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Sol Palha

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Oil to Gold Ratio and the Folly of Creating Fuel from Food

By Sol Palha      Printer Friendly Version
May 12 2008 10:46AM

There are four types of men in this world:

  1. The man who knows, and knows that he knows; he is wise, so consult him.
  2. The man who knows, but doesn't know that he knows; help him not forget what he knows.
  3. The man who knows not, and knows that he knows not; teach him.
  4. Finally, there is the man who knows not but pretends that he knows; he is a fool, so avoid him.

Ibn Gabirol

In October 2007 we stated that the oil to gold ratio had moved from favouring oil to favouring gold but we also stated that we thought it was far better to invest in silver as the returns would be far superior.

When the article was published Silver was trading in the 13.30-14.00 ranges. It recently traded as high as 20.80 before pulling back. Thus from low to high Silver gained over 52% in a relatively short span of time. In the same period Oil went on to gain roughly 40%; from a low of 88 to recent high of126%. Clearly Silver proved to be the better trade. Prior to this in Feb 2007 we stated that oil would make for a better investment than Gold and once again this proved to be true.

Now it appears that this ratio is once again pointing in favour of gold and once again we would favour silver over gold as we think on a percentage basis the gains here will be far larger than those of Gold. Note that this does not mean that the Gold and Silver markets are going to take off immediately however it does suggest that investing in silver could produce more gains than investing in crude oil. Adding fuel to this argument is the recent behaviour of the Dow transports; in light of record high oil prices they were able to trade all the way to 5385 before pulling back; a mere 102 points away from the all time high of 5487. It appears that they must be sensing lower oil prices; do not confuse lower with extremely low oil prices as we are talking more along the lines of a correction than a crash. Right now if oil had to pull back to say the 90-99 ranges everyone would breathe a sigh of relief even though a few months ago such prices were considered exorbitantly high.

As it has broken through the zone of support provide by the 7.5 price point level it will most likely test the lower end of the channel formation. If it should trade all the way down to the 6- 6.5 ranges Silver would make for an even better buy. As always do not ever overload into any investment no matter how good it looks; to do so is to go against all known rules of money management and those that do usually end up in the dog house.

Random musings

The Folly of creating fuel from food, power outages and more

The sad part about trying to create fuel from food is that it unfairly drives the prices of all food crops higher; farmers abandon planting regular crops in favour of the ones that are paying the most. In doing so it drives the prices of other food crops higher as less land is now allocated to them than say 2-4 years ago. In this case the culprit is Corn and so now we have a huge swath of farmers planting corn and planting fewer soybeans, cotton, Rice, etc. In addition instead of planting corn for one season and another crop the next to give the land a chance to recover, they constantly keep planting corn. In order to do this they have to use huge amounts of fertilisers; as corn does not utilise fertilisers efficiently a significant portion drains of into rivers and oceans and promoting the growth of algae which sucks the oxygen out of the water and creates massive dead zones where all life ceases to exist.

Imagine some disaster should strike such as massive series of droughts or extra heavy rainfall, and then we will have even less rice, wheat, soybean etc because reserves were low to begin with. We already experienced a huge spike in the price of wheat because the terrible drought in Australia badly affected its wheat production. Now it is stated that a significant portion of Myanmar’s rice crop has been destroyed due to the recent cyclone. If such an event had to occur in one of the Major producing rice countries such as Thailand or India the situation could spiral out of control and a significant portion of the worlds poor would suddenly find it almost impossible to feed themselves.

Now with the over planting of corn the situation is going from bad to worse. While some of the higher prices in the agricultural sector is due to the effects of inflation a lot of it has to do with simple demand and supply; demand right now is outstripping supply and as more individuals in Asia move into a position where they can afford to eat better, the demand for these bare necessities is going to keep increasing. However the main culprit is still the bio fuel sector as they are placing higher strain on the price of other products by using huge swaths of corn to produce ethanol. For the first time in decades or maybe ever many nations are imposing export restrictions; they are restricting the export of key food items as they want to make sure they have enough to feed their people. No government can stay in power when the masses are hungry and they know it so they will do whatever it takes to make sure that their people have enough to eat. This in turn is going to have an even larger impact on food prices. We have disaster after disaster waiting to hit. A partial list of disasters just waiting to happen

  1. Food prices spiking to insane levels making the once affordable bare necessities luxuries in most countries and a burden in so called developed nations. Already some families in America have to choose between buying petrol and or eating.

