Energy: The Next Generation

“In today’s edition of the Rude Awakening, we are going to take a look at a company that sells precision-engineered products into the demanding market for energy resource exploitation, where – it is not too strong to say – design or mechanical failure is simply not an option. The company also sells components to the wind energy industry. The company’s name is Kaydon Corp.

“To set the stage, let’s think about how a drilling rig, whether onshore or offshore, is similar to an electricity generating windmill farm. Both kinds of structures tend to reside in environmentally harsh and inaccessible locales. Therefore, both kinds of structures must possess the durability to resist the elements – from saltwater, to blazing sun, to extreme temperature to hurricane-force winds to rogue waves. Drilling rigs and windmills must both support rotating machinery for many hours per day, amidst many different kinds of conditions. And if the critical machinery does not rotate, then both drilling rigs and windmills are worse than junk. They are junk that is costing the owner or operator a lot of money.”

Byron King
November 9, 2007

Now, some more views from Short Fuse in Baltimore…


Views from the Fuse:

Back when Alan Greenspan sat at the helm of the Federal Reserve, every time he opened his mouth, he set the markets into a frenzy – and sent the financial media running for their how-to-translate-Greenspeak decoder rings.

While most went back to their respective papers or news programs and tried to figure out what the mysterious Maestro was REALLY saying, Ron Paul never missed an opportunity to take the former Fed chief on head-to-head.

In one of his more humorous opening statements, at a hearing before the U.S. House of Representatives’ Committee on Financial Services, February 17, 2000, Ron Paul had this to say:

“Good morning, Mr. Greenspan. I understand that you did not take my friendly advice last fall. I thought maybe you should look for other employment, but I see you have kept your job.”

Now the presidential candidate has taken on Big Ben – you didn’t think he was just going to sit on the sidelines, did you?

At yesterday’s Joint Economic Committee hearing, following Bernanke’s testimony, Dr. Paul picked up where he left off with Greenspan…

“It is that not only have we had a subprime market in housing; the whole economic system is subprime,” Paul railed. “We artificially lower interest rates. And it wasn’t under your tenure in office; it’s been going on for 10 years and longer and now we’re bearing the fruits of that policy.

“How in the world can we expect to solve the problems of inflation, that is, the increase in the supply of money, with more inflation?” he asked Bernanke point-blank.

“What we’re trying to do is follow the mandate that Congress gave us,” Bernanke said. “And the mandate that Congress gave us is to look at employment and inflation as measured by domestic price growth. And as I talked about today, and I think you would agree that we do see risk to inflation and we are taking those into account and we want to make sure that prices remain as stable as possible in the United States.”

According to most, Bernanke’s testimony didn’t convince investors that further rate cuts wouldn’t be necessary. “Market participants don’t think the Federal Reserve is facing reality,” said Allen Sinai, president of Decision Economics Inc., a New York forecasting firm. “We have a consumer that is facing a lot of headwinds. We have a business sector that is showing lower revenues, and we have a banking system that is showing a lot of cracks.”

As we pointed out yesterday, there are a myriad of factors that have consumers feeling the pinch, and today a University of Michigan and Reuters report shows that the only time in the past 15 years consumer confidence has been this low was when the United States invaded Iraq.

“Sales at retail stores rose 1.6% in October – the worst October performance in 12 years,” write Addison and Ian at The 5 today. “Not since 1995 has the U.S. seen such an unsuccessful October, according to the International Council of Shopping Centers.

“Wal-Mart, the U.S.’s biggest retailer, Gap, the U.S.’s biggest clothing retailer, and Macy’s, the largest department store chain, have all missed their latest round of earnings forecasts. ‘This does not bode well for the upcoming Christmas season retail sector hiring, or store expansion plans,’ writes Mish Shedlock. ‘Wal-Mart has already announced a second reduction in the number of U.S stores it will be building. I expect more cutback announcements from other stores.’

“Dashed housing hopes, no doubt, play a role in sagging retail returns this year.”

