Here are some articles of interest we found this weekend.  Subscribers, make sure you’re logged in and check out our weekend portfolio update. Also, warning: information and ruminations dealing with ethics, justice, and good governance ahead, so stop reading if you are allergic to any of those things.

• Michael Greenberger is the most cogent defender of the view that the recent parabolic move in oil prices is due largely to structural factors enabling manipulative speculation.  In this episode of The Disciplined Investor podcast, he explains his position.  Video of Greenberger’s testimony before the Senate Commerce Committee.
• Andrew Horowitz follows up with some comments of his own, noting that the Enron Loophole (the purported enabler of this price manipulation) was opened in 2000 by then Senator Phil Gramm.  Gramm has also been linked to the late 1990s round of banking deregulation that made the subprime crisis possible, and then as a vice-chairman at UBS used his political contacts to roll back restrictions on predatory lending.  Gramm now serves as the general co-chairman of one of the current presidential campaigns.  Still.  Even after all of these revelations have come out.
• Seymour Hersh, one of the greatest investigative journalists alive today, has an extremely important piece about ongoing American intelligence and destabilization efforts in Iran.  One of the most disturbing revelations here is that the CIA is funding and supporting radical groups with links to al Qaeda:
  

  The Administration may have been willing to rely on dissident organizations in Iran even when there was reason to believe that the groups had operated against American interests in the past. The use of Baluchi elements, for example, is problematic, Robert Baer, a former C.I.A. clandestine officer who worked for nearly two decades in South Asia and the Middle East, told me. “The Baluchis are Sunni fundamentalists who hate the regime in Tehran, but you can also describe them as Al Qaeda,” Baer told me. “These are guys who cut off the heads of nonbelievers—in this case, it’s Shiite Iranians. The irony is that we’re once again working with Sunni fundamentalists, just as we did in Afghanistan in the nineteen-eighties.” Ramzi Yousef, who was convicted for his role in the 1993 bombing of the World Trade Center, and Khalid Sheikh Mohammed, who is considered one of the leading planners of the September 11th attacks, are Baluchi Sunni fundamentalists. [our emphasis]

• Let’s pause for a quick syllogism.  Call it a reductio ad absurdum of contemporary US national security policy, on two counts.
  

  (1) If a government actively supports al Qaeda, the United States should depose that government by force. (premise, per the “Bush doctrine”)
  (2) In 2003, Iraq was actively supporting al Qaeda. (premise, per smoke and mirrors)
  (3) Therefore, the United States should have deposed the government of Iraq. (1, 2, modus ponens)

  As problematic as it may be, let’s grant (1) for the moment. Now, we know that this argument is unsound, since (2) was always false. But we can replace (2) and run the argument again:

  (1) If a government actively supports al Qaeda, the United States should depose that government by force. (premise, per Bush doctrine)
  (4) In 2008, the government of the United States is actively supporting al Qaeda. (premise, per Hersh)
  (5) Therefore, the United States should depose the government of the United States. (1, 4, modus ponens)

  The two counts, in case it isn’t clear, are a) that “al Qaeda” is and always was an ambiguous term, such that basing military invasions on connections with the same is/was a weird idea; b) the US should quit supporting fundamentalists in its bid to quash fundamentalists.  You’d think we would’ve learned our lesson in Afghanistan.

• James Gustave Speth in Barron’s offers some ideas for evolving a less environmentally destructive version of capitalism.  He concedes that this would entail slower or no growth, but rejects the implicit premise that GDP = human well being (as we have discussed previously), which means that an economy focused on improving human society, rather than just infinite meaningless expansion, might not be a bad thing at all.

The clamor over whether “speculators” are driving oil’s parabolic run-up has become almost deafening, with the number of Congressional hearings on the subject reaching 40 this week and the price of oil dominating the nightly news. For every market analyst making the case for a speculative frenzy, the media have found an industry expert to argue that high oil prices are justified by the underlying supply–demand imbalance and weak dollar. If this sounds familiar, it might be because the scenario looked quite similar when the housing bubble came to a head.

Way back in 2005 when the Philadelphia Housing Index peaked. . .no, make that 2006 when it took a major hit. . .er, wait,. . .2007 when it fell 50% from its January high—the National Association of Realtors and the National Association of Homebuilders still refused to admit that current home prices were unsustainable. The real estate bubble was due partly to low mortgage rates, partly to speculation, and mostly to buyers’ fear that if they didn’t buy now, they’d have to pay more later—but it took months of housing declines before the “experts” would admit that things weren’t exactly hunky-dory.

