Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Mon. Feb. 21, 2005
Dear Subscriber,
Early Friday morning, as a bitterly cold wind blew into
lower Manhattan from the Northwest, bond traders
commuting to Wall Street were expecting to see an
equally cold report on the nation's producer price
inflation.
They figured that, excluding energy and food, last
month's rise in core producer prices would be contained
to a meager 0.2%. They assumed that investors in U.S.
bonds would rejoice, as usual. And they counted on many
more months of low, soothing interest rates.
Instead, soon after they arrived at their bond trading
desks, they were greeted by a short burst of
pandemonium.
Reason: The U.S. Bureau of Labor Statistics announced a
shocking 0.8% surge in core producer prices.
It was FOUR times what they expected, the worst since
December 1998 ...
It was running at an annual rate of 9.6% ...
And it was raising the ugly specter of double-digit
inflation!
The news hit the markets like a ton of bricks ...
injecting a megadose of fear into the hearts and minds
of investors ... sending bond prices into a tailspin
... driving interest rates skyward ... and raising a
series of urgent questions for all investors, including
you:
* If price indexes are beginning to rise at
nearly double-digit rates, will long-term
interest rates start heading toward double-digit
levels as well?
* If so, how soon will home mortgage rates start
surging? And if mortgage rates surge, what will
they do to the value of your real estate properties?
* Crude oil is already creeping back up toward
$50 per barrel. If it goes to $60 or $70 per
barrel, like many experts expect, what will THAT
do to U.S. inflation, bonds, mortgage rates ...
and your real estate? And what will it do for
your energy stocks?
* Three weeks ago, Martin on Monday warned that
the ethnic and political conflicts in Iraq would
spread to neighboring countries. Since then, we've
seen outbreaks of new troubles in Lebanon, Syria
and Iran. If this pattern continues, THEN what?
I can't answer all these questions in full this
morning. But I WILL give you a thumbnail response to
each, plus some pointers on where to go for more
information and decision-making tools.
LONG-TERM INTEREST RATES
FINALLY ABOUT TO TURN UP
Strangely, for the past few months, even though short-
term rates have been going up, long-term rates had been
going down.
Why? One reason was because so many people were duped
by assurances that inflation was tame and under
control. But now, that's changing -- and fast. Bond
investors, bankers, and even members of the Federal
Reserve Board are finally beginning to admit that U.S.
inflation, which had been incubating for many months,
is now threatening to blast off.
They can't ignore the fact that cigarette prices jumped
3.4% in January and auto costs surged 1.2%. Nor can
they pooh-pooh the fact that, even WITHOUT these two
items, core producer prices STILL jumped by 0.7%.
Bottom line: We're now seeing across-the-board producer
price surges in almost every single sector.
Result: The Fed cannot and probably WILL not maintain
its so-called "measured pace" of interest-rate hikes.
Instead, the Fed must begin to jack up interest rates
at a faster clip ... raising its Fed Funds rate by a
half point at a shot ... sending a new round of shock
waves into the financial markets ... and, this time,
truly driving long-term interest rates higher.
REAL ESTATE BOOM ... AND BUST!
The specter of double-digit inflation and rising
interest rates couldn't have emerged at a worse time
for America's real estate.
I'm not predicting that America's real estate bubble is
going to pop tomorrow. But it's clearly time to add a
strong element of caution to any real estate decisions
you may be making. Indeed, warning signs are beginning
to surface from various sources:
Warning #1. Mortgage demand, including refinancings,
has plunged dramatically -- down 24% in a year, 65%
from its peak. And even excluding refinancings, it's
off sharply. This is critical: Without mortgages,
consumers rarely buy homes. And without the critical
demand from American households, the primary demand for
housing could break down.
Warning #2. There are more new homes for sale now than
at any time in history. This abundant supply is not yet
being dumped on the market. But an avalanche of
unwanted, difficult-to-sell supplies could be in the
making.
Warning #3. Although home values have been unusually
strong, home rental rates have been unusually weak. As
a result, the price-to-rent ratio for existing homes is
at a record high. If rental rates don't begin to rise
soon, real estate investors will lose their incentive
to buy rental properties.
OIL PRICES SURGING -- AGAIN!
Crude oil prices rebounded past $48 per barrel on
Friday.
And as you can see from this chart, since the beginning
of this year, they've been building up for a new blast-
off -- first to challenge the $50 level ... and then to
challenge the all-time high of $55 per barrel reached
last November.
But even if oil prices fail to surge at this juncture,
the very fact that they have been HOLDING above $40 per
barrel since last summer has been a boon for virtually
every company in the energy sector, even those that use
little or no leverage and aim mostly for income.
In any case, rest assured there is no change in my view
about energy trusts. I still like them -- which
is why I am recommending subscribers hold the balance
of their positions.
Naturally, the more aggressive you get, the more risk
you incur. But the energy sector is not just for
investment and speculation. It's also something you may
want to consider as a hedge -- a protection against the
damage rising oil prices can do to the economy, to the
stock market, and to your personal assets.
