Two things are obvious here. One, American thinks they’ve raised prices as much as they can without causing customers to bail out on them in droves. Two, they’re either clueless or clearly out of options.

The airline industry is long overdue for some serious consolidation. And it’s finally beginning to happen.

In April, Delta and Northwest decided to hook up. And now talks are heating up between United Airlines and Continental.

But despite all the time airlines have spent in and out of bankruptcy, it’s still the same old talk about cutting costs, cutting corners and raising prices when the market allows.

For example, here’s the brilliant strategy that Delta’s president, Edward Bastian, articulated in response to high jet fuel prices: “We have moved quickly to mitigate the short-term impact of higher fuel prices by further reducing domestic capacity and taking a disciplined approach to costs and cash flow.”

YAWN.

It doesn’t take a genius to figure out how airlines are doing. All you have to do is follow crude prices. The airline stocks move more or less in the opposite direction.

The U.S. Oil Fund (USO), the dark blue line in the chart, tracks the spot price of West Texas Intermediate (WTI) light, sweet crude oil. When it was going down in the second half of 2006, airline shares were going up. With oil taking off in 2008, the shares of airlines have plunged.

The problems plaguing U.S. airlines should be well-known by now: unionized pay scales, legacy health and pension obligations, and a bloated and demoralized work force.

In many ways, the airlines have been their own worst enemy. They’ve cut back and cut back on services and perks, that they’ve essentially commoditized themselves.

How do you distinguish one airline from the other? One serves crackers and the other serves peanuts? That’s sure to cultivate customer loyalty.

They have only one trick in their bag of goodies which saves them from being completely commoditized. And that’s their frequent flyer plans. But you know what? It feels more like blackmail than a perk.

I’ve stacked up a couple hundred thousand frequent flyer miles with Northwest. But I don’t care anymore. I hardly fly Northwest. Their service is mediocre and their tickets are expensive. I go mostly with the newer low-cost carriers.

Have I made my case? There are plenty of reasons to hate airlines. As a passenger and a consumer, I’m not going to make you fly on any airline that is pissing you off.

But, as an investor, I’d like you to reconsider your feelings about the airline industry…

First of all, in terms of affordability, air travel has flown in the opposite direction of things like higher education, houses, and designer jeans.

When I first flew to England back in 1973 to attend Lancaster University, the two-way flight cost me around $525. When I flew Rachie – my daughter – to England last year to attend Norwich University, the round trip cost $600.

That’s nothing short of astounding. Taking into account inflation, the $525 price would have more than quadrupled. In real money terms, that ticket now would cost $2,444. It may not feel like it, but flying is a ridiculous bargain.

People have to fly. And, globally, it’s inevitable that they’ll be flying in greater numbers. Higher prices may slow this trend, but it won’t reverse it.

Flying is already taking off in Asia. For example, China’s domestic airline industry is just a fifth of the size of the U.S.’ domestic market, but it’s growing much faster. In 20 years time, it’ll be about half the size of the U.S. market.

• Reuters reports OPEC Secretary General, Abdullah al-Badri, as saying “Record-high crude prices have nothing to do with supply and demand but rather are caused by speculation…”
• The Market Oracle claims “there’s no (oil) shortage; it’s just gibberish.”
• And Global Research says, “as much as 60% of today’s crude oil price is pure speculation driven by large trader banks and hedge funds.”

But I’m telling you now, they are all wrong. The real driver of the price of oil is supply and demand.

Today, I’d like to prove it to you once and for all.

Speculation, speculation, speculation

It’s the cause of all our ills, apparently.

German and US politicians have called for a ban on futures trading to curb this ‘evil practice’.

The US regulator — the Commodities Futures Trading Commission (CTFC) — has launched an investigation… well actually it’s launched a number of investigations. All of them are a waste of time.

The CFTC is trying to figure out how much of the oil price is down to speculation and how much is down to supply-and-demand dynamics… I wish them luck. They’ll need it.

Political pressure has forced the regulator to produce a report that might make them look stupid.