And even if consumers were to go on a spending spree – it’s not like their dollars could buy what they used to.

The greenback has hit yet another record low against the euro, following Bernanke’s testimony, and the ECB’s decision to keep its key interest rate at 4.00 percent.

“Do you remember when you would walk into a store and the owner might have the first dollar he ever earned in a frame, hanging on the wall behind the counter? People were proud of their money and trusted it as a long-term store of value. Not any more,” opines Byron King.

“Yet most people in the U.S. know only the dollar and understand only the dollar and their savings and investments are almost entirely in the dollar. So what happens when the value of the dollar just disintegrates? It is painful to think of the hardship that is coming down the road.

“While the rising price of gold is clearly good for our investments, it is a disaster for the world at large. Both in the U.S. and around the world – even in nations that despise the U.S. and shun the dollar – we are all in for a tumultuous time in history. No one really knows how the decline of the dollar will play out. There is no modern precedent for what is about to occur as the world’s reserve currency evaporates in value. Literally billions of people rely upon the U.S. dollar as the economic rock that holds up the foundations of the world economy. Yet that rock is turning into loose sand. How does one save, let alone invest, in a world where the value of the dollar is in irreversible decline? A declining dollar is the same as the destruction of capital.”

Ron Paul would certainly agree with that sentiment.

By the way, keep your eyes peeled for Byron’s new Energy & Scarcity Investor, debuting this afternoon. More details will follow next week…

Suddenly, the question marks are back. Such as: how much is that in Polish zloty?

The trouble with the financial world is that nothing stands still. We read in today’s paper that houses in the United Kingdom are down – for the second month in a row. During the housing bubble, British housing rose even more than in the United States; it probably has a lot further to go down.

But…what’s this…measured in gold, housing in the U.K. has been going down for the last three years!

Let’s see, if you measured U.S. housing in gold, the average house probably cost about 650 ounces in ’97. Now, the same house costs only about 500 ounces.

And measured in euros (EUR), the average U.S. house cost about 250,000 in ’98. Now, even after doubling in dollar terms, it costs only about 275,000 euros. After the costs of maintenance and taxes, the homeowner has lost ground.But what do you care what your house is worth in euros or gold?

“Wall Street and dollar take another beating,” is the headline in the Times of London this morning.

Colleague Steve Sjuggerud forwarded a chart showing that real estate declines and bear markets on Wall Street always come together. “It’s only a matter of time…” says Steve.

Hold that thought, dear reader. And don’t worry. In today’s Daily Reckoning, we will clarify things. After a very long time when things seemed so very sure…

…when everyone knew the U.S. of A. had the world’s most dynamic, most profitable, and most secure economy…when property prices were clearly going up…when there was definitely a bull market in stocks…

…suddenly, the question marks are back:

…what is the meaning of the credit crunch…?

…is Bernanke fighting inflation…or fighting deflation…?

…are stocks going up? How about the dollar? Is gold hitting another peak?

…and what is ANYTHING worth…when EVERYTHING floats on a bubbly sea of shifting exchange rates?

Relax. Most of these questions are unanswerable…so don’t trouble yourself with them. Instead, let us look at a few things that don’t float. Let’s go back to the eternal verities…the North Star for investors.

There are a few things you can count on. Stocks always go down. Paper money always loses its value. Government always lies.

First, let’s look again at the dollar.

A couple of years ago, we dared to guess that the greenback would hit $1.50 to the euro. At the time, everyone thought the dollar would go down. Even Warren Buffett, who doesn’t like speculation of any sort, was betting against the dollar.

It seemed too easy. Too obvious. Markets don’t usually work that way. People rarely get what they expect, because what they expect is already reflected in current prices. Instead, markets usually surprise us.

How would the dollar surprise us, we wondered?

Either it would not fall…or it would fall much more than people expected. We guessed it was the latter. And so, it is turning out to be. Oil is already getting friendly with $100. Gold is getting very close to meeting up with its highest level ever – $850. And the euro is trading over $1.47.