Yet the future was crystal-clear to anyone looking at the chart on the left. The Japanese stock market in the late 1980s (black line) defined modern bubblology, and the tech bubble (blue line) carved out a paragon of the hyperbolic spike. By the time real estate (green) had traced the same vertiginous ascent, the writing was on the wall.

Now the price chart for oil (red) is looking eerily familiar. Ignore the fact that oil appears to be peaking at the same level as its predecessors—each plot is scaled to the vertical dimension of the chart—but note the rate of ascent over the past year. That vertical wall is the scarlet ‘B’ that flashes “bubble” in ten-foot neon lights.

One of the most credible arguments against the speculation theory comes from Daniel Yergen, “one of the nation’s best-known energy experts,” according to the New York Times. A Times article yesterday focusing on Mr. Yergen’s expected testimony before Congress summarizes his position as follows:

As the ninth hearing of the month gets under way on Wednesday, . . .Daniel Yergin, is expected to tell Congress that the focus on speculation is largely misguided.

Mr. Yergin will join numerous other energy experts who have declared that the rise in oil prices can be explained by basic economic factors, such as the limited growth in supplies in recent years, a weakening dollar, a global surge in energy demand and a string of production disruptions in countries like Nigeria.

Buy wait—there’s more:

Mr. Yergin said the market is relentlessly bidding up oil prices in response to deep-seated fears that the growth in demand will keep outpacing the growth in oil supplies in coming years.

“There is a shortage psychology in the financial markets and that is reflected in the price of oil,” Mr. Yergin said in the interview. “You are seeing a lot of people who have never invested in commodities who are now piling into the market. But calling it speculation is way too simplistic.”

Notice that Yergin doesn’t just overlook the bubbly nature of current oil prices—he actually confirms it, with phrases like “deep-seated fears” and “shortage psychology in the financial markets.” And he doesn’t even touch on forces like the automotive manufacturers’ fixed-price gasoline offers, which must be pumping a huge amount of money (temporarily) into the futures market as these companies hedge their incentives.

But it’s two additional developments that put us over the top. For contrarians, there’s the premier of the cable-TV reality show Black Gold. And for the politically focused, there’s the Republicans’ no-holds-barred drive for legislation permitting oil drilling in previously prohibited off-shore locations, including the Arctic National Wildlife Refuge—heedless of the fact that it would take ten years to have any impact, and that this impact would be minuscule.

Granted, there’s no way to know when the oil bubble will burst. Also granted that the fundamentals do support a certain price that’s above where consumers would like it to be. And yes, the dollar’s weakness is reflected in the price of oil. Unlike the Nikkei, tech, and housing, however, this bubble is likely to deflate only partly, before resuming its climb until alternatives displace oil as our primary energy sources

Position in United States Oil Fund (USO).

Forgive us a short rant this evening. This country is sick. When the three main engines of growth - consumer spending, real estate, and financial services - are broken, it’s just not possible to make any economic progress. And for just a moment, let’s think about how pathetic those key sectors really are.

Cogent analysis of our per capita consumption requires some historical knowledge, since no contemporary people compares with our particular level of decadence. At least the Romans had some style: we borrow profligately to buy more junk than we can keep track of, and then elect corrupt politicians to ensure those products will be as unsafe as possible. We satisfy ourselves with plastic toys and plastic food and live at a standard so high that, when the rest of the world follows suit, the environment will collapse. So part of the problem is that our economic health depends so much on discretionary consumption in the first place. The other part of the problem is that “consume” is too delicate a word for what we do: we gorge.

Our total lack of restraint is evident in our homes as well, which are too large, too expensive, and too ugly. The voluntary plywood prisons filling every suburb are justified only for believers in the mantra that in a capitalist society, no consumer choice can ever be a bad one. We’ve taken on more mortgage debt than we could possibly ever service, which can only be the result of some combination of financial illiteracy and raw greed.

Finally, the fact that financial services ever became such a core element of our economy is itself a testament to our aimlessness. Finance is a tool for greasing the wheels of an economy, and when it serves its proper role, finance can be a very good thing. But it can (and should) never be the economy itself; it is fundamentally derivative on the labor of real people doing real work. By extension, an economy that gives pride of place to what should be a tertiary concern is an economy that is winding down and running out of ideas. Just as the ascendancy of the lawyers is the death knell of an industry (cf. the dying spams of the major record labels and the RIAA), so the dominance of financial services signals an economy that has become tired and spent. Perhaps the common man’s lament that the United States “doesn’t make anything anymore” deserves more respect than it often gets.

Debates about the timing of this recession are beside the point. While the United States still boasts the strongest and most diversified economy in the world, the sources of our prosperity have also become the causes of our decline.  These are social and political problems as much as they are economic ones.  We must find new engines of growth.

