The Daily Reckoning November 15th

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The Future Economic Destruction

All government-directed economic activity grows at the expense of the private sector. And the election suggests that government coercion will drive even more U.S. economic activity in the future. This is a shame, because freely adjusting prices, competition, and innovation elevate living standards. Mandates, price controls, and subsidies — coercive actions — depress living standards. Quality falls. Shortages develop and persist.

Americans are in the midst of a destructive, self-reinforcing political cycle — a cycle that might conclude in a nightmare scenario. A sloppy diagnosis of the financial crisis lies at the root of the destructive cycle.

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The free market did not cause the financial crisis; political meddling with interest rates and credit allocation caused it. Without a proper diagnosis, the medicine can be worse than the disease. In this destructive cycle, the popular response to a financial crisis caused by too much government and central bank influence is “Give us more government and crazier central banks!”

President Obama’s health care law provides an example of how government dipping its toe into a market can start a destructive cycle that ends in even more government control: Years after its passage, many of Obamacare’s details remain unknown. But we know it will demand insurance companies not charge premiums that vary too much for people with different health risks. The insurance companies will receive millions of new (but unprofitable) customers.

It’s easy to imagine price controls and mandates bankrupting many health insurance companies. All the while, politicians would blame the insurers for poor customer service and putting “profits over people.” Before you know it, the political door for a single-payer health care system would be pushed wide open — all because politicians are not interested in honestly discussing the impact of price controls and mandates on markets.

This is not meant to be a political screed. After a year or two of political theater and propaganda, you must be exhausted. But whether we like it or not, politics are an important part of the investing equation. And after this week, it is clearer than ever that the economy will continue getting mauled in a self-reinforcing cycle of more government leading to market failures leading to even more government.

Some of you are disappointed with the results of the U.S. election, some are happy, and some (including those with libertarian views) wonder why any individual or political party would want to preside over a country whose challenges dwarf its opportunities.

Call me a grumpy cynic, but it helps to be a realist when examining this situation. Here’s why: You can’t argue, after thinking about the following four points, that America’s challenges (ignoring individual families or companies) do not outweigh America’s opportunities:

First, the “nondiscretionary” federal budget is set on autopilot, driven by demographics. Political inertia will not allow meaningful reforms. We don’t “have the votes,” as they say in Congress, to reform insolvent entitlement programs.

Second, a critical mass of voters demand government services, including health care — health care that remains waiting for bureaucrats to define. Here is a guess, based on government intrusion into markets: The health care system will become as popular as your local Department of Motor Vehicles within five years. Tuesday’s exit polls revealed that the popular American characteristic of self-reliance is not so popular anymore. Many voters see a European-style welfare state not as a bankrupting failure, but as a model for the U.S. They’re trading their freedom for the illusion of economic security.

Why is government-provided economic security an illusion? Simple: There is no way to pay for these benefits without raising tax rates to a degree that would destroy both the economy and the financial markets or annihilate the value of the dollar. Confiscating the income and assets of the “rich” (ignoring the fact that this would put countless people out of work) would make an unnoticeable dent in the budget deficit. This is a fact, not an opinion. Unfortunately, rather than start a factual conversation about the deficit, politicians choose to inflame the toxic emotion of envy.

Third, the next recession — and we are due for one in the not-too-distant future — would push the federal deficit well beyond expectations. Tax receipts would fall, along with incomes, capital gains, and economic activity. Spending on unemployment programs would rise again. The Obama administration’s predictable response to a recession would be another stimulus plan in which Democrats get more spending and Republicans get more tax cuts.

So in the end, a recession leads to wider deficits, which in turn lead to policies that widen deficits yet again. Paul Krugman and most other economics professors would love it. Krugman would consider this a worthwhile effort to fill some mythical, immeasurable “output gap,” while people with common sense would consider this going down the road to hyperinflation.

Fourth and finally, the Federal Reserve has boxed itself into a corner. Quantitative easing (QE) is a one-way proposition; there is no practical reversal from QE, as newly printed money has boosted the price level above where it otherwise would have been. Reversing QE would bring about dreaded “deflation.” Any exit strategy from QE exists purely in academic models. In reality, reversing QE (selling bonds and draining cash from the financial system) would crash all of today’s manipulated financial markets simultaneously.

The Fed’s goals early on in the crisis focused on supporting the banking system at the expense of savers. Now the Fed will be pressured, threatened, and eventually forced to monetize ever more U.S. government debt — all to finance a government budget that the private sector cannot afford.

