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Jeff Saut Presents: Continuity of Thought

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The surprise for the new year could be that the economy actually reaccelerates and the Fed raises interest rates, not lowers them...

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Editor's Note: The following article was written by Raymond James Chief Investment Strategist, Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

Bernard Baruch, in his autobiography "BARUCH: My Own Story," discusses "the curious psychology of crowds which has been demonstrated again and again in history." He refers to Charles MacKay's book "Extraordinary Popular Delusions and the Madness of Crowds" as:

"...a remarkable documentation of the unbelievable crazes that have swept mankind
down through the ages. No nation has been immune to these frenzies...These crowd
madnesses recur so frequently in human history that they must reflect some deeply rooted trait of human nature. Perhaps it is the same kind of force that motivates the migration of birds or the mass performance of whole species of ocean eels. There seems to be a cyclical rhythm in these movements. A bull market, for example, will be sweeping along and then something will happen – trivial or important – and first one man will sell and then others will sell and the continuity of thought towards higher prices is broken.
"


Greetings from Vancouver (where obviously the Canadians don't recognize the Martin Luther King holiday), since my Monday was spent in meetings with portfolio managers and conducting seminars for my firm's financial advisors north of the border. And by far the most recurring question has been, "What do you think about energy, as well as your so called stuff-stocks?!" Therefore, the question I pose today is, "Will the recent collapse in crude oil prices break the "continuity of bullish thought on energy?" You say "collapse" is too harsh a word to describe the new year's commodity crashette. Well consider this, last week crude oil lost another 5.9%, leaving it down 15.8% from its January 2, 2007 intra-day high.

Turning to the chart below, it shows crude oil peaking in price last July at $78.40 per barrel and sliding into its November 2006 low of $55.92 before a recoil rebound lifted "black gold" back to $64 in mid-December. A similar collapse occurred in gasoline over that same time frame, driven by Goldman Sachs's (GS/$213.99) surprising reduction in the gasoline component of its institutionally indexed commodity index (from 7.3% to 2.5%) staged in incremental reductions right into the November elections, but that's a discussion for another time. Nevertheless, as 2007 began crude's price decline accelerated, punctuated by last week's slide that broke oil below its $55 chart support. Hereto, while warm weather lent a hand, Goldman Sachs once again surprisingly reduced the energy component of its commodity index by 50%, causing one Wall Street wag to ask, "Why, in an energy-centric economy, would Goldman cut the gasoline and crude oil components in the GSCI so dramatically?!" As a sidebar, even with said reductions the Goldman Sachs Commodity Index (GSCI) looks to be breaking down, as can be seen in the chart at the end of this report.



Still the question remains, "Will the price collapse break the continuity of bullish thought on energy?" My firm's resounding response is, "Well maybe." Clearly the new year's price plunge has shaken the bullish consensus, yet my feeling is that it is going to take an eventual "shake out" below $50 per barrel to turn the crowd negative enough to give us the "footings" for a major bottom. Whether a sub-$50 price point is in the offing, however, is debatable given the weatherman's recent claim that, "El Nino is breaking down." Combining that statement with the attendant cold front that is currently sweeping across the nation, we are likely to see a rally attempt this week. Yet, our sense is that it will take a number of "failed rallies" before the bulls are worn out, capitulate, and make the bottom that leads to the second leg of the secular bull
market.

As readers of these reports know, my firm has been shy of energy, and stuff-stocks in general, after having pared-back on those positions during their 2006 January-to-May parabolic upside blow-off. And even though we sold 25%-to-50% of each one of those positions, the declines from their respective highs for our remaining positions has hurt our overall portfolio performance. Still, perusing the long-term charts in preparation for this report suggests that while commodity markets are having their inevitable cyclical corrections, we believe that the secular bull case for "stuff" continues. Indeed, the latest crude oil prices are reaching the point of being overdone with respect to the fundamentals. As the Kiplinger organization notes, "By 2030, figure on world oil consumption in the neighborhood of 118 million barrels a day, up 40% from today...So no let up in global competition for reliable supplies of oil, natural gas and coal as discoveries of new sources come less frequently."

I urge you to read the aforementioned Kiplinger quote, reread it, and then think about long-life oil reserves (50+ years worth of reserves). Ladies and gentlemen, to our knowledge there are only two long-life oil reserves left on the planet. The Orinoco Tar Sands is one such reserve, but it is located in eastern Venezuela and is currently the subject of nationalization by "Tsar" Hugo Chavez. The other long-life reserve is located up here in Canada. Verily, the Alberta Tar Sands have 1.7 trillion proven/probable barrels of oil and they are in a geographically, and politically, attractive place. My firm has invested in the Alberta Tar Sands for more than five years and continues to embrace the tar sands theme. Our Canadian energy analyst has recently penned a 190-page research report on the oil sands with a number of buy recommendations on individual companies. As always, Blue Sky laws should be checked for U.S. investors, but a few names mentioned in our reports, and in the recent 190-page Tar Sands report, include: Canadian Oil Sands Trust (COS.UN); Opti Canada (OPC.T); Synenco Energy (SYN.T). For dually listed names, I suggest considering Suncor (SU) and EnCana (ECA).

Other themes include: Agricultural products; financial revolution; healthcare; media; infrastructure; emerging markets; changes in business models; lifestyle revolutions; aging populations; water shortages; global outsourcing and Internet hub; the restructuring of Japan; education; and the list goes on...

The call for this week: As the Bank Credit Analyst folks point out, "The equity advance has entered a more dangerous phase, which will be characterized by slowing profit growth yet expanding valuation multiples and increased volatility." Moreover, the recent economic data has had a definitely stronger "tilt" that has seen yields break out to the upside, reinforcing our 2007 mantra that, "The surprise for the new year could be that the economy actually reaccelerates and the Fed raises interest rates, not lowers them."

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No positions in stocks mentioned.
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