Reversal Readings

Short-term oversold readings abound, as you might guess, but this is definitely one of those cases where you shouldn’t try to be a hero. Market internals were pretty awful into the close today.

DIA - 5.69
SPY - 3.09
IWM - 1.57
QQQQ - 0.93
XLF - 3.93
XLE - Energy - 57.39
EEM - Emerging Mkts - 1.62
FXI - China - 2.81
XLV - Healthcare - 0.82

We could go on: basically, the only things not oversold are gold, energy, and commodities.

The rally off the March lows is starting to seem like a hot air balloon that has sprung a leak and is getting ready to collapse in on itself.  For today’s rally to be believable, we’d need to see a lot more volume than this. NYSE volume made a new low for the year, and the lack of significant news today suggests this is likely some short-covering rather than a genuine bullish vindication.

The ratio of front-month to 3-month volatility is stretched now further than it’s been all year, and in fact is giving the strongest sell signal that we’ve seen since the top back on Dec 24, 2007. We all know what happened after that.

But never you mind: the permabulls and correlation-causation know-nothings in the financial press can’t keep from dancing. On days like this The Correlation Game becomes irresistible, so let’s play.

The Associated Press purrs:

Stocks up as oil price drop eases inflation fears - Wall Street rallied Monday as oil prices fell back and alleviated some of investors’ concerns about accelerating inflation. [link]

They forgot to include, however, the interview with the fund managers who all must’ve been thinking, “Oh, thank heavens, oil only costs $124/barrel now, so surely we’re out of the woods and inflation is going to ease! Buybuybuy!!” Obviously, blips in the price of oil did not cause today’s rally. And why fixate on oil? Why not spin some yarn about how the tragic earthquake in China will give Chinese industry some difficulties and make US companies more competitive? That nonsense is just as plausible as the oil story!

Be sure to check out the EEM double calendar that Frank posted earlier today. He’s giving these trades away for free and will follow through on at least one roll before Calendar Options launches.

Reversal Readings

Not much to report here tonight - most of the oversold readings we saw last night were alleviated today, but the rally wasn’t monstrous enough to generate too much overbought pressure either. Of the big volatility indexes, the RVX (Russell 2000) has held up the best in nominal terms, but that’s not necessarily meaningful.

QQQQ - 90.51
IWM - 93.01
EWZ - Brazil - 95.58
EWA - Australia - 96.01
XLU - Utilities - 94.64
PHO - Water - 97.45
ILF - Latin America - 92.11

Yesterday we learned that non-farm productivity rose 2.2% in the first quarter of this year. Anyone who was working in an office or factory when the last recession hit in 2001 knows what that means—a lot of people have been laid off or had their hours cut back, and the lucky ones who haven’t are filling in the gap left by their colleagues’ absence. Here’s how the Bureau of Labor Statistics explained the current numbers:

Productivity gains were due primarily to declines in hours worked. . . The decrease in hours was the largest since the second quarter of 2003, when they fell 2.1 percent.

A look back to the 2001 – 2003 period reminds us that productivity continued to grow at a healthy pace throughout the recession.

Wages, on a per-hour basis, rose, but not enough to keep up with inflation:

Hourly compensation increased 4.2 percent during the first quarter of 2008 following a 3.7 percent rise in the previous quarter. . . Real hourly compensation, which takes into account changes in consumer prices, decreased 0.1 percent in the first quarter of 2008 after falling 1.3 percent in the fourth quarter of 2007.

On the brighter side, the economy isn’t in recession, according to the latest official GDP calculations. Unemployment insurance claims data released this morning also suggest that, even though hours worked have fallen, businesses aren’t cutting loose their employees in the numbers one would expect in a recession.

So people are working less and earning less than they need to keep up with inflation, but the economy continues to grind on. What gives? Could it be that, just maybe, we’re spending money we don’t have?

The answer is—drum roll, please. . . Yes. Yesterday we also saw the release of the Federal Reserve’s consumer credit statistics for the first quarter of 2008, which show that borrowing continued to grow at an annualized rate of 5.4%. The monthly figures reveal that in March (the last month for which data are available), total consumer credit rose at an annual rate of 7.2%, and revolving credit (credit cards) increased at a yearly rate of 7.9%. It seems that instead of economizing to make ends meet, we just keep on borrowing.

Are we just postponing the inevitable recession, making it worse by loading up on debt that eventually will force people to stop spending? Or are we idling along with just enough (borrowed) fuel to avoid stalling until we get over the hill of damage done by the subprime crisis? If we knew, we’d sink all our money into puts or calls, get our 1000% return, and retire to a villa in Costa Rica. But since we don’t know, the best thing to do is focus on strategies that, when well managed, bring in steady income regardless of market direction.