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History Tells Us That a Surge in Fuel Costs Makes a US Recession Likely

By Liam Halligan, February 26

Ever since the early 1970s, every single time oil prices have spiked sharply (rising by 80pc or more), regular as clockwork the US has entered recession.

During recent oil price spikes, Saudi Arabia, pictured, has been able to come to the rescue and turn the oil spigot

Economics is not a science. There are no laws or cast iron relationships – as there are in “pure sciences”, such as physics or chemistry. Throughout recent history, though, there have been a handful of economic variables between which the links have been pretty solid.

Ever since the early 1970s, every single time oil prices have spiked sharply (rising by 80% or more), regular as clockwork the US has entered recession. Given America’s massive influence on worldwide economic sentiment, the past five global recessions have all come in the wake of sharp jumps in the price of crude.

Only 8 months ago, oil was trading close to $65 a barrel. Last Thursday, Brent crude momentarily skimmed $120, up 17% in a week, before stabilising at $112. If oil climbs above $120 again, and stays there, it would be 80% above where it was in June 2010. We’d then have a bona fide oil-price spike, the sixth since the early 1970s, which suggests a US recession would follow.

No wonder US stocks are now under pressure. The S&P500, having enjoyed three straight weeks of gains, fell 2% on Tuesday alone, contributing to the sharpest weekly drop in three months. This happened despite surveys showing American consumer confidence at its highest since early 2008 and the Federal Reserve’s recent 2011 growth forecast upgrade suggesting the US could expand by a very respectable 3.9%.

In Asia, stocks also suffered in recent days on fears that expensive oil will derail the global economic recovery. In Japan, stocks shed more than 3% last week. Toyota, the world’s biggest car maker, lost almost 4% of its value.

Events in North Africa and the Middle East, of course, are now looming large in the minds of investors and the broader public. In January and early February, the ousting of Tunisia’s President, followed by the dramatic resignation of Egypt’s Hosni Mubarak, sent oil prices into triple-digit territory for the first time since 2008. Since then, the shocking scenes of conflict in Libya have driven up prices even more.

Muammar Gaddafi has vowed to fight “until his last drop of blood” a growing rebellion in a country which controls Africa’s largest oil reserves and accounts for almost 2% of global production. Having been weakened by his opponents taking control of Libya’s oil-rich East and the loss of his closest advisers, Gaddafi has now reinforced his defences around Tripoli with mercenaries and tanks.

Even before Tunisia’s “Jasmine revolution”, let alone the much bigger riots in Egypt and then Libya, oil prices were rising steadily. What’s changed in recent weeks is that while the market was previously driven by the realities of rising oil demand, it is now spiralling on fears about lower supplies.

China and India between them are home to a third of the world’s population. Even in 2009, when the world economy was on its knees, these emerging Asian giants grew by 8.7% and 6.6% respectively. Last year, although the Western countries to which they sell so many goods remained relatively sluggish, China and India still both expanded by close to 10%.

As they grow, these countries are investing massively in infrastructure development – which is highly energy intensive. At the same time, more and more of their citizens are becoming wealthier, acquiring cars, air conditioners and refrigerators for the first time, while switching to protein-rich diets.

All this is obvious to oil traders – who now almost universally factor rising demand into their calculations of current and future prices. Even the International Energy Agency, a thinktank funded by oil-importing governments, which has long played down the impact of higher global oil demand, has been forced to acknowledge reality. The IEA just raised its 2011 world oil usage estimate to 89.3m barrels per day, up from 84.1m as recently as 2009 and its fifth demand upgrade in as many months.

In 2010, Chinese oil use grew by an astonishing 15.1% year-on-year, with the People’s Republic now burning more than 10m barrels daily. And given that China’s per capita oil usage is still only a fraction of Western levels, as the country’s massive population gets richer, overall oil consumption will certainly keep rising and could even accelerate.

So the “secular” growth story, driven by the emerging markets, has been driving up oil demand. At the same time, Western governments, not least in the US and UK, have been adding fuel to the fire by massively expanding their base money supplies under the guise of “quantitative easing”.

As soon as such extreme policies were adopted in early 2009, some of us warned investors would view them as “currency debasement” and react by swapping dollar- and sterling-denominated investments for “tangible assets”, creating an oil price spike. Such views, previously seen as heretical, have since been shown to be true.