Why? Because…

Long-oil speculation is NOT rising – it’s actually FALLING

It’s almost as if they are trying to shut the stable door after the horse has run over the horizon. In fact, the horse might actually have died after living a long and fulfilling life by the time this report is produced.

Let me prove it…

Net long positions on WTI futures contracts fell 80% to 25,867 contracts on the New York Mercantile Exchange in the week ended 27 May. This compares with a record 127,491 on 31 July LAST YEAR.

You can see the graph of net long positions on futures contracts on the graph below. See the recent plunge in net longs? This actually makes the speculation argument look very, very wrong — and shows the CFTC is wasting its time.

As you can see large crude oil speculation futures have actually fallen…

Net long positions fell during May; investors took profits on positions as the oil price hit all-time highs. This was accelerated last week when futures exchanges started increasing margin requirements as a way of shaking out speculation.

Oil futures trade on ICE Futures (which used to be known as the International Petroleum Exchange) in London and on Nymex in New York. Because futures are leveraged trades, investors have to deposit margin with the clearing house. This is a refundable deposit to cover any sharp losses if the market moves against the trade.

Both these derivatives exchanges have upped margin requirements significantly over the last week — indeed the margin requirement on some contracts has actually been tripled. The aim is to reduce volatility and force out the more speculative players.

LCH.Clearnet (the UK clearing house) said it upped the margin call due to “a change in the nature of the volatility across the oil curves.”

These increases in margin calls last week were therefore partly responsible for the 4.3% fall in the price of the near-month WTI futures contract from its all-time closing high of $133.17 on Wednesday 21 May to $127.35 on Friday of last week.

You have to agree this is hardly spectacular.

Of course, the move would not take all speculative players out of the market; the big players with plenty of cash for margin will just pay up… but the sign is that the speculative element may not be as large as some people think.

The US CFTC is therefore in a quandary. It has to produce a politically-motivated report on oil speculation at a time when speculation is falling.Rather them than me… but at least the report will be a humorous read.

Regards

Garry White
Editor
Smart Commodities UK

P.S. Garry’s Smart Commodities UK resource advisory explores the very profitable world of natural resources and hard assets. He delves into what’s going on in each sector and reveals the exact stocks you should buy as this unprecedented commodities boom fires on.

Source: Why They Are All Wrong About Oil

Right now the gold-to-oil ratio is trading around 7. That means a single ounce of gold is roughly worth seven barrels of light sweet crude. With oil trading near $130 a barrel, this is an extreme low point for the ratio.

The previous drop in mid-2005, when an ounce of gold was briefly worth 6.5 barrels of oil, was the lowest the ratio has been in decades.

Oil Too Expensive, or Gold Too Cheap?

So what does it mean when the gold-to-oil ratio moves toward an extreme like this? In historical terms, it suggests that something is out of whack. Either oil has gotten too expensive, or gold has gotten too cheap.

The last time we saw an extreme in the other direction was late 1998, when the gold-to-oil ratio rose above 26. That was a case of oil being way too cheap… and of course, crude oil bottomed out for all time just a few months after that.

Given the way oil is trading now — the recent rocket ride to $130 a barrel, etc. — some think that oil has gotten too expensive, too fast. Their view would be that the price of oil has to come down, perhaps by a lot, and that the gold-to-oil ratio is reflecting this.

Your humble editor disagrees with this view for a number of reasons.

For starters, there’s a lot of hot air about how oil could be a bubble and speculators are driving oil prices… but there is little proof of this charge, and a lot more evidence pointing in the other direction.

Germany’s Folly

Angry German politicians have gone so far as to call for a worldwide ban on oil trading. They think that $130 oil is all the evil speculators’ fault, and that all the traders should have their hands tied.

This is about the dumbest thing I’ve ever heard, and a good example of how politicians can be dangerous. One of the key functions of markets is price discovery; through self-interested buying and selling, the markets act as a useful forecasting tool. (One of the best forecasting tools we have at any rate.)

Without a functioning market mechanism to determine the price of a valued good, the market breaks down. You either have lots of one-off transactions taking place in the dark, or else you have some government committee setting the price by fiat. I hear Soviet Russia tried that. It didn’t work out too well.

