As we move into the Holiday celebrations, we remain optimistic regarding most asset classes. Bonds are the one possible exception, but since bond prices have fallen significantly over the past month or so, we doubt they have much downside left for now. Meanwhile, stocks, commodities, and precious metals all look bullish. While we still can't say which asset group will lead the pack, we have confidence in all three.
The one big question we have going into 2011 is how resource scarcity will play out on the world stage. Probably the worst possible scenario would be akin to the global “resource wars” proposed by Michael T. Klare in his book by that title. On that score, last week's news that China plans to build a second aircraft carrier was somewhat alarming. (China is already rebuilding an old Soviet carrier, which will be its first.) Clearly, China wishes to assert its sovereignty and its claim over the mineral resources of the South China Sea, if not beyond.
The dangers of any military build-up are well-known. The bigger your military, the more tempting it is to use it. (In fact, if you never use your weapons, how can you justify the cost of buying them?) But in today's world, where resources are becoming scarce, military build-ups create a new type of threat. The world's military forces consume very high amounts of commodities – from steel and oil to everything else. Military spending pushes commodity prices higher, just as industrialization and urbanization do.
On top of that, we have the self-enforcing cycle in which the more countries make an effort to secure resources via military, the more resources they consume. At some point, it will take more resources to defend the resources than is worth the effort.
Clearly, we're not at that stage yet. China believes a bigger navy will help it secure a worthwhile resource base. But eventually we may see some countries deciding that they cannot afford the resources to protect their resources. At that point, the countries with the most remaining resources will be the superpowers.
For this reason, building alternative energy sources while they are still affordable is essential. Yet this obvious fact eludes most nations, organizations, and businesses who still think they're living in a world of cheap oil.
As an example of the kind of lip service paid to the problem, consider Thomas Friedman's recent article in the New York Times. Friedman praised the U.S. navy for its clean energy projects. Apparently, some experts in the military have realized that if they can run their operations on fuels other than oil they could keep more soldiers out of harm's way in the Middle East or Asia. So there has a small push towards fueling ships and planes with alternative fuels such as camelina (from mustard seeds) and algae.
The problem is that these are small test projects only. As great as these alternative fuels may be, rolling out with them would be a very expensive project. Imagine the cost of replacing or refitting every plane the U.S. military owns? Not to mention the infrastructure to support these new fuels. Besides, producing the volume of algae or camelina required would be an enormous agricultural project that would also take a lot of water, energy, fertilizer, arable land, etc.
As much as we would love to think the world is weaning itself off fossil fuels, what we tend to get is regular photo ops but no real roll-out of alternatives. For example, if you Google articles regarding algae as a fuel source, you'll find the same articles get essentially recycled every year. Small demonstrations take place now and then, but no actual progress is being made.
By some estimates, the U.S. military uses half a million barrels of oil per day – roughly 3% of our total consumption. That's a significant amount. If nations around the world start building their military, all the new fleets of ships and planes will considerably boost oil demand – and create an even greater need to guard the earth's remaining oil.
We were surprised to read that oil consumption rose 3% last year. That suggests the gap between supply and demand will narrow much faster than most analysts expect. Growing demand explains why the 2008-9 slump in oil prices was remarkably short. By contrast, when oil prices fell in 1980 it took nearly a decade for them to recover.
We expect oil prices will go much higher very soon. Unfortunately, America is not prepared. Just like a frog placed in a pot of water that is gradually heated, we may not notice what is happening until it's too late and we have already been boiled alive. The temperature in this case is oil demand. And the only way to save ourselves would be to hop out of this pot by switching full-scale to alternative energies.
Meanwhile, as we said in the beginning, 2011 looks likely to be very rewarding for investors – at least the first half. But as in 2008, we must be wary of commodity prices getting too high. Sure, we may get richer. But if oil prices start racing higher, they could trigger another major downturn.
Last week, we pointed out that while China has been resistant to raising interest rates, it does appear willing to let the yuan float higher. If the past decade is any guide, such a move will lead to significantly higher commodity prices.
For now, we're willing to bet on companies that have the wherewithal to help the world reduce its energy consumption and/or costs. These include healthcare companies like Express Scripts (NASDAQ:ESRX) or even certain automobile companies that are promoting energy efficiency. We are very glad to see some companies recycling old technologies in new ways that save on costs and resource consumption. We hope the practice spreads.
We'll have much more to say about the best of these stocks in your next issue of TCI.
Disclosure: Leeb Group, its officers, directors, shareholders, employees and affiliated entities and/or clients of such affiliated entities may currently maintain direct or indirect ownership positions in financial instruments (i.e., stocks, bonds, options, warrants, etc.) of companies or entities whose underlying exposure is in the companies mentioned in this article.