  2. A water disaster; huge amounts of water are being used in mining production and or being polluted due to massive industrial expansion or over farming. There is already a critical shortage of clean water on a global basis and mankind’s current stupidity is going to make the situation even worse.

  3. A global power shortage. Very few nations have prepared themselves to generate a significant amount of power from oil, coal or natural gas, Nuclear energy and as such an ill prepared for huge spikes in demand due to an increase in mining and or massive industrial expansion. One only needs to look at South Africa to see this disaster in action.

As a result of increasing power generation issues we might not witness a strong correction in the base metal sector or precious metal sector simply because supplies are going to start dwindling instead of increasing just when the opposite should be occurring.

The Wall Street Journal recently stated that over 35 countries in Africa are suffering from electricity shortages and the situation looks like its going to get worse. Many of these countries economies depend on mining and should these mines shut down or significantly scale back their operations prices of base metals; precious metals etc are going race upwards even faster. In Port Harcourt, Nigeria, residents enraged at paying for almost non existent electricity chased away the power companies’ bill collectors with machetes. The situation is so bad in South Africa that Eskom the main power provider in South Africa asked the government to raise rates by 50% in order to curb demand. South Africa also supplies electricity to Zambia a huge producer of copper and Botswana (diamond producer). Due to recent power outages it has cut supplies to these two nations and these power cuts have affected the mining operations in both these countries. In Jan because of the severe power outages Zambia’s largest mining operation had to completely suspend operations. Note to that China is suffering from power issues as is India. It seems the next to feel the pain will be many mining nations in South America which like their peers have failed to plan for the future when it comes to power. The potential for huge spikes is real as mining operations are very power intensive and if there is not enough power then these operations have to be shut down or significantly scale down. Normally this would not be a huge factor but with the stupendous growth that is taking place in Asia these power outages are only going to make things worse as the demand for these base metals is not going to ease anytime soon.

Even without the oil factor, not enough power plants have been built globally to keep up with future demand. In the US our power grid is hopelessly antiquated and it’s just a disaster waiting to happen. The only nation that is in a pretty good position is France which generates roughly 80% of its electricity from nuclear power.

If you couple the above factors we have the potential of being hit in the 3 most sensitive areas ever, food, power, and water. As always every disaster provides the basis for opportunity and we are constantly looking for new plays to position ourselves to at the very least profit from such potential disasters. In the years to come individuals should start paying close attention to the areas they live in and ask yourself such questions as, where do you get your water from? Does it come from a source that is shared by several states etc? Are you living in an area that has experienced drought for decades in a row? Is there a back up source for water? If the answer to the first 3 questions is yes and the last one no, then seriously consider moving to an area that is better adapted to handle a potential water crisis. One of the largest crises facing the world today that is receiving very little attention is the water crisis.

We use about 70% of the water we have in agriculture. But the World Water Council believes that by 2020 we shall need 17% more water than is available if we are to feed the world. So if we go on as we are, millions more will go to bed hungry and thirsty each night than do so already. Today, one person in five across the world has no access to safe drinking water, and one in two lacks safe sanitation. Today, and every day, more than 30,000 children die before reaching their fifth birthdays, killed either by hunger or by easily-preventable diseases. And adequate safe water is key to good health and a proper diet. In China, for example, it takes 1,000 tonnes of water to produce one tonne of wheat.