The activity of traders and speculators also provides much-needed liquidity to markets. When, say, an airline like Southwest buys heating oil futures contracts to lower its exposure to jet fuel costs, more often than not there are traders on the other side of the transaction. Without someone to take the other side of a trade, end-users of oil and gas products have no way to hedge their business risk.

In a very real sense, speculators are paid to take on risks that hedgers don’t want. Risk transference is a vital market mechanism. The German politicians don’t get this. Or maybe they do get it, but they just don’t care.

Trying to restrict trading would be a fool’s errand anyway. There is more than enough competition among global exchanges to keep the trading going, even if some goofball government tries to ban trading on a local basis. That’s a very good thing.

Et Tu, George?

Hedge fund legend George Soros is blaming the speculators, too, calling the oil price a bubble. Without putting too fine a point on it, this is a major piece of hypocrisy.

Why? Because the existence of men like Soros show exactly why big markets are hard to manipulate.

If the price of oil were truly in a bubble, some big hedge fund player with guts and foresight could come along and make a killing by shorting the daylights out of it… thus driving the price of oil back down to non-bubble levels in the process.

This is exactly what Soros himself did in 1992. That was the year he earned the nickname “The Man Who Broke the Bank of England,” for the huge score he made shorting the British pound.

The counter bid – announced mid-afternoon today (Friday) – was made necessary after Halliburton trumped Candover’s bid earlier today. The Candover-led consortium’s original $3.2 billion bid had been launched on April 17.

The Halliburton bid represented a 6.2% premium over that original offer. Analysts said they expected Candover would respond with a higher bid – a correct assumption, as it turns out – but noted that they ultimately expected Halliburton to be the winner.

“I expect then Halliburton to top Candover’s bid and become the winner, unless there’s another industrial player,” Jane Coffey, head of equities at Royal London Asset Management, said earlier today in a telephone interview with Bloomberg News.

What analysts such as Coffey hadn’t counted upon, however, was the speed with which Candover came back with a new bid. That quick response is now leading some analysts to predict that Expro will take the slightly higher offer without waiting for a possible counteroffer from Halliburton.

“If I’m Expro, I’m like, ‘No, you had four weeks doing due diligence,’” James Wicklund, of Carlson Capital LLC in Dallas, told Bloomberg. “‘If you want to raise your bid, raise your bid. How many times do you need to go through the underwear drawer to know what you have?’”

Surging demand for oil from developing economies such as China and India have pushed oil to record levels over the past year. Just this week, West Texas intermediate crude crossed the $135-a-barrel threshold.

With oil commanding such a high price, Halliburton and its larger rival Schlumberger Ltd. (ADR: SLB), have profited as oil-rich nations have turned to the oil-services firms for help with excavation and exploration, forgoing the assistance of international oil majors, in hopes of keeping a larger chunk of revenue for state coffers.

At the same time oil demand is skyrocketing, some of the easy-to-reach oil deposits are starting to dry up, forcing the oil majors to experiment with more-challenging and – and much-more costly – deep-sea drilling expeditions. Oil at $135 a barrel can cover the cost of hard-to-reach sites that were previously considered financially unfeasible, making a company with Expro’s technology and experience a valuable asset.

Such heavy-hitters as Exxon Mobil Corp. (XOM), BP PLC (BP), Total SA (TOT), Chevron Corp. (CVX), ConocoPhillips (COP), and Royal Dutch Shell PLC (RDS.A, RDS.B), will spend a record $98.7 billion this year on exploration and production, according to Lehman Bros. Holdings Inc. (LEH).

And some of that almost $100 billion in exploration and production fees is bound to end up in the pockets of Expro, given that it’s among the leaders in deep-sea oil exploration. The firm’s experience with underwater wells at levels deeper than 1,000 meters (3,281 feet) would be a nice complement to Halliburton’s existing services.

Many analysts feel the deal makes too much sense for Halliburton to pass up.