Commodities and other assets governments can’t print more of are now being widely used to hedge against Western inflation and currency depreciation. Just as they are starting to recover from the credit crunch, consumers and businesses in Europe and the US will now suffer badly from a spiralling oil price. Well, to some extent, sky-high crude is a direct result of the grotesquely irresponsible monetary policies pursued by their own governments – which, along with the growing energy needs of the East, have stoked oil demand.

Against this strong demand backdrop, drama in the Middle East has sparked supply-side fears, too. When the trouble was limited to Tunisia and Egypt, neither of which are significant producers, concerns were about “contagion”. But Libya is a sizeable oil nation, pumping around 1.7m barrels daily. The Italian oil major ENI, which dominates Libyan production, says 1.2m barrels of production could be lost – possibly more.

At the same time, many of the European refineries that obtain their oil from Libya can only process light crude, a product even the mighty Saudi Arabia finds difficult to supply.

That’s not the only reason why assumptions that the West can rely on Saudi – holder of 25% of global oil reserves, and the world’s “swing producer” – may be wide of the mark.

The country’s ruling elite, with the monarchy at its heart, is clearly petrified that civic unrest, having now spread to neighbouring Bahrain, could engulf the Desert Kingdom. That’s why they’ve just unveiled a $35bn package of welfare payments to placate an increasingly dissatisfied population.

The reality is that, in the current climate, the Saudi authorities will want to avoid, at all costs, the risk of being seen as too “pro-Western”. During recent oil price spikes, Riyadh has been able to come to the rescue and turn the oil spigot. They’ve used the argument that high oil prices will ultimately derail the big Western economies and therefore undermine global oil demand – which will harm the Opec oil exporters cartel, not least its members in the Gulf.

Such logic is now far more difficult for the Saudis to sell – not only due to growing anti-Western sentiment across the Middle East but also because, given the burgeoning energy needs of Asia, traditional assumptions that the big oil producers need the economies of Europe and the US to remain buoyant no longer wash.

So this oil price spike, similar to its predecessor, might easily cause another Western recession. But it will be different in that it could also be the harbinger of a historic realignment of relations between the Middle East and the West. You see, even when economics seems to produce semi-scientific outcomes, the underlying realities are generally still driven by the vagaries of politics and the ebbs and flows of history.


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Will ‘Chindia’ Rule the World in 2050, or America After All?

By Ambrose Evans-Pritchard, February 27

With a small tweak in assumptions and the inexorable force of compound arithmetic, Citigroup and HSBC have come up with radically different pictures of what the world will look like in 2050.

US President Barack Obama meets China’s President Hu Jintao in London in 2009

Which of the two is closer to the mark will determine whether the West hangs on, or disappears as a relevant voice in global affairs.

For neo-Spenglerites – who believe the West is finished – Citigroup’s Willem Buiter offers some astonishing projections. The Muslim powerhouse of Indonesia will alone match the combined GDP of Germany, France, Italy, and Britain by mid-century.

The economies of China and India will together be four times as large as the United States, restoring the historic order of Asian dominance before Europe’s navies burst on the scene in the 16th Century. Panta Rei, says Dr Buiter: all is in flux; nothing will remain the same.

Africa will at last emerge from its long string of disappointments to take the baton as the fastest growing region, clocking 7.5pc a year over the next two decades.

It does not require miracles of performance for this to occur. Catch-up countries merely need to keep reforms on track, open markets, “don’t be unlucky, and don’t blow it”, and let convergence theory do the work for them.

Having rid themselves of calamitous nonsense – Maoism, the Hindu model, and other variants of central planning or autarky – and having at last achieved a “threshold level” of law and governance, nothing should stop them, or so goes the argument.

“Sustained growth prospects in per capita incomes across the world have not been as favourable as they are today for a long time, possibly in human history.” Global growth will quicken. GDP will quadruple again from $73 trillion to $378 trillion by 2050 (constant US dollars).

Dr Buiter’s team adds the usual caveats: “beware of compound growth rate delusions;” or “the bigger the booms, the more spectacular the bubbles, and the devastating the busts;” or indeed that “convergence is neither automatic, nor inevitable. In history, it has been more the exception than the rule.”

Argentina is a salutary lesson. Why did it diverge from its sister economy Australia, so similar in trading patterns in the late 19th Century? Why did it fall from the world’s fifth richest in per capita terms in 1900 to a third of Australia’s level a century later?