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As a proponent of small, affordable, sustainable — there is a nice buzzword — government, I lament that voters have chosen a government stuck in a destructive, self-reinforcing cycle. Time will tell if this cycle (more government, market failure, more government, market failure…) can be stopped.

The future political environment will multiply the risks facing investors. But there will always be opportunities for contrarian investors on both the long and short sides of the market…

On the long side, look at the best-managed gold and silver mining companies, and companies providing “shale fracking” services and equipment for the American oil boom.

On the short side, look at overindebted companies that, in order to survive, need consumers to continue overspending. Also, look to short companies that pay high prices for raw commodities and resell processed goods into a depressed economy.

Best regards,

Dan Amoss, CFA

Original articled posted on Laissez-Faire Today

The Future Economic Destruction appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

The Spoils… and Oils… of Power

And now, a perk of government “service” that hadn’t previously occurred to us — being immortalized in oils.

“Multiple agencies have quietly commissioned artists to paint official portraits of Cabinet secretaries and other top appointees,” reports The Washington Times. After combing through scads of records, the paper concludes the government has forked over at least $180,000 for this purpose since last year.

The Environmental Protection Agency appears especially fond of these portraits. Current administrator Lisa Jackson’s portrait cost $40,000. Her Bush-era predecessor Stephen Johnson’s cost $30,000.

Recently, the Department of Housing and Urban Development spent $19,500 for a portrait of former HUD secretary Steve Preston — appointed to fill the final seven months of Bush’s term. It will hang on the 10th floor of HUD headquarters — in a work area, out of public view.

Steve Preston: Barely more famous than you are,
but he has an oil portrait and you don’t.

“These are done for future generations to see how we live now, and it’s really a tribute as well as part of a person’s legacy,” says Ann Fader, gamely defending the practice. She’s president of an outfit called Portrait Consultants, “which represents portrait artists,” as the Times puts it.

“It’s a tremendous privilege,” she adds, “to paint a portrait of somebody as accomplished as these people.”

At least as tremendous as your privilege of paying for it, to be sure…

Cheers,
Dave Gonigam

The preceding article was excerpted from Agora Finacial’s 5 Min. Forecast. To read the entire episode, please feel free to do so here.

The Spoils… and Oils… of Power appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

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The Revival of American Manufacturing: An Update

You know those little throwaway plastic red cups that you see at parties? You can buy a case of 288 of these Solo red plastic cups for about $36. I’ll do the math for you: That’s about 12.5 cents per cup. It’s a cheap, low-end item. Made in China, right?

Nope. Made in the USA. The Solo Cup Co. makes them in Lake Forest, Ill.

Recently, another company started making an almost identical-looking reusable red cup. Trudeau USA makes millions of these cups, which they call simply the Red Party Cup. This was a job that in another year not so long ago might’ve headed to China. Not today.

American manufacturing is quietly enjoying a revival on some levels. Goods once made in China are now coming back to the USA — a process called re-shoring. In May, I wrote to my Capital & Crisis readers about “A New Trend ‘Sneaking up on People’” (see article). I talked to Scott Huff, a principal at Innovate International, an engineering design and contract manufacturer for several industries. Scott was actively involved in re-shoring. Recently, I talked to Scott again to get an update.

“That red cup has been one of the most successful things we’ve re-shored,” he told me. I love this story precisely because it goes against what so many people think they know. They think US manufacturing is in inevitable decline. The red cup story is another strand in a growing thread of anecdotal evidence to the contrary.

As Scott says:

“It’s against the paradigm that people have accepted [about what is made in China]. But people are usually about a decade behind in their perceptions. Anything that’s got a significant amount of money on the bill for shipping to the US, you’ve got to consider making it in the US. The shipping that we’re saving, and the fact that we don’t have to carry so much inventory, frees up cash.”

This is especially important now, when it is hard to finance trade. A business always has a certain amount tied up in bills yet to be collected (accounts receivable) and inventory. Usually, banks will finance a decent chunk of this. I was a banker before I started writing newsletters. Financing these trading assets was part of my meal ticket. (The other was financing real estate.) But today, banks are reluctant lenders, for a lot of reasons we won’t get into now.

The end result is kind of like what we see in the mortgage market: superlow rates that not many borrowers can access. Ergo, manufacturers need to run lean these days.

“So,” Scott continues, “if you can make your manufacturing process leaner, you can free up cash. One way to do that is to make it local and turn over the dollars faster.” This way, you don’t have cash sitting in goods on a boat from China.

Driving the renaissance is more than just shipping costs, of course. Many of the factors we talked about back in May are still in play today. Namely: It is getting expensive to do business in China.