When most U.S. citizens think about water shortages — if they think about them at all — they think about a local problem, possibly in their town or city, maybe their state or region. We don't usually regard such problems as particularly worrisome, sharing confidence that the situation will be readily handled by investment in infrastructure, conservation, or other management strategies. Whatever water feuds arise, e.g., between Arizona and California, we expect to be resolved through negotiations or in the courtroom. But shift from a local to a global water perspective, and the terms dramatically change. The World Bank reports that 80 countries now have water shortages that threaten health and economies while 40 percent of the world — more than 2 billion people — have no access to clean water or sanitation. In this context, we cannot expect water conflicts to always be amenably resolved.

In the food markets we might not witness strong corrections also because a large swath of food is being used to generate ethanol, this in turn is pushing farmers to plant more corn and less of the various other food crops, this in turn is driving the prices of other agricultural products higher; it becomes a vicious cycle. Finally the weather has been playing havoc all over the world, many parts are receiving too much rain while other parts are receiving very little to no rain; both are bad for agriculture. If the ethanol craze should catch fire on a world wide basis and nations start to emulate Brazil and start using sugar in the production of ethanol we could witness yet another super spike in the price of sugar.

Extra notes

Vera Sun is building a huge facility in Janesville, MN which should be completed in the 4th quarter of 2008. When complete it will produce 110 million gallons of ethanol and consume over 39 million bushel of corn a year. This company has already built several large ethanol plants and this plant is probably one of their largest to date. It looks like they are also doing their best to contribute to higher food prices. Ethanol producers can keep paying more and more for corn because the price of oil keeps rising and as result so does the price of ethanol; as long as the companies are willing to pay for ethanol, ethanol producers will have no problems paying more for corn. One way to put an end to this would to cut the subsidy currently provided to ethanol manufacturers.

Indonesia, Egypt, Vietnam, China and India have all stated that any surpluses from this year’s rice crop will not be exported. We think these export restrictions will only get worse over time and hence food prices will rise even more. It’s interesting to note and sad how the stupidity of trying to generate fuel from food is going to end up causing massive riots in many third world nations. Kazakhstan the world’s largest exporter of wheat has also decided to halt all foreign sales. Bangladesh has joined the list of countries banning the export of rice and wheat. The world’s major exporter of rice (Thailand) has still not placed any restrictions on rice exports but if it did one can only imagine the chaos this would cause.

The two biggest U.S. warehouse retail chains are limiting how much rice customers can buy because of what Sam's Club, a division of Wal-Mart Stores Inc., called on Wednesday "recent supply and demand trends." Sam's Club declined to say if this is first time it has restricted sales of bulk foods. The limits affect 20-pound bags, not retail-sized portions. Costco President and CEO Jim Sinegal declined to discuss the issue Wednesday with an AP reporter. Sam's Club said it will limit customers to four bags at a time of imported jasmine, basmati and long grain white rice.

UN says soaring price of basic foods such as rice and cereals could affect around 100 million of world's poorest people. Global rice stocks have halved since hitting a record high in 2001 while demand is continuing to rise In Asia rice prices have almost tripled this year alone

Financial speculators, rising populations, floods, droughts, increased demand from developing countries, and removing crops from the food chain to produce bio fuels have been cited as factors. Price rises have led producing nations to enforce export restrictions, further putting the squeeze on supply, especially in countries relying on imports.

China's inflation rose to its highest level in more than 11 years in January after devastating snowstorms worsened food shortages, according to data reported Tuesday, and analysts warned there might be sharper increases to come. Consumer prices in January climbed 7.1 percent from the same month last year, driven by an 18.2 percent rise in costs, the National Bureau of Statistics reported. Economists warned that despite efforts to ease food shortages, China faces pressure for prices to rise across the board due to higher wages and costs for coal, iron ore and other industrial materials.

February inflation "is likely to be much higher than 7 percent, and might even get close to double-digit levels," said Goldman Sachs economists Yu Song and Hong Liang in a report to clients. "Inflation is likely to have further legs to run."

Take all the fools out of this world and there wouldn't be any fun living in it, or profit.

Josh Billings, 1815-1885, American Humorist, Lecturer

Sol Palha



Sol is a self-taught market guru, having read widely conventional and non-conventional texts on all aspects of technical analysis and market timing.