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Great Expectations

REALITY - The human race is expanding at an alarming rate, which is starting to assert immense pressure on our planet. Global warming, extreme weather patterns, rising geo-political tensions and unrest - these are all symptoms of economic and social stress. Take a look at Figure 1, which shows the explosion in world population and gives us an idea of what lies in our future. At present, world population stands at 6.5 billion and roughly 50% of humans reside in Asia. In 1950, our planet was home to (only) 2.5 billion people, which means that world population exploded by 2.6 times over the past five decades! According to the conservative estimates by the US Census Bureau, our planet will add another billion people in a decade and world population will grow to 9.1 billion by 2050.

Figure 1: The ongoing human boom!

Source: US Census Bureau

As far as demographics are concerned, Europe and Japan have a major problem on their hands. Their population is ageing rapidly, birth rates are extremely low and things are not getting any better. Similarly, the US also faces a major problem as its "Baby Boomers" approach retirement. How will these countries support their retired people? Obviously, their social security and medicare systems will be put to the ultimate test. Perhaps, the new Fed chief - Mr. Helicopter Bernanke will really fly around dropping dollar bills over every household!

In spite of the above sobering facts, most analysts and "experts" continue to present a rosy economic outlook. The consensus view is that the global economy will do "just fine", oil will drop back to $30, inflation will remain tame and interest-rates will fall. Amidst this widespread optimism, I ask myself "Is the majority expecting too much or am I missing the point in all of this?"

My own research has convinced me that that in order to get on with the business of living, the rapidly expanding population will need more things over the coming years. Hence, the ongoing bull-market in natural resources, commonly known as commodities. In the future, most of the population growth will come from China and India, where per-capita consumption levels of commodities are extremely depressed and amongst the lowest in the world. As their population and consumption levels continue to increase, you can imagine what is going to happen to the price of commodities!

LIQUID GOLD - Last month, I stated that the oil correction was coming to an end and recommended taking positions in the energy complex. My timing was based on technical factors but above all, my bullish bias is due to the fundamental factors of supply and demand. Crude oil is in a generational long-term bull-market, which is only going to intensify in the future.

The good news for energy investors is that human beings can do without most things in life but everybody needs oil to survive. The gooey liquid is used in pretty much everything we consume. Transportation, agriculture (pesticides), power, and plastic - they are all dependent on oil. Put simply, the demand (need) for oil is largely inelastic and doesn't fluctuate a lot due to changes in price. For example - in the 1970's, crude went from $1.5 per barrel to $40 per barrel - an astonishing 2,600% climb; yet (surprisingly) demand for oil increased by roughly 40% over the same period!

The oil-shocks in the 1970's were politically motivated, hence the shortfall in supply was artificial in nature. On 6 October 1973, the Jewish holy day of Yom Kippur, Egyptian forces attacked Israel from across the Suez Canal, while at the same time Syrian troops launched a surprise offensive. Israel , with help from the U.S., succeeded in reversing the Arab gains and a cease-fire was concluded in November. But OPEC struck back against the West by imposing an oil embargo on the U.S., while increasing prices by 70% to America's Western European allies. This oil-embargo acted as a catalyst in igniting the oil boom, which lasted throughout the decade and only ended after the Iranian revolution. Thereafter, supplies got restored to normal levels and the oil price fell back.

There is one important distinction, which every energy investor must consider. In the late 1970's, whereas Saudi Arabia had the capability to ramp up its production in order to meet the growing demand, it may not be able to deliver in the future. During the 1970's oil crisis, Saudi Arabia utilised all of its excess capacity and output peaked at roughly 10 million barrels a day. Today, Saudi Arabia (pumping close to capacity) only manages to produce roughly the same amount of oil as it did in crisis mode in the late 1970's! So, despite what Saudi officials claim in terms of its huge oil reserves, their country (over the past 25 years) has failed to increase its production in any meaningful way. If Matthew Simmons (leading energy adviser) is correct, today, Saudi Arabia does not have the capability to increase production to meet future increases in demand. In fact, according to several geologists, the world's oil-peak is upon us and global oil production will gradually decline each year.

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