Gold vs. Treasuries, Round 1

Thanks to Cumberland Advisors for putting this nifty graph on their website. What do we make of the recent divergence between gold and the 10-year Treasury yield? Gold has had a sustained rally since 2001, when the Fed really started cranking the monetary/credit stimulus machine. Liquidity seems to have finally spilled into gold, not just the fixed income markets, where it has been poured for the last thirty years. A "relative value"-minded trader might expect the historical relationship to snap back into place and the spread between spot gold and the Treasury yield to narrow. This would suggest a short position in gold and Treasuries. Although we might be tempted to call this spread a mispricing, we are reluctant to short gold when central banks are still pumping liquidity up (see note at the bottom of this). Rather, we think the spread will only close by Treasuries selling off and "catching up" with gold.

Oil: Reality Check

We are very concerned about oil. After hurricane Katrina swept the gulf coast, mainstream America indeed shared our concern - albeit only momentarily. Since then, the mainstream has shifted its focus on the usual name-blame-game. Politicians at the Hill have stepped up their fight against evil price-fixing oil companies, and economists at the Fed have found a scapegoat for inflation and a slowing economy. Sure, prices at the pump have cooled down, but does that mean everything is going to be ok? Should we assume that the US government can successfully stabilize global oil prices? Perhaps as successful as it stabilized peace in the Middle East?

Here's a reality check:

1) The US became oil-dependent in 1970, and today, the US imports 60% of its total oil consumption

2) The US has reached peak domestic oil production, while more than half of its oil refineries went offline post-Katrina

3) China's oil consumption is rising extremely fast, and the US cannot simply tell China to curb its appetite

4) With a surge in non-US oil demand around the world, the ability for Wal-Mart type threats against oil exporters will no longer be an option for the US

5) MAJOR INSTABILITY in the three main oil producing regions: Middle East (DUH), Venezuela (Chavez), and Nigeria

6) It takes many years and costs billions of dollars for oil companies to explore and dig oil - with profit margins at less than 10% (Microsoft's profit margin is 32%), where is the windfall profit politicians complain about?

7) It takes about seven years to build a refinery, and Congress has done nothing so far but to draft a helpless bill

8) After decades of pounding environmental regulations, many States require different blends of fuel - disabling them from assisting each other during supply shortages

9) THE TRUTH: FROM AN OIL INSIDER

10) In the short term, winter is already upon us and fat heating bills are waiting in the mail. During the past month, the energy sector had a downturn when hot money stopped pouring into oil stocks. We see this as temporary noise due to profit taking by large funds (a la, in part, Refco). We expect crude oil price to rise above $70/br by early next year and also expect oil stocks to resume their rally. We're keeping our eyes on PBR, PCZ, and VLO.

Commodities Trade: Palladium

A hearty boom in commodities has been under way for several years now, but not all metals have participated. One in particular is Palladium, a close relative of Platinum that has many industrial uses. The Palladium/Platinum ratio is touching a significant resistance level of 1/4. More than half of Palladium's demand is driven by its use in catalytic converters for autos. Other significant applications include electronics, dentistry, and jewelry. Palladium is also used in the catalytic process involved with petroleum refining.

From Stillwater Palladium:

Today, palladium is in a unique situation. The metal is in demand from a wide range of global industries, yet is supplied by only a few mines across the world. Thus, any interruption to supply can have a dramatic impact on prices. A perfect example of this occurred a few years ago. The biggest palladium supplier in the world is Norilsk Nickel in the Russian Federation, and in the year 2000, Norilsk’s deliveries of palladium became unreliable. The palladium market then was so tight that supply interruptions resulted in huge price surges. Palladium reached a high of $1090 per ounce in early 2001. Palladium is for the moment in oversupply and at less than a quarter of its high, but questions remain with many about future supply reliability.

Given the potentially unstable balance of supply and demand, and the fact that Palladium is touching significant technical levels, we wonder how long it will be before the metal breaks out on the upside...

Great Graph from Rothbard's "Man, Economy, and State"

Quoting mises.org:

Rothbard’s Figure 41 (p. 369) is perhaps the most economical depiction of the Austrian approach to capital and interest. Like the mainstream “circular flow diagram,” Figure 41 shows how, in the ERE, total expenditures (100 oz. of gold) equal total income (17 oz. to capitalists and 83 oz. to land and labor owners). However, Figure 41 goes far beyond the typical macro diagram by depicting the structure of production, i.e. the fact that goods take time to mature from original factors into final consumer goods.

I just began reading this chapter. Another Rothbard masterpiece.

Power of Law

As a first year law student, and a rookie Austrian, I cannot help but to be inspired by Patrick Fitzgerald. Reading over his indictment against Lewis "Scooter" Libby, it is clear that this government is a reckless institution with a serious lack of honesty, transparency, and uniformity. Of course, today's indictment is only a small step. Patrick Fitzgerald has made a bold point, however, that "without the truth our criminal justice system cannot serve our nation." The 9/11 probe, the invasion of Baghdad, and the post-Katrina revelation of gross mismanagement are all signs of a bloated and divided government. What next?

It's about time...

We finally have a place to archive our thoughts and ideas. Boh.