Can you count on the dollar losing more value? Yes, you can. The dollar is the I.O.U. of the USA…a nation more deeply in debt than any has ever been. It’s a cinch to go down… Central banks around the world are turning to other currencies to stock their vaults. Celebrity models are demanding payment in euros. Investors are getting interested in gold.

But exactly how…when…and against what will the dollar decline? Oh dear reader, you’re asking too much.

But here’s another verity:

America’s middle class is getting squeezed.

“Homeowners Feeling Pinch of Lost Equity,” says the New York Times.

Diesel fuel and heating fuel are both selling for more than $3 a gallon.

And the Boston Herald reports that appraisers are now killing housing sales. They give their opinions just as they did before. But now, their appraisals are not high enough to get mortgage financing.

And now Ben Bernanke is warning of inflation. Hmmm… He told Congress yesterday that higher energy and higher import prices “put renewed upward pressure on inflation.”

What he meant to say was that he and his colleagues were destroying the value of the dollar…and people were beginning to notice.

Then, he went on with the remarkable line:

“We are going to make sure that the inflationary impact that may come from a weakening dollar is not passed into broader prices.”

How is he going to do that? If the dollar goes down, it will take more dollars to buy things. That’s what inflation is. Can you have inflation without rising prices; can you have a falling dollar in which the dollar doesn’t fall? Mr. Bernanke did not venture into the metaphysics of it. Instead, he left the false impression that he and his sidekicks at the Fed were going to catch the buck in mid-air. Ha! They’re not going to catch it at all. They’re going to let it fall. We remember Paul Volcker; and Ben Bernanke is no Paul Volcker.

And so, dear reader…the story is getting more and more interesting.

The financial industry is sitting on something between $100 billion and $500 billion of as-yet-undisclosed losses. The Financial Times says the “crisis will get worse before it gets better.”

About 2 million American homeowners are set to lose their homes.

The dollar has already lost 10% of its value against other major currencies so far this year.

Americans’ most important asset – residential property – is going down at nearly 5% per year. Since property prices are in dollars, in world terms, the householder is losing about 15% per year. And yes, dear reader, housing will keep going down. There’s another thing you can count on. The typical family doesn’t earn enough money to buy the typical house. Either family incomes must rise, or housing prices will fall. Which will it be?

Which is more likely? Here, we’ll take a wild guess – uh…housing prices will fall.

And now, dear reader, here comes the other shoe – the drop in stock prices. Yesterday, the Dow was off a few points. It was down 360 points the day before. If this presages a general collapse in share prices, it means that ALL major forms of wealth and savings are in decline for Americans. Housing, stocks, even money in the bank.

The only things that are not going down are the cost of living…and gold.

Ben Bernanke implied that the Fed would not be lowering rates again…not any time soon. He’s not going to allow the cost of living to get out of control, he says. But if stocks slide, what else can he do?

One way or t’other, stocks are going down. Because real estate is going down. And because profits are going down. Profit margins are high now, for reasons we’ve explained in these Daily Reckonings. But profits never stay this high for long. They always regress to the mean. Besides, the growth in profits has come from financial activities, not manufacturing. Finance is peaking out. Wall Street itself is selling off. Goldman (NYSE:GS), Merrill (NYSE:MER), Morgan Stanley (NYSE:MS)… these dogs have had their day. Now, they’re on their way down, and so are business profits, generally…and so are stocks.

Want some other sure things?

The middle class is sinking. Houses are going down. Stocks are going down. Isn’t that enough?

Okay, how about this: inflation, worldwide, is picking up. There are many more people with much more money in their pockets than there were a few years ago. Wages are rising in the East. Prices for basic materials and food are soaring. Soon, the asset inflation we’ve seen over the past few years will give way to consumer price inflation. Not just in the United States, but worldwide.

Until next week,

Bill Bonner
The Daily Reckoning