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The Daily Reckoning Tuesday, January 26, 2010 Housing numbers are out, much to the dismay of tealeaf economists, One assertion about oil stocks that you can literally take to the bank, Plus, Bill Bonner on unemployment, DC "dumbos" and jammin' with Jules... --- The Global Race for the 3rd Element Is On... --- The Daily Mail calls it, "A wonder...that may save the planet." And nations are battling to get their hands on this element that could soon siphon off as much as $10.4 trillion in oil revenues. Which tiny company controls 50% of the market? Find out here. -------------------------------------------------------------- Eric Fry, reporting from Laguna Beach, California... US stocks bounced a little yesterday, despite the news that home sales tumbled a lot. Sales of existing US homes plunged 17% in December, the biggest decline since record-keeping began in 1968. This disheartening news item shocked economic forecasters, but hardly anyone else. Most of us non-experts understand that folks without incomes or credit buy very few houses. But for some reason, the experts shun this intuitive logic. Instead, they study their econometric models, tweak their spreadsheets and go public with forecasts that would embarrass a tealeaf. These seers might not be so blind if they bothered to observe the world around them, rather than their computer monitors. Then again, the "world" that surrounds most Wall Street economists is a place that still practices (slightly less) conspicuous consumption...and therein lies the root of their woefully misguided forecasts. Out on Main Street, conspicuous consumption has become so inconspicuous that it's invisible. Out on Main Street, incomes are still dropping and credit is still contracting. This combination never produces an enduring economic recovery. But don't try telling that to a Wall Street economist. They have their models and their compromised opinions. We non-economists have only our common sense. But lest your editors be accused of undue cynicism, let us give credit where credit is due. Adam York, an economist at Wells Fargo Securities LLC in Charlotte who correctly guessed December's steep drop in home sales, expects "a pickup in existing home sales in the next couple of months. We're past the bottom," he predicts, "[But] I don't think there's going to be a lot of buyers out there looking for a home outside of the tax-induced effects until they feel more comfortable with the labor market." "Past the bottom," but going nowhere, is a forecast we can live with. For perspective, the "recovering" housing market has not really recovered at all. For all of 2009, existing home sales rose 4.9% to 5.16 million, the first gain in four years. This is the "past the bottom" part of the story. The "going nowhere" part is that the median sales price dropped 12% from 2008, the biggest annual drop on record. In other words, the NUMBER of existing homes sold increased slightly in 2009, but the VALUE of all existing homes sold actually DROPPED. This unusual divergence suggests that most sales are occurring at the low end of the housing market, where the government's $8,000 tax credit provides the greatest relative benefit. Meanwhile, at the mid- and high-end of the market, where $8,000 would represent the cost of renovating a half-bath, sales are still dead in the water. Net-net, the recovering housing market is not recovering. The Daily Reckoning PRESENTS: There's a lot we don't, and probably can't, know about the future of energy. Thankfully, it's what we CAN know about oil stocks that really matters. Chris Mayer, editor of Mayer's Special Situations, has the details in today's guest essay... Buy Oil Stocks... No Matter What By Chris Mayer Gaithersburg, Maryland We really don't know as much about the oil market as we think we do. There are many numbers out there, but most of these involve a lot of guesswork. For example, we really don't know just how much oil the world will need. The US Department of Energy says we'll need 106.6 million barrels a day by 2030, but how does it know? It can't know. The DOE can't know what the world will look like in 2030. We don't really know how much oil we're discovering or how much will actually come to the market any time soon. We don't really know how much it will cost to get this oil. We can guess, but our guesses are frequently wrong. Goldman Sachs wrote in a research report issued in February of last year (230 Projects to Change the World) that the cost of bringing on additional oil sands project would come to $80-$90 a barrel. It sounds nice, but it's a guess. We don't know a lot, even though we put decimal points on lots of numbers as if we knew precisely. And there is plenty of room for people to fudge numbers and make up stuff. It happens all the time. Of course, no one knows what the price of oil will be, but there is no shortage of forecasts. Goldman Sachs says it will be $95 by the end of 2010. Deutsche Bank says $65. They are all guessing. There is one thing we do know. And fortunately, this is the most important thing to remember as an investor in oil: The market is still pricing proved oil reserves at less than replacement cost. In other words, it is cheaper in today's market to buy proven reserves in the stock market than to drill for new ones. I would cite the 2008 reserve and finding cost study published by Howard Weil. It shows the average cost of reserves through the drill bit is about $43 per barrel, with the median (or midpoint) around $25 per barrel. These are hard numbers, not soft guesses. You can do this yourself and find out how much it costs for your favorite oil company to add a barrel of proved oil reserves by drilling for it. So we have a good idea of what it costs to create a barrel of proved oil reserves today. Figuring out these numbers is easier than guessing what the price of oil will be in the future. Granted, even these cost numbers will change. There are no constants. But here is the trick. You want to buy oil companies when you can pick up proved oil reserves for a lot less than what it costs to produce them. In the market, that's where we are today. In fact, you can pick up proved reserves for less than $15 a barrel. You have lots of companies in which