“The consortium is private equity, with returns that need to be made – the higher their bid, the lower their returns,” Phillip Lindsay, an analyst with ABN Amro Holding NV (OTC: ABNYY), told Forbes. “I would say Halliburton is in a stronger financial position. I certainly think Halliburton could bid higher.”

Source: Halliburton Offer Sets Off Bidding War for Deep Sea Oil Expert

The WTI futures market is now in “contango” – a highly extraordinary situation.

And it’s yet another bullish sign for the oil price. I’ll tell you how to best profit from this in just a moment.

First though, what is contango? I’ll explain…

It is where the price of a commodity for future delivery is higher than the spot price – i.e. how much it’s trading for at this precise moment in time.

What normally happens is the opposite. Longer-term futures are usually lower than near-term.

This tells us one crucial thing: that fears for future supply are high.

You see, major oil companies don’t use the latest futures contracts to plan their budgets… they use the futures strip price which is the average value of the next 12 contracts.

And right now, that’s more than what oil trading for.

What’s also unprecedented is the speed with which this change in the curve has happened.

The WTI contract for delivery in December 2016 has surged $17.08 (a staggering 14%) in just three trading days. Not only that, crude for delivery in July this year rose just 1.9% over the same three-day period.

So, what’s going on..?

This price action in the derivative markets could mean one of three things:

1. The market expects near-term demand to slump.
2. Fuel-reliant businesses such as airlines, cruise operators and logistics companies are hedging against significant price rises.
3. The market expects future oil supply will not meet future oil demand.

Now, nothing in this world is caused by just one event, a combination of factors entwine to cause a reaction. However, I think we can discount a near-term slump in oil consumption as the reason for the curve shift.

All the headlines in the US are about how high fuel prices are affecting people’s lives.

But with most of the developing world subsidising their fuel, WTI price rises do not affect demand in these countries. It just puts more strain on their treasury departments.

Take the recent demand figures from China…

The country’s consumption hit a record high in the first quarter of this year. The China Petroleum and Chemical Industry Association said consumption of gasoline, diesel and kerosene rose by 16.5% year-on-year in the first three months of 2008. Crude oil consumption rose by 8%.

This scenario is being repeated all across Asia.

Demand for oil is 2 million barrels higher than current supply

The second point, about hedging, is very pertinent indeed.

I believe that the Goldman Sachs forecast that oil would hit $141 in the second half of the year must have caused finance directors at all the major airlines to turn a whiter shade of pale. This, I reckon, is the cause of a significant amount of the gains.

However, I think the most important reason is concerns about future supplies.

When T. Boone Pickens parroted Goldman’s view on Tuesday (he said oil would hit $150 in the second half) he said it was because supply wasn’t keeping up with demand.

Opec expects demand this year to be 87m barrels per day (bpd). The world is only pumping 85m bpd – leaving an expected deficit of 2m bpd.

The combination of Goldman’s warnings with Pickens comments has sent the futures market higher. This has made its way into spot prices (which hit a record just below $130 yesterday).

These type of comments are almost becoming self-fulfilling prophesies. Goldman (which has been best at calling the oil spike) says something will happen so futures are dragged higher. This pulls up the spot price.

Great news for one under-valued oil play…

These events are manna from heaven for our Smart Commodities UK oil play.

If analysts other than Goldman don’t raise their oil-price forecasts, then it is almost certain that it will beat consensus expectations in the next quarter and its shares will be re-rated.

If other brokers do actually raise their expectations, then the whole sector will need to be re-rated because the forward price-earnings multiple would fall to a ridiculous level.

Even after recent gains, my recommendation is trading on a price-earnings multiple of around 8.

This is an utterly ridiculous rating for a company selling a vital product in a contango market.

If you’d like to access this company’s details, you can do so here.

Review my service

Regards,

Garry White
Editor
Smart Commodities UK

Source: An Unusual Oil Glitch Is Set to Make One Stock Soar

Both gold and oil are hedges against inflation… but which one is the best?

The divergence between the prices of gold and oil has been the subject of much speculation over the last few months. The FT waded into the argument this morning with two opposing views on the front page of Companies & Markets.

