Blood, Money and Oil

Saudi Arabia controls 90% of the world’s cheap oil, and as such, attracts the evil eye of al Qaeda. It’s not just oil that’s at risk, but the very Kingdom itself…

Fed Chairman Alan Greenspan isn’t simply focusing on interest rates these days. He’s also expressing concern regarding a topic close to our hearts undefined our energy needs.

The Fed chairman has announced that energy prices are likely to stay high. The higher cost of energy "is almost surely going to affect the growth of oil and gas consumption in the United States," he said in April.

The Fed Chief then admitted that sky-high prices for natural gas have already forced energy-intensive businesses that deal with chemicals and plastics to close plants and lay off thousands of workers.

And Greenspan goes on to note that the sharply higher energy prices that have emerged since the 2001 recession are affecting more than just big industrial users…nearly every American business has made investment decisions assuming moderate energy prices, and now they are being forced to re- evaluate their strategies.

Saudia Arabian Uprising: An Athabascan Investigation

Greenspan’s extensive comments on petroleum underscore the fact that, even in the 21st century, oil fuels the world. If you don’t believe me, just ask an Islamic extremist. He just might tell you of his plans to recruit even more extremists willing to strap TNT around their bodies and run into an oil refinery plant.

Ever since 9/11, the global oil industry has been on edge. Two months after the Twin Towers attack, I was in Alberta’s far north, touring Suncor’s giant oil sands project. I had just left the project and turned onto the highway when a small army of Royal Canadian Mounted Police descended toward the Suncor property. At the roadblock a couple of miles ahead I asked a Mountie what all the commotion was about.

He told me that police were acting on a tip that Arab terrorists were planning an attack on the Athabasca oil fields. I would have asked him how seriously they were treating the threat, but when a helicopter flew overhead, it seemed superfluous. Since then, the oil sands projects have upgraded security significantly.

But oil at home is just a small concern. The oil industry in post-Saddam Iraq has also become the target of Arab insurgents fighting the U.S.-led occupation. Terrorists are conducting a relentless campaign against oil installations in the Persian Gulf undefined a campaign that security experts fear could inspire terrorist attacks on key energy facilities in other countries.

In Iraq insurgents have repeatedly attacked a 600-mile-long pipeline that runs from the Kirkuk oil fields in the north to the major oil export terminals of Ceyhan. The pipeline can deliver 800,000 barrels a day, but has been shut off for a year.

The oil carried by this pipeline is crucial to rebuilding Iraq. According to L. Paul Bremer, the top U.S. administrator in Baghdad, the loss of the Kirkuk-Ceyhan pipeline has already cost $2.5 billion. It’s anyone’s guess when, or even if, we will be able to rely on it to deliver exports to tankers.

Saudi Arabian Uprising: The Future of Saudi Arabia

The largest risk of all, however, is one that is rarely spoken of. I’m talking about the future of Saudi Arabia. The OPEC swing producer has more than 300 billion barrels undefined or one-third – of the world’s oil endowment. The Saudi Kingdom must face Muslim fundamentalism and its leaders, who have openly called for the overthrow of the House of Saud.

In November 2003, the Saudi Institute Press, an independent Washington-based organization, reported that Islamic militants were planning attacks on oil installations and Western personnel in the kingdom’s Eastern Province. According to the report, four suspected al Qaeda militants, arrested two months earlier, had rented an apartment in Nasariyah, in the oil-rich province, to prepare their attacks.

And just this May, a series of suicide bombings in Riyadh, Saudi Arabia, killed 25 people, including eight Americans. Foreign governments, including coalition leaders from the United States and Britain, have advised their nationals to leave the country. They’ve also temporarily shut down their embassies in Saudi Arabia in response to intelligence reports that more attacks are "imminent."

In his book, The Thousand Year War in the Mideast, Richard J. Maybury writes that Iran is aggressively inciting revolt inside the borders of Saudi Arabia. "My guess is that Iran’s secret agents will continue working to foment revolution, and they’ll do it in a way designed to prevent U.S. intervention. The rebels will claim to be fighting for a more democratic Arabia. Once they’ve succeeded and are in power, they will request assistance from Iran to ‘stabilize’ Arabia. This voluntary invitation to Iran by the new ‘democratic’ government will be an end run that will deprive the U.S. government of justification to intervene."

If militant Iranian mullahs can control Arabia, then they will own the rights to half the world’s oil reserves undefined and about 90% of the world’s cheap oil.