Here's how it works: If we don't see a sharp rise in
energy prices and inflation, your other investments
should do well. If we do see the sharp rise, your
energy investments should do well. In either scenario,
you're likely to be covered.
My advice: If you don't own the energy trusts we've
been recommending, allocate some of your liquid assets
to them right now, buying half at the market and the
balance on the next correction. In addition to powerful
supply and demand forces, one key reason is this ...
THE ETHNIC CONFLICTS I WARNED YOU ABOUT
THREE WEEKS AGO ARE ALREADY SPREADING
As you may recall, three Mondays ago, on the morning
after the Iraqi elections, I wrote:
In most of the West, governments are welcoming
Sunday's landmark election in Iraq as a victory
for direct democracy, a form of government born
in Athenian Greece circa 508 BC.
In the Middle East, however, many are viewing the
Iraqi election primarily as a new, potentially more
violent chapter in the war between Shiite and Sunni
Muslims -- an ethnic/religious conflict born with
the death of Muhammad's grandson during the battle
of Karbala in 680 AD, over thirteen centuries ago.
Both of these interpretations are largely correct,
and both are being hotly debated throughout the
region. But only one will determine the course of
history.
If democracy prevails, it's assumed that, in the
best-case scenario, the region's oil supplies will
flow freely, the world economy will continue to
grow, inflation will not be inflamed, and investors
will prosper.
If the Shiite-Sunni conflict prevails, however,
the picture changes drastically. In this worst-case
scenario, the Sunni population rises up in a broader
rebellion, Iraq bursts into civil war, the conflict
spreads to neighboring countries in the Persian Gulf,
and the world's most critical oil supplies are
severely disrupted.
I hoped it would be the more peaceful scenario and, God
willing, it still can be. But right now, the conflict
has already begun to spread in ways that no one, myself
included, could have predicted three weeks ago. Instead
of spreading into the Persian Gulf, new troubles have
first struck the neighboring countries of Syria and
Lebanon:
* One week ago, on Monday, February 15, a car
bomb in Beirut killed former Prime Minister Rafik
Hariri of Lebanon. This is a country that had
finally recovered nicely from a long civil war
among Sunnis, Shiites, and other ethnic groups.
Now, according to the New York Times, the
assassination was "the most serious blow to the
stability of Lebanon in more than a decade."
And according to the Bush administration, it
was a "terrible reminder" of the need for Lebanon
to break loose from Syria.
* U.S. tensions with Syria, already near the
boiling point, literally went off the charts
-- with the U.S. withdrawing its ambassador,
with Defense Secretary Rice launching a verbal
attack, and with Iran and Syria threatening an
unholy alliance to defend themselves against any
future U.S. aggression.
* In Iran, meanwhile, unexplained explosions in
the same province as Iran's major nuclear
facilities rocked not only the region but the
world's financial markets.
And ironically, all this happened soon after elections
in Palestine, Iraq, and even in autocratic Saudi
Arabia.
So again, recent events beg the question: Which will
prevail -- democracy or chaos?
I hope and pray it will be the former. But at the same
time, there's little doubt about this fact of life:
Democracy alone -- whether legitimate or feigned --
does not preclude chaos in the short term.
Nor can any reasonable observer question the fact that
the spreading chaos is a growing threat to oil in the
region. Take a look, for example, at this chart of
Iraqi oil production in the last four years.
After a natural bounce-back following the Iraqi war
last year, little additional progress has been made in
boosting output. And in the most recent month for which
we have data, oil production fell again, matching the
lowest level in over a year -- largely due to insurgent
attacks.
What's most distressing to all of us who are closely
watching the Iraqi situation is that the insurgency is
not dwindling, let alone ending. Despite the capture of
Saddam Hussein ... despite the hand-over of power to
the Iraqi interim government ... despite the elections
last month, the threat to oil production in the region
is not receding.
Forbes puts it this way:
The oil export facilities face problems from
attacks (which may get worse) and from technical
problems (which are clearly getting worse). Rumors
of serious technical problems with the Northern
Fields have been rife for many months. Production
fell from 2.4 million barrels per day in October
to 1.5 million b/d in December. At the end of
January, problems with water injection meant that
exports of Basrah Light for February would be cut
from 1.6 b/d to 1.45 million b/d ...
Although some oil majors are showing interest in
providing technical assistance, no serious
investment will take place until there is a credible
and recognized government with serious legislation
in place to govern upstream oil agreements. This is
a long way off given that the constitution will
almost certainly not be ready by the mid-October
deadline. Similarly, violence against oil
installations will continue, perpetrated by a
combination of Sunni dissidents and foreign
jihadists, who understand that these attacks
are a way to damage a U.S.-backed administration.
Prognosis: A continuing trend toward double-digit
inflation and, in its wake, double-digit interest
rates. Don't get caught off guard. Be ready!
Good luck and God bless!
Martin
Rogue