The first came from Ian Harnett at Absolute Strategy Research. He noted that an intriguing feature of the current oil price spike was that it brought the price of WTI to a 40-year high when compared with the price of gold.

“Only briefly – back in the late summer of 2005 – has an ounce of gold purchased fewer barrels of oil. We expect such a situation is unlikely to last for long… so it may be time to be long gold and short black gold,” he said.

Then there was the view from Julian Jessop of Capital Economics. He argues that the ratio between the two commodities was not stable over time and he reckons that gold has its limitations as an inflation hedge.

He thought gold’s recent slide was down to the fact that the dollar is set to undergo a slight recovery and the rise in the oil price was down to expectations of emerging market growth. The fledgling economies need more oil than gold. Based on this argument, he reckons that the gold price will not get moving until there is evidence of significant inflation in the US.

So where do I stand?

Well, I lean more toward the view from Julian Jessop. My argument is that the gold price fall was driven by the realisation that the US Fed was running out of rate-cut ammunition. They can’t cut rates much below 2%.

However, I am also sure that inflationary pressures are building in all economies, driven by food-price inflation and rising raw material costs. I think significant inflation is here already, so Jessop’s trigger that will get the gold price moving again is actually with us now. When markets will wake up to this fact I simply do not know… but I believe they will.

I also reckon that supply and demand dynamics in the oil industry will keep the oil price above $100 for the rest of this year… but I cannot ignore the speculative element of recent gains.

The view that gold will not start moving again until US inflation ratchets up is commonly held in the market – this has made investors seeking a hedge favour oil. Recent US inflation data has been tame, but regular readers know that I do not believe inflation figures released by governments… they are all damned lies.

US consumer prices rose a smaller-than-expected 0.2% in April and everyone breathed a sign of relief. I reckon this was a mistake.

Governments manipulate figures. They change the way unemployment is calculated to flatter the figures and they massage inflation data to meet their own ends. I therefore don’t believe the US inflation data – and anyone who buys food or gas in the US (that’s, almost everyone) could see that these figures are essentially a lie.

Fortunately, shadowstats.com calculates CPI the old-fashioned way. It uses the methodology applied before 1990, when Bill Clinton started playing with the way these figures are worked out.

Pre-1990 methods indicate a US annual CPI rate of just below 12%.

This is much more believable. I think the same is the case in the UK too… just think about how much your electricity bills, petrol costs and food bills have gone up. That’s not even considering soaring council tax bills and Gordon’s underhand stealth taxes.

The reality is that we are in a very serious inflationary environment. We are also seeing accelerating oil demand from emerging economies.

Investors seeking a hedge against inflation can choose between gold or oil. Over the last few months, oil has won out and investors seeking a hedge have put money in oil futures as a momentum trade. Harnett’s argument was that this was about to be reversed and you should sell oil and buy gold.

I disagree…

You should buy oil AND buy gold…

Demand will support the oil price and inflation will eventually get the gold price moving.

There may be time in the coming months and years when the market favours gold as a hedge and when it favours oil. By owning both, you can let debates such as the one seen in the FT today play out, safe in the knowledge you are hedged against the ebb and flow of these views.

Long-term, however, the price of oil is heading higher and the price of gold is as well, so the which-is-a-better-hedge debate is irrelevant to those with a long-term view.

These commodity-price rises will be caused by rampaging inflation, by the demise of the dollar as oil is priced in other currencies and by soaring demand from Asia.

You need to own both gold and oil. Then you can ignore these debates about which is the better hedge.

Remember: We are investors not traders… the long term outlook for both commodity classes is extremely bullish.

The only problem you should be facing… is deciding which oil and gold stocks to buy. With the prices for both certain to rise… and give a great hedge… what does it matter which stocks you buy?

Such thinking is nonsense… there are a multitude of wrong moves to be made in these markets. Discover what all the right moves are now…

Regards

Garry White
Editor
Smart Commodities UK

Source: Gold or Oil, No One Agrees on the Best Hedge

Société Générale has said that the global gold miner hedge book had shrunk to its lowest level in 16 years. This means that most miners are not hedging their positions to protect against price falls.