Saudi Arabia is huge undefined more than one-fifth the size of the United States undefined but it is hardly cohesive. The House of Saud has been walking a razor-thin line between appeasing its Western oil clients and pacifying Islamic militants. It’s no coincidence that the majority of the 9/11 terrorists were from Saudi Arabia.

Clearly, the numbers favor the radical elements. Just consider the big picture: Iran and Iraq have a total population of over 90 million. Kuwait and Saudi Arabia have fewer than 30 million people. If push comes to shove, the Sunni royals running Saudi Arabia will be the underdog when matched against the Shiites of Iran and Iraq. And chances are the Saudis won’t even have the loyalty or heart of their own people.

Saudi Arabian Uprising: Disliking the House of Saud

The majority of Saudis are not only offended that their government is loyal to the West, but they also see the House of Saud as an aberration of Muslim values undefined a government where corrupt billionaire princes ignore the Koran.

And it seems doubtful that the Saudi military will remain loyal if there were an internal uprising or a foreign invasion. Their ranks are filled with tribes conquered by the royals when they seized power. The top officers were born into the house of Saud, and most have Swiss bank accounts.

The Saudis have been loyal to the Anglo-American alliance because, in the 1930s, Britain and the U.S. government cemented their power. But it is a shaky alliance.

"Saudi Arabia is the root of the problem and has harbored the fanatical Islamists in the Arab world," wrote the Financial Post in April. "Washington is pressuring the kingdom to clean up its act, and there are tensions. Indications are the United States has military contingency plans to intervene if there is an attempted coup d’etat there or major attacks on Saudi oil fields."

Without any of the current tensions, oil prices would probably be around $26 a barrel, instead of the $39 they are now. The current $13 premium is built in as a result of ruthless terrorists and Arab hostility against the United States.

But factor in the deteriorating military and political situation in Iraq, along with the continued fighting in Afghanistan undefined and the built-in premium for crude oil could soar. Throw in an implosion in Saudi Arabia, and oil prices would burst past $50 a barrel…to $70…and could potentially spike towards $100 a barrel. Today’s oil price of $39 a barrel might not sound cheap right now, but looking back on it five years from now, it will seem like an incredible bargain.


John Myers
for The Daily Reckoning
June 8, 2004

Mundus vult decipi, ergo decipiatur.

– The world wants to be deceived, so let it be deceived.

Stocks rose briskly yesterday. Investors seemed to like the latest jobs report; it showed nearly 250,000 new jobs in May.

Deconstructing the jobs data will surely reveal at least a fraud or two. But it is fraud this market wants. Americans believe that the world’s most indebted economy will grow as long as people have access to more credit. The secret to economic success, they think, is merely to spend more and more money you don’t have! (What’s so hard about that, they ask themselves…why can’t the Japanese seem to get the hang of it?)

Almost every citizen is now engaged in his own little ‘carry trade’ – borrowing short-term in order to buy long-term assets. Short rates are low. The return on houses is high. Why not? All you have to do is to ‘extract’ the ‘equity’ from your house. You will have more money to spend…and lower monthly payments. And you will never have to pay the money back; some day, you will simply sell your house at a higher price.

"It is almost too good to be true," writes Mark Thornton. But it is a perfect investment strategy for people who have lost their minds – a no-brainer. Perfect…as long as things don’t change, that is.

"The case of Japan’s real estate bubble is instructive," Thornton continues. "Japan had a stock market bubble in the 1980s that was very similar to the U.S. stock market bubble in the 1990s. As the Japanese stock market started to bust, the real estate market continued to bubble. One general index of Japanese real estate shows that prices rose for almost two years after the stock market crashed with prices staying above pre-crash levels for more than five years. The boom in home construction continued for nearly six years after the stock market crash."

But what happened? Did things never change? Were the people who wanted to be deceived, happy to be deceived forever? Well, not exactly. In the mid-’90s property prices in Japan began to fall. "Prices for commercial, industrial, and residential real estate in Japan continue to fall," adds Thornton, "and are now below the levels measured in 1985 when these statistics were first collected."

It has now been 4 years since stocks dropped in America. Everyone is convinced that the worst is over. Clear sailing ahead, they tell themselves. And along comes the Labor Department with just the weather forecast they had hoped for: not too hot, not too cold.

The nice thing about the jobs data is that they are neither good nor bad. If many new jobs had been created, the Fed would be pressured to do something to head off an inflationary surge. More jobs mean more competition for employees…which means higher salaries. Not only would employers’ costs go up…putting upward pressure on prices…there would also be pressure from the demand side. As soon as people get more money in their wallets, they are bound to bid up prices on everything they buy.

