Inflation is up significantly from the 1.7% increase reported in April, Statistics Canada reported yesterday (Thursday). And high gas prices are to blame as fuel costs rose 15.0% in May compared with the same month last year – that’s considerably faster than the 12-month change of 11.6% posted in April.

Excluding gasoline prices, 12-month inflation grew 1.6% in May.

Last week, the central bank voted to keep its overnight interest rate at 3%, warning that inflation risks have “shifted slightly to the upside.” But the bank quickly followed that up by saying global demand for Canadian goods and services remains strong despite a U.S. slowdown.

“This report will not push the bank to raise rates in 2008, but we do see 100 basis points of hikes coming in 2009 as Canada’s inflation problem heats up,” Meny Grauman, an economist with CIBC World Markets Inc. in Toronto, said in a note to clients, Bloomberg News reported.

With an end to the rate cuts, the Canadian dollar is on the rise. The loonie has gained 1% since the June 10 decision to hold rates steady, Bloomberg reported.

Recession Protection?

Earlier this month, Canada announced its gross domestic product (GDP) shrank 0.1% in the first quarter, marking the country’s first decline since the second quarter of 2003.

But this is where inflation could actually be a friend.

In today’s world, where interest rates are low and commodity prices are high, Canada’s in a very strong position for two reasons:

• It has oil reserves – somewhat larger than the Middle East – in the form of the Athabasca oil sands.

• And it’s the world’s largest producer of uranium, with 25% of the world market. (Australia is a close second, with about 23%.)

Since Canada is a chief oil exporter, its oil companies are on the receiving end of soaring prices. And in turn, that helps pad the economy’s pocket, becoming an unlikely protective barrier to another quarter of negative GDP growth.

Also working in the economy’s favor, month-to-month wholesale sales jumped 1.4% in April, more than doubling forecasts of 0.6%, Reuters reported. This suggests that domestic demand is able to wade through inflationary waters and lends credence to justifying a future interest rate hike.

The Bank of Canada’s next scheduled date for announcing the overnight rate target is July 15.

Source: Can Inflation Save Canada from Recession?

However, during a visit with Saudi Arabia’s King Abdullah U.S. President George W. Bush was able to convince the world’s leading oil exporter to increase its output.

Light sweet crude for June delivery jumped $3.31 a barrel, or 2.7%, to reach $127.43 in electronic trading on the New York Mercantile Exchange. Oil prices have now soared 103% in the past 12 months.

The jump was largely attributable to a new prediction from investment-banking giant Goldman Sachs, which raised its price forecast for the second half of the year to $141 a barrel. Goldman Sachs analysts had previously quoted a price of $107 a barrel.

“Supply constraints continue to push crude prices higher,” Goldman analysts wrote in a research note Friday. “The dire macroeconomic impact from the current oil shock has yet to materialize.”

This is the second time in as many weeks that a Goldman Sachs oil-price prediction has ignited a trading tempest in the crude-oil markets. Goldman Sachs, JP Morgan Chase & Co. (JPM) and CIBC World Markets Inc. each recently put forth scenarios that have oil surging over $200 a barrel in the next two years, as soaring gas prices and wary U.S. consumers have failed to put a significant dent in oil demand.

In their report, CIBC analysts actually predicted that gasoline would reach $7 a gallon within four years as oil prices surged to $200 a barrel.

However, Money Morning Investment Director Keith Fitz-Gerald – a longtime energy bull – has actually gone a step further suggesting prices will spike as high as $225 a barrel.

That projection represents a revision from a market call he made in December, when crude prices were in the $90-a-barrel range: At that time, Fitz-Gerald caused a stir when he predicted that oil prices were headed for $187 a barrel. He reiterated that prediction back in early March – just before the investment-banking crowd started making their hefty forecasts for oil and gasoline.

“The math is really simple here,” Fitz-Gerald said in an e-mail interview from China, where he was heading an investment-research tour. “We are burning through supplies at a rate that’s four times to five times faster than we’re discovering new reserves. Throw in a few [surprises] … perhaps a terrorist event …and add in the accelerating use of oil and gasoline in Third World countries, and we have the recipe for far higher prices. That’s already in the oven.”

In addition to the proprietary strategy he uses to project market prices, Fitz-Gerald said he relied on some of the observations he’s been making as part of the investor trip he’s leading through China.

