A Melman Minute — April 22, 2008

Few subjects seem to raise the emotions like the price of gasoline, which is soaring in Canada, the USA and many other part of the world. As can be seen in the accompanying chart, over the past six months or longer, the increase in commodity gasoline prices has been quite dramatic, rising from near $2.00 (all prices US$) this past August to about $3.00 per American gallon at this time.

Of course, many in the public realm claim the rise is due to corporate greed and, in order to satisfy public pressure, politicians in America are hauling oil company executives in front of public cameras to explain what is going on. However, it is worth noting that one writer, Sterling T. Terrell, a Ph.D. candidate in the department of agriculture and applied economics at Texas Tech University, had an article published today on the Ludwig Von Mises Institute website (www.mises.org) in which he opines that there are several factors including inflation, taxation and changes in the demand/supply equation that play an important role in the final price of gasoline.

Relating to inflation, Terrell notes, “…something that cost $1.00 in 1950 would cost about $8.78 today. As for gas prices, in 1950 the price of gas was about 30 cents per gallon. Adjusted for inflation, a gallon of gas today should cost right at $2.64.” He explains long term inflation in this way: “The result of the Federal Reserve printing too much money is a loss of purchasing power of the dollar.”

Next, he discusses taxation. “The tax per gallon of gas in 1950 was roughly 1.5% of the price. Today, federal, state and local taxes account for approximately 20% of gasoline’s posted price.”

Regarding demand and supply, he writes, “The world economy is growing. China and India are obvious examples. At the same time Americans continue to love driving SUV’s and trucks. As for supply, we are prohibited (whatever the reason may be) from using many of the known oil reserves in our own country. Furthermore, due to government regulation, the last oil refinery built in the United States was completed in 1976”. (our bold emphasis)

He adds one interesting last note. Terrell compares the profit margins of integrated oil companies to those of other lines of business such as periodical publishing, shipping, application software, tobacco, and water utilities and finds that in every case, those other industries have net profit margins in excess of those integrated oil companies.

From our point of view, we ask the question of whether these trends will intensify, continue close to unchanged, or diminish over time. In our opinion, inflation is likely to accelerate, given the extreme rate of money creation we have witnessed in the past few years; taxation levels do not appear to be abating at all, particularly as it relates to product taxation; and, lastly, the trend toward additional government regulation of the marketplace appears to be both relentless and accelerating.

Therefore, we continue to hold to the opinion that over time, we are more likely to see much higher gasoline prices at the customers’ pumps than much lower. We believe this will be an important factor leading to increasing rates of inflation, which historically has been a plus factor in previous golden bull markets.

We also hold to the opinion that these same rising gasoline prices will drain consumer purchasing power away from other retail purchases and some of those industries could begin to suffer as well.

Relating to the latter point, the New York Times just carried a detailed study on the fact that many American workers now find that their hours of work, both overtime and regular time, are beginning to fall and that unfortunate reality is further crimping their discretionary consumer purchases. As the newspaper notes, “…The gradual erosion of the paycheck has become a stealth force driving the American economic downturn”, also noting, “…At the end of last month (March, 2008), more than 4.9 million people were working part time either because they could not find full-time jobs or because their companies had cut hours in the face of slack business.”

Compounding the problem is the difficulty in obtaining credit for many consumers. Since the sub-prime debacle, many lenders have steeply raised their lending standards and the article points out, “…borrowing against the value of real estate…has been pared back as home prices have plummeted and as banks have tightened lending standards in the aftermath of the collapse of the housing bubble.”

From our point of view, economic difficulties in America will be fought by the Federal Reserve Board, combined with the political system, attempting to reverse the downturn by even further loosening of the monetary system, which, according to economic theory, should put further upward pressure on inflation

Therefore, we continue to hold the opinion that we remain inside a long-term bull market for the precious metals, particularly gold and silver which both have a lengthy history as monetary alternatives to paper currencies.

In today’s markets, oil continues it spectacular recent climb, reaching above the $118.00 level in overnight trading. Gold opened quietly, but by 8:30 AM PDT had gained about $5.00 to the low 920’s with silver up about 20 cents and platinum ahead by $13.00. Base metals are putting in a solid performance, with copper up seven cents, once again touching the $4.00 per pound mark, while nickel, zinc and lead are also strongly ahead. Securities markets are split with Canada’s TSX gaining about 30 points while the Dow Industrials are down close to 70.

The U.S. Dollar has encountered some heavy selling, with the DX Index off about one-third of a point, trading very close to its historic low, and the Canadian dollar is stronger, once again approaching parity with the Greenback.

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

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