Ethanol, Food, Oil, And The Fed: Inflation Ahead

Includes: COP, GLD, PSX, STO, WLL
by: Michael Fitzsimmons

As reported by Reuters on Thursday, the United Nations has called for an "immediate temporary suspension" of the U.S. ethanol mandates. Their concern is another world wide food crisis. While I share that concern (and the social unrest that could follow), I would also point out the damage these mandates have done to America's middle class.

The ethanol mandates were announced by President Bush in his State of the Union address in 2007. Bush proposed a mandate for 35 billion gallons of ethanol by 2017. These mandates have been continued by the Obama administrations. Here is a link to a comprehensive discussion on ethanol on Wiki.

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The Wall Street Journal reported this weekend that 46% of the corn crop will be used to meet the energy legislation. 38% is used for animal feed and residual use. It is clear from the chart above the price of corn has tripled since the introduction of the ethanol mandates.

The ethanol mandates are bad energy policy for many reasons. Here are a few:

1) They cause huge dislocations across the food sector - raising prices on everything from bread and tortillas to animal feed and eventually meat.

2) The have been a very wasteful bucket in which hundreds of millions of tax-payer money have been carelessly frittered away.

3) They have contributed to the real inflation rate felt by all Americans, every day, at the grocery store.

4) They keep Americans firmly addicted to dirty and expensive liquid fuel (gasoline) derived from foreign oil when we should be transitioning to cheaper, cleaner, and domestic natural gas.

5) They negate the opportunity we have to leverage our #1 economic advantage against all other countries - out abundant reserves of cheap and clean natural gas reserves combined with our 2+ million mile pipeline distribution infrastructure.

6) As the mandate keeps us addicted to gasoline, it also keeps us emitting high level of CO2 while at the same time spewing out the toxic particulates of burning gasoline.

Proponents of the mandates, some of whom are corn farmers or on the receiving end of government funding, will say that Americans are paying less at the pump for gasoline. While this may be true to some small degree, does the cost of the program rationalize this small benefit? Is the cost of a gallon of gasoline less than the cost of a gallon equivalent of natural gas? The answer is a resounding: NO.

The ethanol mandates are bad for our economy, bad for our environment, and bad for our national security. Last week 25 U.S. Senators urged the EPA to adjust the mandate. The only energy policy worse than the ethanol mandates are the billions that have been wasted on the myth of "clean coal" (an oxymoron if ever there was one).

The current drought in America has exposed the ethanol mandates for what they truly are: a simplistic, ineffective, and very costly band-aid on America's #1 economic problem: its addiction to foreign oil imports. It is clear from the chart below the price of oil has continued to march higher in spite of the ethanol mandates.

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What America needs is a strategic, long-term, comprehensive energy policy that will leverage our abundant, cheap, and clean reserves of natural gas. Here is such a policy (feedback welcome):

So what does all this mean for investors? My take, as it has been for years now, is that our addiction to foreign oil and the subsequent negative effects on the American middle class means:

1) The American middle class will continue to struggle paying for food and gasoline. and consumer spending will be weak.

2) The U.S. government will continue to look at inflation and the trade deficit in the most favorable way possible - "minus food and energy" and "minus oil", respectively.

3) The middle class will continue to struggle with high food and gasoline price. Consumer spending will weaken.

End result: the Federal Reserve and their peers over at the U.S. Treasury will rationalize continued "easing", and that is just a shorthand substitution for the phrase "printing money". The effects here are well known and have been seen in the recent past:

1) The U.S. dollar will weaken.

2) Gold and oil prices will rise

3) The U.S. stock market will have an unsustainable rally.

4) The market and economy will slow, and we'll be left with something as sure as death and taxes: high foreign oil import prices.

5) The Fed will print money to "pay" for our foreign oil imports.

Gold has followed oil higher. It is one of the best ways for Americans to protect themselves against a future of higher and higher oil (gasoline) prices.

In this yo-yo of a market, so dependent on oil and monetary policy, an investor must be very nimble and get in and out before the music stops. Right now, prior to an election where the current administration will be doing everything possible to get re-elected, and with Eurozone and U.S. policymakers readying the printing presses - it's best to be long. As my readers know, I prefer the real assets of energy companies. My favorites include Whiting Petroleum (NYSE:WLL) with its oil production growth, Phillips 66 (NYSE:PSX) which is profiting from the mid-continent spread in oil prices, ConocoPhillips (NYSE:COP) for its unconventional assets and rich dividend yield, and StatOil (NYSE:STO) for its nice dividend and its recent huge discoveries. Also, every American investor should own some gold and silver to keep pace with the high inflation rates that surely must be coming. For those who don't care to own bullion, just get some buy the gold ETF (NYSEARCA:GLD). Good luck!

Disclosure: I am long WLL, COP, STO, PSX.