It is hard to pin-point where the rot began, though Peron clinched decline by bleeding farm wealth to fund his populist patronage, and by forcing the central bank to print the shortfall. Bad policies hurt.

Oddly, Britain will scrape through in Citigroup’s global reshuffle, just holding on as the world’s 10th biggest economy in 2050, the only EU state left in the top ten. It will even overtake the US in per capita terms.

Can this be so? Britain has slipped to 25th in reading, 28th in maths, and 16th in science in the Pisa rankings. Shanghai’s school district takes top prize across all three, ahead of Korea and Finland. While the UK faces a less disastrous ageing crisis than much of Europe, this is thanks to our unrivalled leadership in unwed teenage pregnancies.

HSBC’s report also sketches an era of unparalleled prosperity, yet the West does not sink into oblivion. China overtakes the US, but only just, and then loses momentum.

Chimerica, not Chindia, form the G2, towering over all others in global condominium. Americans prosper with a fertility rate of 2.1, high enough to shield them from the sort of demographic collapse closing in on Asia and Europe. Beijing and Shanghai are 1.0, Korea is 1.1, Singapore 1.2, Germany 1.3, Poland 1.3, Italy 1.4 and Russia 1.4.

Americans remain three times richer than the Chinese in 2050. The US economy still outstrips India by two-and-a-half times. This is an entirely different geo-strategic outcome.

My own view is closer to HSBC, perhaps because my anthropological side gives greater weight to the enduring hold of cultural habits, beliefs, and kinship structures, and because of an unwillingness to accept that top-down regimes make good decisions in the end.

Both studies rely on the theories of Harvard economist Robert Barro, but differ on how easy it is to handle population collapse. The great unknown is what rapid ageing does to creative zest, and how many decades it takes to turn the demographic super tanker.

China’s workforce peaks in absolute terms in four years. While the population keeps growing until the tipping point in the mid 2020s, it is ageing very fast. Hence warnings by Chinese demographers that there may soon be an epidemic of suicides, as the elderly step out on the ice to relieve the burden.

Zhuoyan Mao from Beijing’s Institute for Family Planning said China’s fertility rate had been below replacement level for almost twenty years. “Population momentum” turned negative over a decade ago in Beijing, Tianjin, Shanghai and Liaoning, but the countryside is catching up. “The decline speed in rural areas is faster,” he says.

It is bizarre that China should still cling to the one-child policy, though Shanghai’s local authorities have been encouraging couples to have a second child since 2009. The policy is losing its relevance at this stage, though gender picking (female infanticide, at the ultrasound stage) has left the legacy of a male/female ratio of 1.2 to 1, with all that implies for social stability.

China’s fertility rate is collapsing anyway for the same reasons as it has collapsed in Japan and Korea – affluence, women’s education, later pregnancies that stretch generations, in-law duties, and costly housing. You cannot reverse this with a wave of the wand. The lag times can be half a century.

George Magnus, UBS’s global guru, writes in his book “Uprising” that China faces a “triple whammy of ageing”. The number of children under 14 will fall by 53m by 2050; the work force will contract by 100m; and the over-60s will rise by 234m, from 12pc to 31pc of the total.

Mr Magnus is scathing about the “muddled thinking” of those who fall for BRICs hysteria, or who succumb to the facile conclusion that the global credit crisis finished the West and served as catalyst for a permanent hand-over to Asia.

The crisis also exposed the fragility of Asian mercantilism, even if this has been disguised for now by a stimulus blitz in China that has pushed credit to 200pc of GDP.

I might add that China is depleting the non-renewable aquifers of its northern plains at an alarming place, and faces a separate water crisis from receding Himalayan glaciers.

Cheng Siwei, the head of China’s green energy drive, told me a few months ago that eco-damage of 13.5pc of GDP each year outstrips China’s growth rate of 10pc. “We have an intangible environmental debt that we are leaving to our children,” he said. That debt is already due.

Perhaps the 21st Century will be America’s after all, just like the last.


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NEWS: Orvana Reports Measured and Indicated Resources Increase of 50% for Pre-Feasibility Study at Copperwood, Michigan, USA

Orvana Minerals Corp., through its wholly-owned subsidiary, Orvana Resources US Corp (“Orvana USA”), announced today an updated resource estimate for the Copperwood copper project, Upper Peninsula, Michigan, USA. This estimate includes the mineralization in the adjacent area, previously referred to as Copperwood S6, and will be the basis for the mine plan and design that will be included in the prefeasibility study expected to be released in June, 2011. The estimate is summarized in the table below.