The hedge book stands at just 835 tonnes, which is the lowest level since 1992, and is equivalent to 34% of 2007 production levels. De-hedging in the fourth quarter was 72 tonnes. For the whole of 2007, dehedging came in at a record 446 tonnes.

It was revealed this morning that investors bought 72 tonnes of bullion through gold exchange-traded funds in the first quarter of 2008, bringing the total to 943 tonnes.

The gold price averaged $924.83 an ounce in the first quarter, around about where it is now

Gold remains a buy

Tell the truth, Mr Naimi

The oil price continues to hit highs this week on supply concerns.

WTI futures hit a new all-time high overnight of $119.90, before retreating to nearer $119. It looks like I may soon have to upgrade my view to come in line with legendary oil investor T. Boone Pickens’ prediction of $125.

Opec has said that there is no shortage of oil in the world market – but they would say that, wouldn’t they. It is becoming obvious that Opec are at the limit of their pumping ability.

Comments over the weekend for Saudi oil minister Ali Naimi were manna from heaven for the Peak Oil crowd. Apparently, Saudi Arabia has put on hold plans to increase long-term production capacity from its oil fields because there isn’t the demand.

This is patently a bunch of utter nonsense. With the oil price at a record high, surely they would want to cash in?

I reckon the main reason that they are not going to expand production from 12.5m barrels a day to 15m barrels a day is because they can’t. They don’t have the infrastructure and they don’t have the oil. Yet again we have more Opec smoke and mirrors.

You can, however, see the real situation if you looks at the futures strip price. It has now hit $114.675.

Oil is still a buy as well.

Regards,

Garry White

PS: should you know anyone else that you believe will find my musing of interest please forward this link so that they can sign up for the service.

PPS: I also write a newsletter each month called Smart Commodities UK which expands on the views expressed in Garry Writes and makes specific recommendations in the resource, infrastructure and biotech sectors. To discover more click here.

Pickens became the 117th richest person in America by a series of oil corporate raids and acquisitions in the 1980s. He is a genuine legend. He’s also man enough to admit when he is wrong, which means I respect him even more.

Pickens admitted he got it wrong on the oil price. He has been running the BP Capital hedge fund and revealed overnight that he has now reversed his short position in crude futures.

“I covered the short position; it was a mistake on my part. We missed.”

Indeed, he has now gone long and has predicted that WTI futures will hit $125 in short shrift. My current view is that we will see $120 sooner rather than later, so we now appear to be singing off the same hymn sheet.

The oil price is now at $111.15, with the futures strip price (the average of the next 12 months WTI contracts) at $111.81, up from $111.61 at the start of trade on Thursday.

Continues below…

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There was more bullish news for the oil price this morning from Nigeria. Not only is their infrastructure in crisis, but pipeline explosions have become almost de rigueur.

The Movement for the Emancipation of the Niger Delta (MEND) issued a press release this morning, saying it would funnel explosives to communities there to use against oil companies.

Oil companies working along the coastal region of Nigeria “are in for a raw deal as the military is not in the position to protect them… [it will] offer materials such as explosives to communities that have now realized that it is better to destroy oil facilities in their territory since they do not benefit [from] them in the first place.”

Now, of course, the people of the Delta have a point. It appears that they are not benefiting at all from Nigeria’s oil wealth (although bombs are not the way to reverse that situation in my mind).

However, it is not my job to moralise on this situation; I’m here to look at facts.

With global supply so tight, any supply disruptions will send oil traders into a tizzy – and give T Boone Pickens his $125 level sooner than he thinks. This is yet another bullish factor for the oil price.

Regards,

Garry White

PS: should you know anyone else that you believe will find my musing of interest please forward this link so that they can sign up for the service.

PPS: I also write a newsletter each month called Smart Commodities UK which expands on the views expressed in Garry Writes and makes specific recommendations in the resource, infrastructure and biotech sectors. To discover more click here.