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Musings from the Oil Patch

Musings from the Oil Patch Thanks to a subscriber for this edition of Allen Brooks ever interesting report for PPHB. The full report is posted in the Subscriber's Area but here is a section on the sustainability or otherwise of the secular bull in commodities:

There appears to be a growing number of variations on the theme of the end of the commodity super-cycle that Mr. Morse has suggested, but his seems to be the most well thought out. He believes this seismic shift in the commodity sector means all commodities will be impacted, although others believe the shift will cause little disruption. Mr. Morse believes that returns from investing in commodities will be more differentiated among raw materials in the future depending on their specific supply/demand balances. This is why he argues that long-only commodity investment strategies will not be as successful in the future as in the past. His view contrasts with that of Jeremy Grantham of investment manager GMO. Mr. Grantham recently authored a detailed analysis of the long-term future of the U.S. economy and proclaims that its historical growth of 3% per year is now no longer possible due to demographic and productivity trends that he sees little hope of reversing. Furthermore, he believes that resource prices are likely to continue rising at the 7% per year rate he says has existed since 2000 as we run out of cheaper resources to exploit. The combination of these trends suggests to Mr. Grantham that our future economic output will be consumed merely trying to secure the resources to keep it running, thereby providing little or no growth in the future. There is even the possibility that our economic trend could begin to decline if any of these trends proves worse than he anticipates.

My view There has been a great deal of debate about the commodity complex and the sustainability of historically high nominal prices over the last couple of years. A simple reduction to supply and demand dynamics offers perhaps the most accessible way of addressing this issue. Let us consider some inflation-adjusted charts in monitoring commodities.

The evolution of the unconventional oil and gas sector in the USA has been a game changer for the energy complex. This source of new supply has so far only been exploited in North America but is replicable elsewhere and it is only a matter of time before this is accomplished. The result is that while 10 years ago there was a widespread perception that new sources of supply were unavailable, the allure of higher prices has encouraged entrepreneurs to figure out how to tap previously inaccessible reserves. On the demand side, higher prices have forced consumers to become more efficient and this trend is likely to persist. Therefore when we look at the long-term outlook for energy, the potential for oil prices to drift lower over the next decades and more is quite compelling. However, even in the most bearish scenario, much of the new supply is comparatively expensive to develop. Whereas $40 was a ceiling for decades, it is likely to offer a floor in future. Here is the inflation-adjusted chart.

This section continues in the Subscriber's Area.

First Savings Drop Since 1999 Limits Rate-Cut Room
This article by Jeanette Rodrigues for Bloomberg may be of interest to subscribers. Here is a section:

Inflation remains sticky, Harihar Krishnamoorthy, Mumbai-based treasurer at the Indian unit of FirstRand Ltd., South Africa's second-largest financial services provider, wrote I a Jan. 11 e-mail. Thus it's unclear whether there could be space for larger policy cuts, especially in the light of deposit growth lagging advances in the banking sector. While gains in the benchmark wholesale price Index slowed for the third straight month to 7.18 percent in December, official data showed Jan. 14, they have exceeded 7 percent since December 2009. Consumer prices accelerated for the third month in December to 10.56 percent, compared with increases of 5.84 percent in Brazil, 6.6 percent in Russia and 2.5 percent in

RBI Governor Duvvuri Subbarao said yesterday inflation remains quite high and policy makers lack room for stimulus measures. Economic growth remains a concern, and India will be lucky if gross domestic product expands 5.5 percent in the year to March 31, he told management students in the northern Indian city of Lucknow. That would be the slowest pace in a decade. The central bank will lower its benchmark repurchase rate by 25 basis points, or 0.25 percentage point, to 7.75 percent at its Jan. 29 policy review, nine of 11 analysts said in a Bloomberg News survey last week.

My view China and Japan have garnered the majority of column inches over the last month as political and macro factors drove rallies from relatively depressed levels. However the Indian stock market's performance is also noteworthy.

Bottlenecks in the supply chain and an inefficient bureaucracy have long contributed to not only high inflation but the sticky nature of this phenomenon. This is why Manmohan Singh's decision to embrace reform last year is so important. Inflation remains high but there is now the prospect that some of the factors gumming up the system will be dealt with.

This section continues in the Subscriber's Area.

Email of the day on additions to the Chart Library:

Can you pls add Kunlun Energy HKG:0135, China Resources Gas (HKG1193)? Many thanks.

My comment Thank you for these suggestions which have been added to the Chart Library.

Email of the day on spread-betting as a way to play Japan without the currency risk:

I was surprised that your comments on how to hedge exposure to the yen when investing in the Japanese stock market that you didn't mention spread betting. Buying the Nikkie is a straight bet on the level of the index and does not involve the yen.

IG index quotes the March 2013 (which expires on 1 April) with a 0.2% spread.You would have to roll it 4 times per year to maintain the bet, presumably giving an annual cost slightly under 1%. Are you aware of any spread betting company offering a longer term contract? IG index offers a one year bet on the UK FTSE 100 index."

My comment Thank you for mentioning spread-betting which allows investors a tax efficient, leveraged means to access markets without currency risk and is available to UK and Irish investors residents. David has also mentioned spread-betting as a potential vehicle for accessing Japan in the Subscriber's Audio over the last month.

This section continues in the Subscriber's Area.

Please note - David is away today on Fullermoney business but returns tomorrow.

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