Resource Category   Short Tons (millions)   Metric Tonnes (millions)   Copper, %   Silver, gpt Copper, million lbs
Measured   25.7   23.2   1.71   4.7 877
Indicated   7.6   6.8   1.44   3.0 219
TOTAL M & I   33.2   30.1   1.65   4.3 1,098
Inferred   3.1   2.9   1.07   2.0 67

The resources assume a $2.50/lb copper price, $10/tonne mining cost, $10.80/ton processing cost, 83% copper recovery, $2.75/ton G&A, $5.63/ton sales cost, a minimum of 1.5 metres (5 feet) mining height, and a 0.8% cutoff. Marston & Marston,, Inc., St. Louis, MO, under the supervision of Michael B. Ward, a qualified person who is independent of Orvana for the purposes of NI 43-101, prepared the resource estimate, which effective date is January 25th,2011.

“We will now optimize the throughput for the prefeasibility study since this estimate increased M&I tonnage by over 50% and contained copper by about 40% as compared to that used for the September Preliminary Economic Assessment,” said Bill Williams, President of Orvana USA.

Marston & Marston of St. Louis, Missouri was retained to prepare the updated mine plan and design. KD Engineering of Tucson, Arizona will oversee the prefeasibility study.

As reported in the December 14, 2010 press release, the resource estimate of 25.01 million tonnes of 1.40% indicated (771 million pounds) and 36.14 million tonnes of inferred (1,033 million pounds) in the area of Copperwood, referred to as the Copperwood Satellites, will be evaluated after the mine is operating in order to assess expansion possibilities.

Copperwood is a sedimentary stratiform copper deposit hosted by the Precambrian Nonesuch Formation. The mineralized unit, or the copper-bearing sequence (“CBS”), lies at depths between about 30 metres (100 feet) and 265 metres (870 feet). The CBS is amenable to underground, room-and-pillar mining. The mineralization is analogous to the White Pine mine, located 30 kilometres (18 miles) to the east, where nearly 2 million tonnes of copper was produced between 1953 and 1996.

Mineral resources that are not mineral reserves do not have a demonstrated economic viability.

Marston & Marston, under the supervision of Michael B. Ward, who is an independent qualified person for the purposes of NI 43-101, prepared the resource estimate. A summary report will be made available on the Company’s website, www.orvana.com, and on SEDAR, www.sedar.com, within 45 days.

Full release

Royal Canadian Mint Now Saying It’s Difficult Securing Silver

By Eric King, February 24

We are constant listeners of perhaps one of the best interviewers around, Eric King. If you subscribe to our newsletter, you know this already since we always recommend his interviews. Eric is very aware of what’s going on, and with gold and silver markets heating up, we want to publish a short piece posted on his blog yesterday.

Royal Canadian Mint Now Saying It’s Difficult Securing Silver

With continued reports of booming sales and tightness in the silver market, today King World News interviewed Dave Madge director of sales at the Royal Canadian Mint.  When asked if the RCM is having trouble acquiring silver Madge responded:
“Demand right now for silver is through the roof and it shows no signs of slowing at this point.  Sourcing silver is becoming very difficult.  We are competing with a great many players when it comes to purchasing silver and many of these players are bidding the price higher.”

Dave Madge of the Royal Canadian Mint continues:
“Our advantage is that we have had long-term relationships with our suppliers and that has helped us in this situation.  We have been able to leverage off of those relationships to get supply, but it still remains a big challenge sourcing material.  We’re looking at ways of mitigating our risk regarding supply of silver.
We are anticipating it to become even more difficult to secure supplies in the future.  This is based on what we are seeing firsthand and what our suppliers are telling us.  We work closely with these banks to secure silver and they tell us there is a lot of competition.”

When asked what this means for the price of silver and how long this condition is expected to persist Madge stated:
“I think you are going to see the premiums go up in order to secure silver.  At some point some players will be priced out of the market.  I don’t think this is a short-term situation, I think there are a lot of issues going forward and this may be the new norm.”

The key here from Dave Madge is that he expects it to become even more difficult in the future to secure supplies of silver.  In my mind this is an extremely important testimonial regarding how tight the silver market is because the information is coming directly from the Royal Canadian Mint itself.

The Royal Canadian Mint is known as a world-class provider of minted products and KWN is thankful to both the RCM and Dave Madge for this interview.


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