“The glory days of China’s export business are over,” Scott says. “Now it is down to hard work. The adjustment in the renminbi [China’s currency] took some of the pressure off the export companies, but the cost of living continues to just crawl upward — the cost of food and the cost of housing, especially. Those don’t come down. There is only so much you can do with currencies.”

Cheaper US energy prices also help along the re-shoring trend. Fertilizer and chemical firms want to put down roots in the US and plug into cheap sources of natural gas. In Asia, natural gas costs at least four times the price.

“Natural gas production has gotten to the point where we can’t store it all,” Scott says. “Natural gas prices should be even lower. And things that include natural gas as a raw material, such as olefin plastics, propylene and ethylene, should be cheaper to make here. We should have the cheapest propylene and ethylene in the world in the US.”

The same could happen with oil. US production is up 25% since 2008 as new technology cracks up new supplies. As I write, the price of West Texas Intermediate, the US benchmark oil price, is down nearly 16% on the year.

So China’s cost advantages have been ground away in several ways. Still, there are challenges bringing stuff back to the US — like a dearth of manufacturing know-how.

“You have a base of experience in Illinois and Michigan and places that have traditionally been the centers of excellence for some of these manufacturing processes,” Scott said. “A toolmaker who is capable and has kept up with the technology — well, let’s just say there aren’t very many unemployed toolmakers. There’s plenty of opportunity now as people are trying to re-shore stuff.”

I was fascinated by a role reversal Scott described.

“The vast majority of my design engineers are Chinese and work in my office in China,” Scott said. “And these are guys that have been with me for five years or more, in some cases as long as I’ve been in China. I’ve been there eight years. They’ve got a lot of experience.

“So,” he says with a chuckle, “one of the things we’re starting to do is bring some interns from the States to work with them. It’s kind of a role reversal. We have design engineers that actually put lines on paper in China for the products being made in Chicago. Eight years ago, I was taking a handful of older American guys to China with me to help work with these young Chinese designers. And now it’s going back the other way. Now I have young American graduates I’m shipping over there for six months to get experience with people that know what they’re doing.”

Incredible, isn’t it? All things change. As I like to say, if you stand around long enough in markets, you’ll see them come full circle.

US consumers also favor US-made products — to a point. “People love this story,” Scott said. “Having US-made products is an advantage in the marketplace. But on consumer products in particular, as much as people love US-made products, there is a limit to what they’ll pay for them. The economics of it all will still rule the day.”

There are a handful of publicly traded US manufacturers headquartered in places like Milwaukee, Wis., and Mansfield, Ohio, that are lean and world-class competitors. They are in good position to gain from this trend. But, as always, patience is key.

The stock market may be somewhat overzealous in its enthusiasms at this very moment. While keeping my eye on this still-nascent trend, I’ve determined to wait for better prices — and they will come, I have no doubt. In the meantime, though, the revival of American manufacturing is an important story to keep in mind…especially for contrarians who don’t mind getting paid to go against the crowd.

Regards,

Chris Mayer
for The Daily Reckoning

The Revival of American Manufacturing: An Update appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

The IEA’s Latest Report And The Real Story On America’s Energy Comeback…

Did you hear the news?

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In case you missed it, the beginning of this week was awash with stories of America’s energy comeback.

“U.S. Redraws World Oil Map” – Wall Street Journal

“U.S. Oil Output to Overtake Saudi Arabia’s by 2020” – Bloomberg

“U.S. to become biggest Oil Producer – IEA” — CNNMoney

What’s with the newfound energy discussion and the IEA’s new report? And are there any new ways to profit? Let’s take a look…

Here are a few snippets from this week’s release of the IEA’s World Energy Outlook 2012:

  • The global energy map “is being redrawn by the resurgence in oil and gas production in the United States”
  • “The recent rebound in US oil and gas production, driven by upstream technologies that are unlocking light tight oil and shale gas resources, is spurring economic activity – with less expensive gas and electricity prices giving industry a competitive edge – and steadily changing the role of North America in global energy trade.”
  • “By around 2020, the United States is projected to become the largest global oil producer” [Overtaking Saudi Arabia]
  • “North America becomes a net oil exporter around 2030.” [Note: it says “North America, not the United States]
  • “United States, which currently imports around 20% of its total energy needs, becomes all but self-sufficient in net terms”
  • “Unconventional gas accounts for nearly half of the increase in global gas production to 2035, with most of the increase coming from China, the United States and Australia.”

There’re plenty of interesting tidbits that came from this week’s report, none of which should come as a surprise to loyal DRH readers. Let’s break it down…

For starters, it’s clear that America’s energy comeback is for real. Goldman Sachs came out with the first groundbreaking report on this idea back in September…OF 2011.