After all, with all the bustle and development taking place in that country, all it takes is for one to stroll down the street to see that the demand for oil and gasoline is going to increase far faster than most analysts would ever believe.

“Nowhere is that more evident than China where I’m traveling now,” Fitz-Gerald said last week in an e-mail from Mainland China’s capital. “Beijing alone is adding 14,000 vehicles a day (1,500 of which are just cars). Across China, the number is obviously higher. [The] same [is true] in India, but I don’t have the figures at my fingertips. Then there’s the other side … evidence suggests that OPEC reserve figures may be artificially high. Imagine what’s going to happen when people figure out that there really isn’t as much oil as everybody thinks. $225.21 is not out of the question … after we get to $187.”

Famed investor Jim Rogers shares Fitz-Gerald’s belief that the Organization of Petroleum Exporting Countries (OPEC) may be guilty of some subterfuge in reporting its reserves.
“Saudi Arabia has announced for 20 years in a row that they have 260 billion barrels of oil in reserve,” Rogers recently told Money Morning during an exclusive interview in Singapore, where he now makes his home. “It’s astonishing. The figure never goes up and it never goes down. They have produced dozens of millions – billions – of dollars of oil in that period of time.
“If you go to Saudi Arabia you have to wonder: ‘How could this be? How could it be that every year for 20 years in a row, you always have 260 billion barrels of oil in reserve?’ The Saudis say: ‘You either believe us or you don’t.”And that’s the end of the conversation.”

Saudi Arabia Changes Its Tune

OPEC nations have routinely resisted calls to increase output, insisting that investor speculation has hijacked the market and high oil prices have nothing to do with demand, which they see declining as the U.S. economy continues to slow. OPEC, which pumps more than 40% of the world’s oil, has kept output targets unchanged during its past three meetings, on March 5, Feb. 1, and Dec. 5.

In fact, in its Monthly Oil Market Report for May, the cartel said global demand for oil would grow at a significantly slower rate than previously forecast. World oil demand will rise by 1.16 million barrels per day (bpd) – 40,000 barrels per day less than previously predicted.

However, OPEC analysts also acknowledged that non-member nations would produce less oil than originally thought, and after President Bush met with King Abdullah Friday, there was a sudden reversal of fortune.

Late Friday, Saudi Oil Minister Ali al- Naimi said the country would raise output by 300,000 barrels a day to 9.45 million barrels a day in June, Bloomberg Newsreported.

“On May 10 we increased our response to our customers by 300,000 barrels because they asked for it,” al-Naimi said. “So our production for June will be 9.45 million barrels per day. This is the request of about 50 customers worldwide.”

In its monthly report, OPEC said its production fell by about 390,000 barrels a day in April, mostly due to violence in Nigeria. The same report said Saudi Arabia’s April production was 9.02 million barrels a day, down 37,000 barrels a day from a month earlier.

The increase comes as gas prices climbed to historic highs, drawing the ire of many U.S. politicians. It so happens that Saudi Arabia has a number of deals on the docket with the United States that risk interference should high oil prices persist.

The case for the target-price increase of 20% was very clear.

“The math is really simple here,” Fitz-Gerald said in an e-mail interview from China, where he was heading an investment-research tour. “We are burning through supplies at a rate that’s four times to five times faster than we’re discovering new reserves. Throw in a few [surprises] … perhaps a terrorist event …and add in the accelerating use of oil and gasoline in Third World countries, and we have the recipe for far higher prices. That’s already in the oven.”

Crude-oil futures jumped up over the $123 a barrel level yesterday (Wednesday) – closing at an all time record – as worries about worldwide oil supplies continued to sweep away any good news in the energy sector. In fact, prices have soared more than $11 a barrel – or 9.8 % – over the past four days alone, reaching back to last Thursday, MarketWatch.com reported.

But it wasn’t the price increases that prompted Fitz-Gerald to boost his oil-price target. In fact, he did that last week. In addition to the proprietary strategy he uses to project market prices, Fitz-Gerald said he relied on some of the observations he’s been making as part of the investor trip he’s leading through China.

In that country, all it takes is a stroll down the street to see that the demand for oil and gasoline is going to increase far faster than most analysts would ever believe.

