This has been a fairly quiet week as holidays in the US and Canada have kept many away from their desks. The markets continue to gyrate as confusion reigns over inflation, the price of oil, will there or won’t there be a recession… the math proving a recession is becoming more difficult. Typically defined as two quarters of shrinking GDP, a recession could also be defined as a period of extended slow growth. Avid readers may recall that the final quarter of 2007 in the US showed growth of about 0.6% and the unrevised data for the first quarter of 2008 shows growth of 0.9%. We may be seeing the growth impact of the stimuli of rapidly falling interest rates, increased liquidity and the fiscal stimulus of the recent rebate cheques coming over the next few quarters. Of course, we will also see the inflationary impact and this will be the battle that will be waged over the near term. We cannot forget the risks from housing and battered financial balance sheets, but there is lots of relief already applied. When you are looking at an economic ship of about $60 trillion in size in the US, it takes time for such a large ship to turn.

We have seen signs that interest rate cuts are working through the firming of the ISM Non-Manufacturing survey and the fact that the ISM Manufacturing survey did not decline through the second quarter, but yesterday’s declines seemed to reflect pricing pressures but an unexpected increase in activity in the ISM Manufacturing survey. Consumer sentiment is at a low point, with the University of Michigan Consumer Sentiment Indicator showing a drop in confidence to a level not seen since 1980-1. When you take a historical look at both of the ISM surveys and overlay the Fed Funds rate, you can see patterns that seem to reflect that the interest rate cuts we have seen should start to show increases in both services and manufacturing. The consumer sentiment numbers are probably great contrarian indicators.

I would like to make one more point that I found interesting this week. I mentioned previously that the Saudis had stated that they would increase production by 200,000 barrels of oil per day, they then added that they would add another 200,000 boe per day, but you may have noticed that oil prices did not decline. I was speaking with a client this week who said that oil prices should fall on that news, and they would be right, normally. The issue was could they do it? I wonder how much sea water could still be pumped into their oil fields? Just this week they announced that they would not add to production, so the market had been told that 400,000 of barrels of oil per day would have been added to supplies, only to find a few weeks later that it would not be there. Nigerian production has been slowed to about 1 million barrels per day, but is expected to return to about 1.9 million barrels per day (when?). As the world needs to reach into increasingly risky places to find oil, and spend increasing amounts to develop oil fields, does anyone out there expect to see $40 or $60 for a barrel of oil anymore? We may see a slight decrease in energy demand as a number of emerging markets try to roll off their subsidies but the reduction in demand will likely be nominal but let’s look at a few numbers… there were about 20 million cars on the road in China in 2005… car sales in China were up 50% in 2006… by 2020, there are expected to be 140 million cars on the road, in China alone. There are about 125 million cars on the road in the US. The US uses about 25% of the 88 million barrels of oil consumed daily, and about 25% of that is used for cars, that works out to about 5.5 million barrels per day for cars alone in the US. If we tack on another 5.5 million barrels for Chinese cars by 2020 (let’s hope they don’t drive SUVs), then we can see how it is expected that we will need to produce somewhere north of an additional 44 million barrels per day by 2025 (Source: EIA) Will hybrids make a leap in technology and cost effectiveness to offset the demand, probably but to what extent? So how can you offset the inflationary impact of energy, invest in it.

Have a great weekend!

Tariq