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Melman Minutes - By Leonard Melman
MELMAN MINUTE March 16, 2012

The petroleum complex world has certainly moved front and center into the economic spotlight over the past few months and several recent developments suggest that we take a renewed look at just how important these events could be for our economic - and social - futures. 



As can be seen on our long-term chart of Crude Oil, prices have moved into the area where they are now threatening to break out above the highs of one year ago near $115 per barrel, which would leave only the historic high of $147 per barrel as a price target.  What many find most interesting is that the rallies over the past year have taken place during a period when the news background, for the most part, would have suggested lower prices.


During the past year we have seen economic weakness which would presumably sap demand thereby adding pressure for lower prices; we have seen abundant North American production ramp up which would also presumably indicate lower prices ahead; and we have also seen the collapse of natural gas prices (see chart below) to literally the lowest quotes for this century and, as a consequence, that should be creating two more forces which would normally point to lower crude prices.  First, we should see a gradual switch from gasoline-powered vehicles to those burning natural gas and, next, a switch-over at electric power generation facilities away from fuel oil toward natural gas.


There is also a new factor which should mitigate toward lower crude prices, at least in the short term.  I am referring to the new agreement just signed at the White House between Barack Obama and David Cameron of the U.K. whereby they are consdiering releasing sufficient supplies from both countries' strategic petroleum reserves to put a damper on further price increases.


And yet, any weakness of late in Crude's prices is quickly overcome as the trend continues toward higher prices.



On the other hand, we can think of two reasons why crude might not fall and why it might indeed rise further during the rest of the year.  First, we have the Iranian-Israeli impasse over credible indications of potential Iranian development of nuclear weapons and, second, many believe we are now witnessing a gradual improvement in the world's economic picture which would augur toward an increase in demand for petroleum products.


The results of this tug-of-war could have vital consequences for the world's economic picture.  We have already seen gasoline prices in the USA soar toward $4.50 and even $5.00 per gallon in some regions and that has had an immediate effect on US inflation numbers as those increasing gasoline prices were instrumental in pushing up the inflation rate for the Consumer Price Index to 0.4% during February, the steepest such figure in 10 months.


It appears consumers are beginning to feel the pinch as well as the just-released University of Michigan Consumer Confidence Index fell during early March from mid-February's reading of 75.3 to 74.3 this month, despite some generally upbeat economic data. 


What follows is a general commentary relating to the investment concept of following "hot trends".  During my forty-odd years of investing, being an investor, a broker and now following a financial writing career, I have noticed a strong tendency for specific plays to arise, blaze hot, but then, for the most part, they are not sustained.


Going back a few years it is easy to recall the fervour for the "Nifty Fifty" stocks of the late 1950's, the computer-leasing stocks of the mid-1960s; the dynamic play in gambling stocks in the late 60's and early 70's; gold and silver's spectacular runs in the late 1970'as and into 1980; the high-tech and computer bonanzas of the 1990's - and many others.


Our own world of mining has seen several such runs during the past decade, specifically including the uranium shares of several years ago and the rare earth shares of this past 36 months. 


As Richard Nixon was wont to say, "Let me be perfectly clear."  I am not saying these trends will not continue into the long run and they may truly generate outsized positive price performances ahead.  However, and I believe this is true of any "hot play", there is a particular vulnerability within groups that have had huge, rapid run-ups.  They just might become the subjects of news that could cause them to react negatively - and in a hurry.  We have just seen two such articles.


Perhaps no argument appears sounder than that supporting higher uranium demand and prices down the road.  Uranium power has proven to be non-polluting, incredibly safe, somewhat economic (and it would be more so without many of the obtrusive government requirements) and the potential for fuel supply discoveries appears bright. 


During the past decade, two other strong fundamentals have come into play; namely a gradual abatement of fuel grade uranium supplies developed from the retirement of nuclear weapons stocks - combined with a steady drumbeat of announcements by many nations that they were planning to increase nuclear power production.


However, the nuclear power world was hit hard during the past 12 months by two developments. First, the earthquake and tsunami in Japan one year ago had a serious impact on their nuclear power generation facilities and now, thanks to serious natural gas price declines combined with abundant new supplies, we have just seen an announcement by a large group of utilities that they were turning toward natural gas fired power plants.  They are cheaper to build and they can come on-stream much faster.  As a result of this new trend, only two power companies in the USA are still planning to build nuclear facilities, down from 15 just a very few years ago.


The other "hot play" referred to was rare earth metals and at the very heart of the argument was China's declaration that they would no longer be supplying the world with abundant exports.  Since there are few substantial producing rare earth metals mines in current production outside China, it appeared that supply shortfalls would soon occur, particularly as those shortfalls might affect United States military weapons development programs.  Upon China's announcement, the vast majority of rare earth mining shares posted strong rallies.


However, this morning a story appeared in the Wall Street Journal headlined, "Pentagon downplays China's rare-earths controls."  A key quote from Pentagon sources reads, "...The growing U.S. supply of these materials is increasingly capable of meeting the consumption of the defence industry base."


I have just reviewed several rare earth element shares and must report that many of those companies have now returned virtually all the gains of the boom years of 2009 and 2010.


As noted, this does not mean that I consider shares in uranium and rare earths to be bad investments.  Not at all.  But I believe it is essential that investors be aware of the risks involved in following such dynamic "plays".  And, as always, we repeat out caution at The Melman Report that no investments should be made without prior consultation with a registered investment professional.


As of 9:15 AM PDT, financial markets in the USA are little changed with the Dow Industrials up by four points while Canada's TSX Index is about 50 points to the upside.  Precious metals have recovered from early selling and gold is now trading near $1,655, up from a morning low of $1,638 while silver remains just under the $32.50 level.  Base metals remain slightly lower on average while mining share indexes are little changed on the session.


In other markets, long-term interest rates continue their recent rise; crude oil is trading just under $106 per barrel and the US Dollar Index is about 30 basis points lower.



All quotes US$ unless otherwise noted.


There will be a change in our Melman Minute schedule for the coming week as I will be in a remote section of northern Mexico for a couple of days on a mining visit.  Therefore, our next "Melman Minute" has been re-scheduled for Wednesday, March 21.    



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