Back then, they said that the U.S. would surpass Russia and Saudi as the No. #1 oil producer in the world. Also back then, the news was a great shock – indeed we’ve had a year’s worth of write-ups on how to profit (more of which we’ll touch on below.)

On that front, the IEA report didn’t bring much to the table, more than just reaffirming that this resource boom is for real. As the kids would say, the IEA was “tardy to the party” – heck, even OPEC made recent note of America’s great shale story.

Today, I figure it’s only right if we say: Welcome to the conversation IEA!

But the IEA report did make a few points that I’d like to clear up now, too.

As you may have seen this week, there’s been a lot of “energy independence” talk flying around. One of the key points the report made was that the U.S. is set to become energy independent. Great news, right?

To be clear, the IEA isn’t saying we’re going to be “oil independent.” Instead, the report uses an amalgam of energy: nat gas, oil, coal, nuclear. And sure, when you look at it that way the U.S. is darn close to being energy independent as it stands – we’ve got a bountiful stock of coal, uranium, nat gas and even oil!. Indeed, there’s no new news there.

Also, the report boldly stated that North America will become a next oil exporter. Remember, this is North America, not the United States. Again we’ve known for some time that the U.S. and Canada are the two up-and-comers in the unconventional oil game.

So, that’s what you need to know. The IEA report reaffirms our stance on America’s energy renaissance. More oil and gas are going to be flowing through the pipes in the coming years – all at the same time the rest of the world will be demanding even more oil and gas.

But, as you could guess, today’s issue isn’t just all about critiquing the latest energy report. Instead, we can use this latest report to further our discussion on profiting from this imminent boom…

Let’s Play America’s Energy Comeback (Again)

To say the least, it’s good to be an investor in America’s energy future – especially in the next 3-5 years.

The first way to play this scenario is with domestic energy producers. Here, I still like Statoil (STO), ConocoPhillips (COP), EOG Resources (EOG) and Pioneer (PXD.)

These are the types of companies benefiting from America’s shale patch, locking in lease agreements and maximizing efficiencies at the wellhead. Sure, they aren’t the wildcat opportunities that will hand you quadruple digit results (at least not in a year or two), but by locking in to a few of your favorite domestic energy producers you’ll have a one way ticket to profit.

Remember, this shale boom isn’t happening everywhere else in the world. So when global disruptions in crude oil stem from the Middle East turmoil or rising China demand, these domestic players will cash in on higher oil prices. Heck, even the IEA knows that much. By their mid-range metrics energy demand is set to grow more than 30% by 2035, which bodes well for America’s energy bounty.

The second category, from which we can pull profits, is dividend payers.

With more oil and gas flowing through America’s pipelines and more “harvesting” of the wealth we’re pulling from underneath our feet, there’s surely plenty of cash to grab. Now more than ever we’ll start seeing that cash in the form of dividend payments.

In this realm I still like DCP Midstream Partners (DPM) – which consistently pays at solid dividend, currently at 6.5%. DCP Midstream is a big player in the natural gas liquids (NGL) game. With more oil and gas flowing to the surface, there’s severe need to separate and optimize the energy flow. That’s where a player like DCP comes in – and they are willing to pay us along the way.

Pipeline players, midstream players and “MLPs” (master limited partnerships) are where you’ll find a lot of solid dividend payouts.

There’s also another place to look…

Concentrating on natural gas opportunities, I don’t think we’re going to see high prices for many years to come. As the story unfolds, it’ll be music to the ears of U.S. chemical and fertilizer makers.

Remember, as we’ve covered here before, nitrogen-based fertilizer companies are set to cash in on a confluence of events. First, they get to produce products cheaper with the use of abundant natural gas. Next, they should enjoy resilient demand with farmers attempting to make up for last summer’s drought. This could be a win/win for a company like Terra Nitrogen Company (TNH) – currently paying a 7% dividend.

America’s energy comeback is a once-in-a-generation opportunity. Our newfound oil and gas wealth will help boost the economy (steering it away from disaster, like we’re seeing in Europe) and should allow us to turn a solid profit.

Instead of holding any specific credence from this week’s IEA report, let’s just say our U.S. energy prediction is right on track.

Keep your boots muddy,

Matt Insley

Original article posted on Daily Resource Hunter

The IEA’s Latest Report And The Real Story On America’s Energy Comeback… appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

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avatarThe Daily Reckoning - The Daily Reckoning posted Thursday, November 15th, 2012.

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