaguely swarthy look. Maybe they were from the South of France…maybe from North Africa…we couldn’t tell.

The fight soon turned to curses…epithets…and expletives. The restaurateur tried to get them to leave…one went out the door…but soon came back. Finally, they settled down…

"What was that about?" we asked the waitress.

"Oh, it was a religious argument…"

"What do you mean?"

"They’re both Jews…but one is Ashkenazi; the other is Sephardic. I don’t really know what they were arguing about…"

Leaving the office on Friday, we saw a man sitting in a doorway. He had large bushy hair…and a beard to match. We wondered if he had been drawn to the area by the commies; he looked just like Karl Marx!

Then, walking along the Boulevard de la Villette, we passed Chinese supermarkets, with strange odors coming out onto the street…Arab bars, with men sipping coffee on the sidewalk…and bicyclists threatening to run us over, coming from all directions.

Turning right on Belleville Street, we felt as though we might have been in North Africa. Most people seemed to have been from Algeria or Tunisia or Morocco. But there were plenty of people from sub-Saharan Africa too. Women in traditional African dress, with the colorful fabrics wrapped around them…an often a child on their backs…pushed shopping carts. The North African men sat in bars, smoked and drank coffee. A few French bums hung out on street corners, drinking from large bottles of beer. There was even a group of men from Eastern Europe – or maybe Russians – who had set up a tent in a square and seemed to be living there.

Shops adjust to their clientele. One offered shoes for 10 euros…which looked for all the world just like those on sale for 150 euros in better neighborhoods. Another had clothes spread out on tables…shirts for 5 euros…jeans for 25…underpants for 2.

We were walking down the hill. As we went down, the people on the street became whiter and whiter. By the time we got to the Place de la Republique, we were among a more typical assortment of the French again.

Until tomorrow,

Bill Bonner
The Daily Reckoning