“Nowhere is that more evident than China where I’m traveling now,” Fitz-Gerald said last week in an e-mail from Mainland China’s capital. “Beijing alone is adding 14,000 cars a day. Across China, the number is obviously higher. [The] same [is true] in India, but I don’t have the figures at my fingertips. Then there’s the other side … evidence suggests that OPEC reserve figures may be artificially high. Imagine what’s going to happen when people figure out that there really isn’t as much oil as everybody thinks. $225.21 is not out of the question … after we get to $187.”

Alternative energy is the only answer, Fitz-Gerald says. But some of that is years from being commercially viable – cheap and reliable enough to be affordable to, and used by, mainstream consumers.

“Barring the introduction of a truly [alternative] and inexpensive technology, this is going to get ugly … and very pricy before it gets better,” Fitz-Gerald wrote. Investors need to be “long energy, long commodities” for right now, and for the foreseeable future.

China is doing all it can to overcome the massive energy deficits that it faces. One such project is the massive Three Gorges Dam, which Fitz-Gerald had visited the day of his interview with Money Morning.

“It’s surreal how big this project really is,” he noted.

Fitz-Gerald sees oil-and-gasoline prices going higher – much higher. And four factors will be the key catalysts. They are:

• Obfuscation by OPEC: Members of the Organization of the Petroleum Exporting Countries have been misrepresenting their reserve capabilities for years. The key players have reported no new discoveries for decades.

• Terrorism Threats: The odds that a terrorist act will interrupt oil supplies – in the near term or the long term – are higher than most security experts would ever publicly confirm, Fitz-Gerald says. And this is especially problematic because of the double-whammy effect: Damage to a major pipeline or a strategic refinery could crimp supplies just as demand is continuing to escalate.

• The Dollar Doldrums: Oil is priced in dollars. And the dollar is in the dumper. Indeed, rising inflation and falling interest rates have put the greenback into a steep downward spiral. And if prices keep rising, and if Federal Reserve policymakers keep cutting short-term interest rates, the dollar will continue to lose altitude against other key global currencies. OPEC members will counter the greenback decline by marking up the price of crude, causing prices to increase still more in dollar-denominated terms.

• Cruising Goes Global: As an increasing number of households in China, India and other advancing overseas economies join the world’s middle class, they’ll start making such basic purchases as electronic goods, houses – and automobiles. The fact that China’s oil imports jumped 18% in one month is evidence enough that this is happening. And the fact that leading India automaker Tata Motors Ltd. (TTM) has unveiled a $2,500 car, the Nano, underscores that international carmakers are looking to recruit a whole new group of motorists. The fallout: For U.S. refiners, oil will first get lots more expensive, and then supplies will start to dry up as countries opt to halt exports and keep the precious black gold for themselves.

Oil Becomes a Strategic Asset

Oil prices have made a major move in the past five years – just as the emergence of China, Russia and several other key economies transformed crude-oil pricing into much more of a global game. High prices have sent cash pouring into the coffers of oil-producers in Asia and the Middle East. Many countries have used that capital to finance global investment initiatives, creating government-controlled “sovereign wealth funds” to do their bidding.

Little wonder crude oil has become a strategic asset – as well as an energy source.

“As oil and other fuels become a more and more precious resource, OPEC countries, China, Russia and others will begin holding back oil, instead of putting it into the market,” Fitz-Gerald says. “That’s going to be devastating in the short-run.”

Some big oil consumers such as the United States have lobbied OPEC to boost production in order to bring market prices down. But it’s done no good: Members of OPEC have said over and over that market supplies are adequate and that the surging prices are not something that they can control.

China – a growing consumer of oil – has embraced a different strategy: To create captive supplies of crude, China has demonstrated that it’s more than willing to endure controversy and cut deals with countries U.S. refiners either can’t or won’t deal with. China Petroleum & Chemical Corp. (SNP), and PetroChina Company Ltd. (PTR) – two of China’s biggest oil companies – have invested in such political hot spots as Africa and Iran.

The Chinese government, desperate to lock down supplies of such crucial natural resources as metal ores and crude oil, has sealed deals with Sudan, Chad and the Congo. African Business reports that trade between Africa and China has advanced at a rate of 40% a year since 2001. In 2006, bilateral trade between the two was $50 billion.

Already, 14% of China’s oil imports come from Angola. About 60% of Sudan’s oil goes to China.

To understand why you should heed Fitz-Gerald’s observations, it’s important to understand just how far ahead of the pack he’s been – and how far ahead he remains – when it comes to predicting long-term energy trends and investment opportunities.