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June 04, 2004

The Terror Factor
by David Chapman

For the second time in a month and for the fourth time in two months, armed insurgents attacked westerners in Saudi Arabia this time killing 22 civilians. Oil prices predictably jumped over a $1 on fears that further attacks will be made against the Saudi energy infrastructure. The message being delivered to the Saudi Royal family is clear that if they raise production the workers that Saudi Arabia depends on to maintain their oil production will be targeted. As well there are kilometres of pipeline in the country all of which can not be guarded constantly. Given the ease that insurgents have been able to hit pipelines in Iraq it should not be any more difficult in Saudi Arabia.

Of course the Saudi regime, which has remained relatively loyal to the US, is caught between a rock and hard place. They have undertaken to increase production at the same time that OPEC is already over producing and US refinery capacity is at its limits. OPEC members are generally more hard-line towards the US regime then are the Saudi regime who in a sense owes their continued existence to the US although they have clearly fallen out of favour with the current administration because of their possible ties and financing of Al Qaeda. Other OPEC countries that are also ruled by regimes that owe their existence to the US include Bahrain, Kuwait, Qatar and Abu Dhabi. All are committed to supplying or increasing oil supply so as to ensure a secure supply and in an effort to ease high prices and curry favour with the US.

Despite all this does it mean very much? Oil prices have been all over the place in the past few days. First they soared to new all time highs at $42.33 then they reversed and fell sharply the next few days when the announcements were made. But as many analysts point they are already pumping as much oil as possible before so this announcement doesn't really change very much. Many believe that the price of oil is upwards of $15 over priced because of the terror factor. Some believe it is because speculators are driving up the price egged on by the terror factor in Saudi Arabia and the ongoing disruptions in Iraq.

So will this announcement make any difference? In the short term it will take some of the speculative fever out of the oil price but with oil increasingly a strategic commodity not only is the US trying to rebuild reserves, China, India and others are also trying to build their reserves because of the concern about possible supply disruptions. Irregardless this will keep pressure on oil prices. That coupled with the firm and growing demand in China and India coupled with very little in the way of new supply coming on the market would have ensured that prices would rise over time anyway.

The insurgents are not about to go away. To dismiss them as terrorists seems far too simplistic. To think that all of this is driven by some guy running around in the mountains of Tora Bora actually boggles the imagination. The truth is that a corrupt and privileged elite rule a country where unemployment is rising and incomes are falling and there is no room for nary a liberal voice. The only real opposition is religious conservatives who are learning from the insurgents in Iraq that you can take on a more powerful force and demoralize them. That is not new either as the Russians found out in Afghanistan and before them the Americans in Vietnam.

So expect the terror factor to return. And expect our own complicity to continue by continuing to put the emphasis on security of supply rather than focusing on energy savings. Saudi Arabia is not the only potential hot spot as things remain problematic in Nigeria and there is continued potential for instability in Venezuela. But is all of it in the cards anyway? Our charts have continued to indicate that near term at least the targets for oil are $55 to $58 and longer term at least $70. Oil has been climbing in a very bullish pattern. If instead we had gone straight up as we did in 1990 at the time of the Gulf War 1 then we would agree that can not hold. But the weekly chart of oil clearly shows a bullish stair step fashion.

There is huge expectation now that the OPEC increases have been announced that energy prices have peaked. But oil installations in Saudi Arabia and other Gulf producers were not built for security. So they remain highly vulnerable to attacks, as does the human infrastructure of foreign workers that supports the oil industry. Instructions have been issued to foreign workers to get out of Saudi Arabia. A number of the insurgents in the recent attacks actually escaped and there were a report that some were in Saudi military uniforms suggesting that the use of deception to gain access to sensitive areas is in play. Of course deception is an old trick and has been used for years with great success by in particular the Israeli Mossad whose motto is "By way of deception, thou shalt make war". Even though reserves are being rebuilt a severe supply disruption remains a serious risk.

But Saudi Arabia is not the only place where the terror factor may play. Homeland Security recently announced that there is a very high probability of a terrorist attack in the United States in the coming months. The announcement was premised that the intelligence was that Al Qaeda had specific intentions to attack the US hard. Coming of course after the attack in Madrid on March 11, 2004 (oddly 911 days after the September 11, 2001 attacks taking out the leap year) the announcement has to be taken seriously. Of course once again the thought of someone running around the mountains of Tora Bora directing a major terrorist attack leaves a lot to the imagination.

