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December 28, 2005

Scarcity
by Ron Ellison

All in a hot and copper sky,
The bloody Sun, at noon
Right up above the mast did stand,
No bigger than the moon

Day after day, day after day
We stuck, nor breath nor motion;
As idle as a painted ship,
Upon a painted ocean
Water, water everywhere,
And all the boards did shrink;
Water, water everywhere
Nor any drop to drink

Samuel Taylor Coleridge

How would you like to pay 48 percent more this year for an item that costs you about $150 last year? Well, that's exactly what is happening to many Americans this winter.

According to the U.S. Energy Information Administration, households that heat with natural gas this winter face just such a prospect. Natural gas is the primary heating source for approximately 55 percent of U.S. homes. Ninety percent of all new homes being built use natural gas. And what about those who heat with coal? The picture is similar. Industrial and private users have seen the price of coal soar over the last 24 months. A good portion of the country's energy supply comes from coal-fired utilities.

Prices of coal stocks shot up last year and at least two coal companies came public. That should reveal something about the old saying: "When the ducks quack, feed them." Bottom line: Coal suddenly was too expensive to stick in Xmas stockings in 2005. And if our take on the energy situation is even remotely correct, those decorative stockings won't be seeing any lumps of the shiny, black stuff any time soon. You might want to bet on some enterprising toy company to come out with ersatz, biodegradable coal to stuff those stockings of the future.

When oil prices spiked many economic seers and other market gurus rolled out their trusty but trite mantra that on an inflation adjusted basis crude was still cheap. That's interesting. By our calculations if you figured the inflation rate the old fashion way, before they began fiddling with the figures and the indicators, inflation is now running about 6.5 or 7 percent. That's nearly three to three and a half times what most money market funds yield. It also reflects a similar ratio to what officials say is the current inflation rate. And if you believe that the government doesn't have good reason to keep inflation fears under wraps, you probably believe that Mata Hari was a nun.

So what's an investor to do? Buy the pullbacks. Energy and utilities led the market in 2005. The dollar rebounded also, surprising many experts. It's rare for a hot sector to lead the market two years running, though it does happen as when technology stayed hot for several years. With energy, however, and here are those famous words, it's different this time; you are not buying it for 2006. You're buying it because of myopic bureaucrats, overly zealous environmentalists, uneducated educrats and simple, pure demand. Current capacity is about 85 million barrels a day. Current demand is 84.5 million barrels per day. The Saudis claim they can crank out more crude, but talk, as the saying goes, is cheaper than a barrel of oil.

Energy is indispensable to the economy, technology, national defense; and energy is indispensable to you. And you're also buying it as an inflation hedge. Forget the CPI, not to mention the so-called experts. If it's costing you more to heat or air condition your home and fill-up your gas tank, that's inflationary to you. And who cares more about you, despite Bill O'Reilly's nonsense, than you do? And that's no spin.

Consider it a put option on what can go wrong no different from that insurance policy you have on your car or your home. The only way those policies get more valuable is for those insured items, your car and your house, to lose value owing to theft or an accident. Insurers call it event risk. When that happens, if it ever does, you're really glad to have those policies. Consider the price of owning some energy shares similar to the deductible you pay on those policies; the only difference those policies usually don't pay any dividends or provide any income. Most energy stocks can and do.

And while you're at it toss in some gold and water and foodstuffs. Again think pullbacks here. Two-thirds of the earth may be water, but as Coleridge pointed out in The Rhyme of the Ancient Mariner precious little is potable. And less than 25 percent of the world's households have running water. If demand for energy is on the rise, and it is, the demand for food and water won't be far behind. It may be true that man has ingenuity and technology at his disposal; and those things have helped bail him out of difficulty before. But both of those are based on one great big assumption: he is allowed to use them. Betting that such is an automatic is akin to believing because things have been this way they will stay that way.

Years ago when I took my first job at the headquarters of a major bank in a major city most of the elevators had elevator operators. You now have a generation of folks who wouldn't recognize one if they saw one, so much for domestic outsourcing. Investors, like literary critics, need to understand the limits of understanding. Nature is at once familiar and mysterious and nothing less can be said of the human kind.

Ron Ellison
Blasingham and Ellison Financial Group

Ron Ellison is a principal of Blasingham and Ellison Financial Group, a money management firm in Newport Beach, California, and can be reached at www.Befg1.com.

Copyright © 2005-2007 Ron Ellison

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