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I don’t know what you all
read daily, but I stop by various forums as part of my research. I
particularly focus on comments by average people. One thing I recently
noticed was the real pain being felt by high gas prices. Now that gas is
cracking the $4 range, people are either drastically cutting driving, and or
considering quitting jobs that require a mild commute. The people say that
(at their $10 an hour jobs) the cost of gas is not worth it.
But we have a real doozy of a
price hike coming this summer in gas, and also inflation, which I will get to
in a moment and that is going to shock the US economy.
But, consider that at $10 an
hour, that equates to $80 gross for a day’s work. Take out 20% taxes,
that leaves $64. For a 20 mile commute one way, figure 20mpg for an older
car. Round trip, that comes to 40 miles, or 2 gallons of gas. For the trip, gas alone is $8, not even counting auto maintenance expenses, insurance and
so on. Now the person has $58 left for the whole day’s work. He has to
live on that, pay rent, food, heating oil, electricity and so on. Forget
medical insurance.
Following these message boards,
I find that a large percent of people could not pay their heating energy
costs this winter, and had to carry forward huge balances after winter ended.
They are having either their water, electricity or other utilities shut off. They
have no idea what they are going to do when winter comes again this year.
Many of these people earn close
to the median income in the US – 30 to 50k roughly. Even at that, they
are all going downhill and running monthly deficits. So, it’s not only
the $10 an hour crowd who are desperate. It’s average America. Between skyrocketing food and energy prices, I estimate the average US household is spending $200 a month more for food and energy than a year ago. Bottom line
is, they cannot afford it and are using credit cards to cover that increase.
These are not a few anecdotal
stories. There are so many of them, it’s clear this is very
widespread…and is not only the $10 an hour worker.
Fuel price shock
Now let’s move forward to
the summer gas prices. You may have asked yourself that, with oil prices way
over $120, why is gas only a buck more a gallon (at $4), when the oil price
is so much higher? What will happen when gas prices reset to reflect $120/130
a barrel oil?
Gas prices are set by purchases
that are forward contracts by suppliers. These contracts are one or two
months ahead. That means that, when the newer contracts start to come into
effect, gas prices will start to reflect this $120/130 oil. That’s this
summer. A few months from now, it’s estimated that gas prices can reach
$5 to $6 at that point.
That price will absolutely shock
the average US consumer. They are already pulling back all unnecessary
driving. Sure, we will hear stories of many other people spending and driving
away regardless. But I can tell you, that people already are really pulling
back, and just cannot afford to commute to work at $4 gas. What happens at $5
to 6?
Gold and oil prices in this
scenario
First of all, energy prices have
a direct impact on food prices. Agriculture is very energy intensive. With
rising energy costs, fertilizer (made from natural gas for instance) prices
have doubled. Grain production, already not enough to meet world demand at
the moment, is going to suffer more. With rapidly rising diesel and
fertilizer prices, food costs are going to soar. They are already soaring.
High oil prices affect most
other prices. Oil is used both to make and transport most products, including
food.
Between skyrocketing energy and
food prices, inflation this summer is about to explode in the world, more
than it is now. Gold will react to that in a big way. We have discussed some
of the problems in the US, but in other developing countries ,food and energy
is heavily subsidized.
Already, Egypt, Indonesia, India, China, and others have made efforts to curb subsidies that are breaking
their fiscal budgets. In all cases, riots have ensued and in many cases the
price increases had to be rolled back to stave off mass rioting.
The point here is that, coming
this Summer, fuel prices in particular are set to skyrocket if oil prices
stay at the $120 plus range. Inflation statistics in the US are going to go through the roof this summer, and there will be no more room to use
‘seasonal adjustments’ to hide skyrocketing fuel prices. After
enough time, the seasonal prices start to reflect the higher average fuel
prices, and the seasonal ‘out’ can’t be used any more to
hide inflation. At that point, US inflation numbers will skyrocket –
the government stats will have to admit it. Gold will love it.
Inflation expectations
There is an inflation
expectation building in the US and the EU right now according to their
central banks. This is precisely what central banks fear, a cycle of
inflation and inflation expectations that only big increases in interest
rates can combat.
Atthe very least, the US will
have to consider raising interest rates by Fall, or else we will see
inflation start to spiral out of control by then. The Fed is saying as much
anyway. The average person in the US already is well aware of the very
painful price increases in food and fuel, and this summer, if gas prices do
hit $5 and $6 as is expected, there will be tumultuous noise from the US consumers. Congress will go crazy trying to mitigate the situation. The news media will
have a lot of stories on rapidly rising prices and the pain it’s causing.
But in any case, the central
banks will really start to shift focus to higher interest rates. Since the
central banks are well behind the inflation curve now, with too low interest
rates, stagflation emerges. But, the US economy cannot take interest rate
hikes by any means. The average consumer has record debt of all types. They
will not be able to afford higher interest on that debt.
Poisonous combination
This poisonous combination, of
rising interest rates, rising inflation, and resultant stagflation will do
two specific things to gold and oil.
First, if demand for oil does
not rapidly slow worldwide, oil will continue to be bid up by the investment
community. Oil is considered a hedge against inflation. Gold also will be bid
up, if there is not a pull back in oil prices, and inflation.
Second, the stage is being set
right now for a big spike in fuel prices in the US, a spike in inflation, a
further spike in food prices, a spike in inflation expectations. This
scenario is scaring the hell out of the central banks, though they only talk
in mild terms about their concerns. I can definitely state that the
developing world, that subsidizes food and energy, is really getting panicky.
Just take a look at the widespread efforts to cut subsidies, and the immediate
riots that ensued. And remember the food shortages as well, added on
top…
OPEC stated this week that there
is not a lot they can do to slow oil price hikes because they are already
producing as much oil as they can. They are blaming speculators too. Of course,
there is other production coming online, but these increases in
production are not even enough to keep up with falling production in the
world’s big mature oil fields such as in Saudi, Mexico, the North Sea , etc.
I suppose that it is possible
that oil prices might correct to say $100, as there is indeed a speculative
premium in oil prices now. But, considering all that we have discussed, oil
is going to continue with upward price pressures through summer, and we might
be looking at $120 oil wistfully in a year….unless there is a really
significant increase in dwindling world oil production.
The same goes for food overall. If
fuel and fertilizer prices stay high, food prices will stay high and even
increase going into 09. This does not even cover the developing world
shortages of wheat and rice either…
All of these developments are
the reason why we told subscribers on May 8 that rising world inflation would
cause the gold market to switch its focus to inflation. For the rest of 2008,
the big developing story will be inflation. It’s a shift of investment
community focus from the credit crisis to inflation. The media will focus on
inflation, the public is already well focused on it. And the US will find it impossible to hide rising inflation in the CPI and such reports.
Again, there is always the
possibility that gold can correct to $900, and oil correct to $100, as both
have risen so much in the last 6 months. However, we expect gold and oil to
be high into the summer. If gas prices rocket in the US this summer, gold will set new highs over $1000.
The Prudent Squirrel newsletter
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Chris
Laird
Prudent
Squirrel
Chris Laird has been an Oracle
systems engineer, database administrator, and math teacher. He has a BS in
mathematics from UCLA and is a certified Oracle database administrator. He
has been an avid follower of financial news since childhood. His father is
Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He
has grown up immersed in financial news. His Grandmother was Alice Widener,
publisher of USA magazine in the 60?s to 80?s, a newsletter that covered many
of the topics you find today at the preeminent gold sites. Chris is the
publisher of the Prudent
Squirrel
newsletter, an economic and
gold commentary.
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