But it goes deeper. It was even suggested that the intelligence was confirming that they were seeking recruits who could portray themselves as Europeans. That of course boggles the imagination again as that could literally be anyone including you or me. Photos were released of suspected operatives and one, Aafia Siddiqui, a microbiologist with a degree from the Massachusetts Institute of Technology, was reported to have been in the custody of Pakistan in 2003 and according to reports handed over with other Pakistanis to the US.

The terror factor will become more heightened as we move closer to the election in November. Already it has the possibilities of disrupting the election. Yet terror alerts have been a constant in the US since September 11 where nothing of course has happened. Thus far the highest alert has been Orange but if a Code Red were ever issued it would effectively shut down the United States and place it under military rule. Any rise to Code Red and an actual attack would of course shake the markets severely.

Whether a terrorist attack takes place prior to the election is of course not a given. But what is assured given the terrorist alert already seen is that the terror factor will remain prominent. It is not as important whether one actually occurs as it is to maintain a high level of probability that one could take place. The fear of a terror attack. This suggests to us that the markets should remain weak into the election. Certainly the 1934 cycle pattern that has thus far dominated this year (Michael Jenkins - Stock Cycles Forecast) suggests a drop in the markets into July followed by another rebound then a drop into September. The markets begin to improve in November.

The third terror factor is not really a terrorist attack at all but what call monetary terror. It is the massive growth in money supply (M3) seen thus far this year. Figures to the end of April suggest growth in M3 could exceed $1 trillion this year alone. Recent numbers have been on pace for the equivalent of $2 trillion. In an article by Robert McHugh (Financial Markets Forecast and Analysis - May 30, 2004) he has suggested "that by raising money supply (M3) by crisis proportions .... What awful calamity do they see? Something is up .... Unprecedented, unheard of pre-catastrophe M3 expansion...."

We don't doubt that the Fed is acting irresponsibly by setting the conditions that allow an increase in M3 at this very high rate. But the Fed only has direct control over M1 (as does the Bank of Canada). The remainder comes in the banking system and can be driven by sharp increases in loans whether it is by consumer credit, mortgages or business loans. We await these numbers which we suspect have increased sharply of late.

Still it puts a lot of money awash in the system and it can wind up in the stock market to help continue fuel a stock market rise and it can help continue to fuel the housing bubble and some of it can actually help in creating more jobs which have been reflected in the job numbers. That a big chunk of them remain in the service sector that could be here today, gone tomorrow remains a negative. And the risk of interest rate increases remains high where Fed Funds futures have now priced in a 100% chance of a rate hike by the end of June.

One thing for sure is that continued sharp increases in M3 and in debt growth only heightens the potential for a future rise in the price of gold. What the growth in M3 ensures is that the US currency continues to be debased. The US$ Index is toying once again with a breakdown. A break down in the US$ and the high potential for the terror factor whether in Saudi Arabia against oil installations or on US soil could lead to financial chaos, all excellent conditions for rising gold prices.

An interesting chart we came across recently is the Fear Index created by James Turk of www.goldmoney.com. The Fear Index formula is:

US Gold Reserves X Gold's Market Price
M3

Our chart shows the Fear Index over the past 38 years. We have now broken out of the third fan line we drew from the top made at the highs of gold prices in January 1980. This tells us that a new bull market in Gold is underway with confidence in the US$ and the monetary/banking system is falling. When the index is declining, as it did from 1980 to 2001 confidence was rising in the US$ and in the monetary/banking system. There were a few incidences of a rise in the index as seen in the early 1980's at the time of the Mexican debt default and other third world debt defaults particularly in Latin America; the late 1980's during the Savings and Loans crisis; and, again in the mid-nineties at the time of the Mexican Peso Crisis and the US bond market collapse in 1994.

There is the old saying "we live in interesting times". And today not only do we live in interesting times we live in very dangerous times. The war on terror and the potential for a collapse in the monetary/banking system is enough to shake anyone. Making it worse of course is that the news we get in the mainstream media contrasts sharply with the reports of numerous analysts and stories on the Internet.

On June 25^th the film "Fahrenheit 9/11" is to be released. This is the controversial film by Michael Moore that raises many questions about what really happened on September 11, 2001 including drawing links between the Bush and the Bin Laden families. As well there are numerous web sites devoted to what really happened on September 11, 2001 and inquiries asking questions that are not being answered by the official commission on September 11 and versions that do not jibe with what we have been told. When we combine this with the terror factor that is currently there in Saudi Arabia and in the US it promises to give us a potentially volatile summer leading into an election where the incumbent President is failing at the polls. And if we have a volatile summer on the terror front then that also promises to bring increasing volatility to the financial markets.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.

Copyright © 2002-2008 David Chapman

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