More new jobs might have meant inflation and a higher key- lending rate from the Fed. Fewer new jobs would have signaled a continuation of the ‘jobless’ recovery and a possible slump into deflation.

The fraud the carry trade needs is the fraud of stability. And that’s what the new employment figures gave it. Despite the quarter of a million new jobs, the unemployment rate stayed just where it was the month before – at 5.6%.

Hallelujah, nothing has changed. Yet.

Over to North America for more news:


Eric Fry, from the Big Apple…

– The June swoon will have to wait…as stocks worldwide soared yesterday. Overnight rallies in the Asian and European stock markets inspired American investors to toss a few homegrown stocks into their shopping carts on Monday morning. By the time Wall Street had hung out the "Closed" sign yesterday, the Dow Jones Industrial Average had soared 148 points to 10,391 and the Nasdaq had jumped more than 2% to 2,021.

– Breaking from tradition, gold rallied alongside the stock market, as the yellow metal gained nearly $4.00 to $393.85 an ounce. Investors seemed eager to buy almost anything yesterday. So what’s powering all this frenzied buying? Or, to rephrase the question, what’s causing nearly every asset class to rally simultaneously?

– These related questions do not invite a simple answer, but we will suggest a simple answer anyway: a 1% Fed funds rate is powering every major asset class. This rate is so extraordinarily low that it encourages all manner of speculation – from leveraged stock buying to leveraged bond buying to leveraged home buying.

– "Atrociously speculative;" that’s what the successful bond fund manager, Bill Gross, terms Alan Greenspan’s 1% Fed funds rate. Other market commentators have charitably referred to the 1% rate as an "emergency rate." It is both; it is an emergency rate that is atrociously speculative by virtue of the fact that no emergency exists.

– "Atrociously speculative." The phrase conjures up images of drunks at a roulette table stacking $1,000-chips on "00." But Gross refers instead to the actions of a soft-spoken bureaucrat, whose lone game of chance involves pushing around one little interest rate.

– Desperate times may call for desperate measures. But ordinary times do not also call for desperate measures. Indeed, desperate measures applied to ordinary circumstances can produce far more harm than good – like shooting fire hoses into a house to extinguish a stove flame. "[Greenspan] went to 1 percent well over a year ago with a deflationary emergency in mind," says Bill Gross. "It’s clear that no longer persists."

– If ever there were a recent financial emergency in America that necessitated the lowest interest rates since the days Ike puffed Camels in the Oval Office, that emergency would seem to have passed. The economy added almost a quarter of a million jobs in May, bringing its grand total for the year to more than 1 million net new jobs…where’s the emergency?

– The Nasdaq Composite Index sells for more than 60 times earnings – hardly the sign of panic. "The last time short- term interest rates were 1%," your Paris editor reminded the attendees of last week’s New York Gold Show, "we were in a great Depression. But there is no great Depression now."

– So it’s not difficult to understand why Bill Gross calls a 1% Fed funds rate atrociously speculative. On the other hand, it’s not hard to understand why this rate persists…it’s very handy for leveraged speculation of all sorts – the sorts of leveraged speculation that make investors very happy. "He’d better get on his horse and ride interest rates higher before we create too many more bubbles," says Gross. But Greenspan may be too late already. Most inflation gauges are already flashing amber, and he has not yet raised interest rates…not even once. [Ed. Note: John Myers considers the CPI and the Fed’s Funds rate in today’s featured article on the website. You’ll bark when you see his conclusion!]

– "In due course, history will reveal multiple deceptions at the core of the current bear market," says John Hathaway, portfolio manager of the Tocqueville Funds. "A core deception of the moment is the notion that a few upticks of 25 to 50 basis points in short-term rates will be sufficient to arrest the forces of inflation set in motion by the most aggressively accommodative Federal Reserve in history. Once inflation becomes entrenched in the industrial economy, financial structure, and public expectations, it is notoriously difficult to root out. The longer the Fed waits, the more severe the market pain. The Fed’s policy dilemma contains the seeds of a prolonged bear market in financial assets… and a bull market in gold."

– "I don’t know what’s gonna happen in the future," your Paris editor told the attendees to last week’s New York Gold show, "or when it’s gonna happen. But whenever whatever happens happens, I want to own a pile of gold."


Bill Bonner, back in London…

*** Nothing has changed…the dollar continues to sink; yesterday, it slipped above $1.23 against the euro.

*** Houses are selling at record prices. And more and more houses are being constructed. Hmmm…supplies increase alongside prices….something funny about that.