you can buy oil in the ground for under $10 a barrel...and remember it costs an average of $25 a barrel to replace it. I could not make a more compelling argument for oil stocks than this. Buying for less than replacement costs is one of my main compasses in investing - whether I'm buying potash mines or gold mines or factories or oil rigs or what have you. If I can buy something in the stock market for less than it costs to replace those assets - and as long as I'm not buying buggy whips - then I've got a good chance of making money. That's because the stock market is, after all, just a market. Eventually, prices correct. In the oil market, we'll see more acquisitions. It's cheaper and easier to grow reserves that way. The buying pressure will lift the price of oil stocks so that the disparity is not so great. Simple as that. In the case of oil, we are also looking at strong odds that the costs of producing a barrel of oil reserves will go up. Recently, The Wall Street Journal ran a piece titled, "Cramped on Land, Big Oil Bets at Sea." Now, you've probably heard of all the big deep-water oil projects. All the major oil companies are moving farther offshore in their quest for oil. The WSJ article leads with this: "Big Oil never wanted to be here, in 4,300 feet of water far out in the Gulf of Mexico, drilling through nearly five miles of rock. It is an expensive way to look for oil." Yes, it is. This is another of the great unknowns. We don't know how much it will cost at the end of the day to get this oil. We know that it will cost a lot. Chevron spent $2.7 billion over 10 years on just the first phase of a deep-water oil project in the Gulf. That's one of the more tame projects. Some of the sub-salt discoveries involve drilling more than 30,000 feet. They will be the most expensive wells ever drilled. You really don't need to know a lot about geology or oil to guess that this deep-water oil is going to be more expensive than the good old oil wells onshore. So the average cost of reserves is likely to go higher. Meaning that if you can lock in quality, low-cost, long-lived reserves today for only $15 a barrel or less - you should do it. That's why you own oil stocks today. Joel's Note: Right now readers can try Chris' service, Mayer's Special Situations, for a full month for just one dollar. Usually, it goes for a thousand dollars per year. The mathematically inclined will understand the difficulty in overstating the value of this special...so we won't even try. To get a month of Mayer's Special Situations for a buck, click here. --------------------------------------------------------------- And now over to Bill Bonner, who has today's reckoning from Paris, France... It's gray, cold and snowy in Paris this morning. We were supposed to be on our way to warm India, but a change in visa procedures caught us off guard. Our passage to India will have to wait until next month. And so we turn to our Daily Reckoning, as we do everyday. Our goal is not to make readers rich. Nor is it to win a Pulitzer Prize for financial journalism. No, we set much lower targets. We just don't want the cleaning lady to be embarrassed to work for us. Even in that, we frequently fall short... "Mr. Bonner... I spotted another split infinitive in the DR..." said Clara. "I'm sorry," was our response. "I will try to always do better." (Mistakes are inevitable. But, rather than try to catch them all, it's probably easier to get a new cleaning lady. One who is not an intellectual.) In the meantime, what a recovery! If the economy keeps recovering like this we'll soon all be busted... House sales are falling...unemployment is rising...and people are getting poorer! The Dow rallied a piddly 23 points yesterday. Oil is selling for less than $75 this morning. Stocks are in trouble. As we said yesterday, this could be the beginning of the end for this bear market. We've seen the first leg down. We've seen the rally. We're ready for the next big plunge. Yesterday, the latest numbers on existing house sales for December came out. They were disappointing - nearly 17% lower than the year before. Unemployment is still rising, as near as we can determine. It is rising for two reasons. Because we are in a depression. And, because the feds are trying to 'do something about it.' In this regard, we refer to three different phenomena. They are inter- related...they all show the same thing: an economy going downhill. First, initial jobless claims surged last week...with 36,000 more claimants. This also from Bloomberg: "Employment dropped in 39 US states in December, seven more than in the prior month, indicating job losses were widespread. "Payrolls in California showed the biggest decline, falling by 38,800 last month, according to figures issued today by the Labor Department in Washington. Texas followed with a 23,900 decline and Ohio was next with a 16,700 drop. "With the national unemployment rate projected to average 10 percent this year, state budgets may continue to be strained by limited tax revenue and jobless insurance payments. While the pace of firings has eased over the last year, the time it is taking to find a job rose to a record 29.1 weeks in December. "Employment is 'still very weak, which is why we think the unemployment rate is going to continue to rise,' Marisa Di Natale, a director at Moody's Economy.com in West Chester, Pennsylvania, said before the report. 'There are some states that are in pretty big trouble, fiscally speaking. 2010 is not going to be a good year.' "The jobless rate in the US held at 10 percent in December, the Labor Department said on Jan. 8. A jump in the number of discouraged workers leaving the labor market kept the rate from rising... "Employment in all 50 states dropped in 2009, with Wyoming, Nevada, Michigan and Arizona showing the biggest percentage decreases. The District of Columbia gained jobs, adding 6,200 in the 12 months to December. "Nevada and West Virginia had the biggest increase in joblessness among states last year, each climbing 4.6 percentage points. Alabama was next with a 4.5-point gain, followed by Michigan's 4.4-point increase." An analysis done by the AP shows that stimulus spending has no effect on employment. The AP looked at counties that got a lot of stimulus money to repair roads and bridges, and those that didn't. They found no connection between the spending and employment rates. Even we are a bit surprised. We knew that stimulus spending was a waste of money. But we figured the feds could force a little extra hiring here and there if they really put their minds to it. Apparently not... At least not on the scale of the present stimulus spending program. Stating the finding a bit more broadly: stimulus spending doesn't really stimulate at all. In fact, it retards. And then it debilitates...by taking capital out of productive uses and squandering it. Instead of leaving the private sector alone so that it can find new ways to put resources to work, the feds take the resources and waste them in the old-fashioned, unproductive ways. Result: money spent; no stimulus; people poorer. Second, the Brookings Institution came out with a warning yesterday. It said 30% of the nation was either in poverty already or headed to it. The US is becoming like a 'developing nation,' said the report, with 39.1 million people living in poverty. Many cities have already reached the 30% poverty rate - including Cleveland, Detroit, Youngstown, Buffalo, Syracuse, Dayton and Hartford, Connecticut. But poverty is increasing fastest in the suburbs, says the report. We add a footnote. About 40 million Americans are also living on food stamps - a new record. Third, while the feds take money away from productive enterprises and honest savers, they also encourage people NOT to work. How is this possible? Alan Reynolds, writing in The New York Post last month, explained how the feds had probably added two points to the unemployment rate simply by stretching unemployment benefits from the traditional 26 weeks to the current 79 weeks. "When you subsidize something, you get more of it..." he writes. That is how the feds operate. They punish success and reward failure. If a man is lucky enough to get a good job and earn a lot of money, the feds tax it away from him. If he fails to find a job, on the other hand, they give him money. The longer he stays unemployed, the more money they give him. If a banker runs his bank well, he gets nothing but trouble from the feds...paperwork, bureaucracy, pettifogging regulations. But if he runs it badly, he gets billions of dollars worth of bailouts. If an automaker takes the best business in the world and runs it into the ground, he gets the support of the federal government. If he runs his business well, he gets nothing but headaches. The feds' recovery program pays for failure. Naturally, they get a lot of it. Breaking News: Expert researcher reveals urgent, once-in-a-generation market opportunity... And more thoughts... Ben Bernanke seems to be sailing to another term as the nation's chief central banker. Obama gave him a big push. When it looked like that might not be enough, Tim Geithner tried blackmail. Failure to return Bernanke to the Fed could cause market instability, he told the Senators. These poor dumbos...all of them. Larry Summers, Ben Bernanke, Tim Geither...Barack Obama...and all the House and the Senate (the only exception we know of is our old friend Ron Paul)... ..None of them has a clue. They warned Congress in September '09 that the world would come to an end unless Wall Street was bailed out. They got their way. Wall Street was bailed out; and the world didn't come to an end. So, they must have been right about it. None of them knows what is going on. And none of them has any interest in finding out. When it comes to the feds, ignorance pays. Who wants a Fed chief who admits the truth? "I'm sorry," Bernanke should tell a televised joint session of Congress. "Our economy is de-leveraging. There is nothing we can do except get out of the way. "If we bail out failed enterprises, we will have more failed enterprises. "If we pay people not to work, we will have more people not working. "If we provide more credit, we will have even more debt. "If the government uses more resources, the private sector will have fewer resources. "Forget it. There's no way out. So, let's stop all this gimcrackery. Let's back off and let the markets do their work: let failed companies go broke...let homeowners who can't pay their mortgages lose their houses...let speculators lose money...let the chips fall where they may, so that the next generation of entrepreneurs can pick them up and make something with them. Let it be." Mr. Bernanke would be lucky to make it out of the Capitol alive. Paris is not a bad place to be delayed for a few days. Yesterday, we went out for a drink at a bar in the "Marais" - once a swampy area...then the Jewish quarter...and now a very hip part of town. The bar was crowded and lively. "My business was going well until last year," said our friend, who rents apartments in Paris to visiting Americans. "But Americans aren't coming to Paris anymore. It's too expensive. No one has any money, I guess. My occupancy rate is way down." Americans who used to have their own pied a terre in the city are now settling for 'fractionals.' Instead of owning the whole apartment, they own a share of it. "It's actually a great deal," explained our friend. "People only come for a month or two. They don't need a whole apartment. And they don't want the hassle of owning an apartment when they're not there. This way, for about one fifth the price, they can get as much time as they actually want...and afford a much better apartment." Back at our own apartment, we're happy to have some company. Our son Jules is working on his musical career, composing and performing songs. He just has to figure out how to market them. And a pretty 23-year-old French woman has taken up residence in Edward's room. Marie-Helene is a friend of the family. Last night, she was our audience as Jules and I performed a repertoire of songs by Willie Nelson, Hank Williams and Jules himself. After a rendition of "Your Cheatin' Heart" we put the question to Marie-Helene. "Have you ever heard that song?" "Yes, but never quite like that." Regards, Bill Bonner, for The Daily Reckoning --------------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com   The Daily Reckoning - Special Reports: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the BIGGEST FINANCIAL SWINDLE in world history.