But rentals are cheap, say the experts. People are being drawn into homeownership by low mortgage rates and the lure of easy money. This has left apartments and rental houses empty, looking for renters. A clever move: the ‘carry trade’ carried backwards? Sell your house; rent a comparable house on a long-term, fixed-rate lease. Put the money in gold and euros. Buy the house back 10 years from now.

*** $100 to fill up your car? It’s already a reality in Europe. Soon, it will be in America too, according to an article from the BBC. A group of oil experts, including Dr. Colin Campbell, a former V.P. of TotalFina, say oil should be priced at not $40 a barrel, but $182!

The world’s oil production has peaked out, they say; the planet is running out of oil and doesn’t realize it. No major new oil fields were discovered last year. Old fields are being pumped dry. And much of the world’s reserves are phony. Hmmm…[Ed. Note: More on oil in today’s guest essay, below, and another reason why the oil price could spike far higher.]

*** We only met Ronald Reagan once…at his first Inaugural Ball, and then not long enough to draw his measure. Still, Reagan was the kind of man you instinctively liked.

Reagan’s policies were probably no better than the average president. But they were no worse.

And he seemed a decent sort, with a genuine sense of humor. That is about all we ask in a political leader; that…and inactivity.

One of the stories Reagan told concerned the time he lived in Paris as a student. He spoke French poorly, but was asked to help translate for a British couple that wanted to know where they could find a good restaurant. The Gipper posed the question, not quite correctly, to a gendarme…who answered with such a gush of rapid French that Reagan did not understand a word.

"What did he say," asked the Brits.

"I don’t know," said the future president, "I don’t understand his French, I only understand my French."


*** "This is just overwhelming…" Elizabeth sighed this morning. "It’s just too much to organize."

She referred to the family’s summer plans, which include a 6-week "See America" road trip.

Our children are growing up in Europe. The younger boys are now more French than American; they play in French, their friends are French. For his last birthday party, Henry, 13, organized a 4-course sit-down dinner for his friends (which ended with water balloons tossed from the balcony…)

It is time the boys saw a little of their native land. Or, at least, their parents’ native land. Or what has become of it since it became the ‘homeland.’ They need to meet their relatives, too. Uncles and aunts are in their 80s; you don’t want to wait too long to visit aging relations.

"Rental cars, airplanes, hotels – this is going to cost a fortune," Elizabeth pointed out. "I dread it. Driving around in the heat of summer with a car full of teenagers, we must be out of our minds."

But there is a more immediate and practical reason for the trip. Jules, 16, has to apply to college next year. He has spent the last 7 years in French schools. He would like to go to college in America. But where?

"I don’t have any idea: I’m not even sure I want to go to college right away," Jules had explained after dinner last night. "And I don’t know what I want to study either. I think I might like a career in the movies…but I don’t know how you get into something like that. "

"Well," Elizabeth concluded, "we just have to take a look around…show you some of the choices."

The plan is to do a kind of ‘grand tour’ of the United States. Beginning in Maine, Elizabeth and the boys will drive down the East Coast, while your editor works in Baltimore. They will visit colleges in New England, including Elizabeth’s alma mater, Harvard, and Elizabeth’s family. Then, we will all meet up…take a look at some of the Virginia schools…and visit the other side of the family.

And then, we head out across country…with stops planned in Memphis, New Orleans, Santa Fe, Aspen, Las Vegas, Los Angeles, and San Francisco. Finally, we will fly to Vancouver for our annual Financial Conference…and then back to Europe. Whew!

"Well, the nice thing about this trip is that once we have done it, we will never have to do it again," concluded Elizabeth.

*** "’Ignorance is Bliss’ [from Friday’s Daily Reckoning] reminds me of a joke I found in the front of a great little book about investing called, ‘The Proof of the Pudding,’" writes Dan Ferris. "Here’s the short version:

Albert Einstein died and went to heaven.

St. Peter greeted the genius at the pearly gates, and expressed sheepishly that heaven was crowded and Einstein would have to share a room with three others.

Einstein entered the room and asked the first guy what his IQ was, hoping it would be high enough that they’d actually have something to talk about.

‘180,’ the man said.

‘Splendid,’ the old physicist replied. ‘We’ll be able to talk about thermodynamics. I have some ideas about molecular physics that I’d like you to consider as well.’

Einstein asked the second man his IQ.

‘120,’ came the reply.

‘Oh, good. We can discuss Dostoevsky and analyze T.S. Eliot’s poetry.’

Einstein looked at the third man, and asked him what his IQ was.

‘Um…I think it’s about 60.’

After a pause, Einstein looked at the man and asked,

‘Well…what do you think about the market?’"

The Daily Reckoning