Dear Paul,

Why is the price of oil continuing to go up?

There are a number of reasons for high oil prices. The most important is “SUPPLY AND DEMAND” created by the growing consumption of newly developed countries in Asia and Latin America, like China, India, Mexico and Brazil. China is now the second largest car market in the world.

Another reason is that oil is priced in “DOLLARS PER BARREL” and when the dollar drops in value, the price of oil automatically goes up, because it takes more dollars to buy the same barrel of oil.

But, if you consider inflation and other factors, is oil really higher now than in the past? Michael Lewis of DEUTSCHE BANK has come out with an interesting new report on how to value the price of oil.

AS REPORTED BY THE ECONOMIST MAGAZINE

The price of oil has soared to a new high, hasn't it?

A casual observer might be forgiven for thinking that the oil price reached a new record, of $120 a barrel recently. And so it did, in nominal terms. But by other measures, oil is not quite as expensive as it seems. That, in turn, may go some way towards explaining why demand for oil continues to rise in many countries, despite prices that would have been unimaginable just a few years ago.

INFLATION

Michael Lewis of DEUTSCHE BANK has come up with several different ways of comparing past and present oil prices. The first step is to account for inflation. But what measure of inflation is most suitable? If historic prices are inflated in line with America's producer-price index, the previous record, struck in the early 1980s, would be the equivalent of $94 in today's money—a level exceeded some months ago. But if the consumer-price index were used instead, oil would need to climb to $118 to hit a record.

But an adjustment for inflation, however it is measured, takes no account of the growth in Western consumers' incomes over the years. Back in 1981, the annual average income within the GROUP OF SEVEN countries would have been enough to buy only 318 barrels of oil. To set back Western consumers by the equivalent today, DEUTSCHE BANK calculates, the price of oil would have to rise to $134 a barrel.

SHARE OF AMERICAN’S DISPOSABLE INCOME

By the same token, the American government reckons that energy ate up its biggest share of Americans' disposable income in 1980: 8% compared with about 6.6% now. To drive spending on energy to the same level again, says DEUTSCHE, the price of crude would have to rise to $145.

Spending on oil as a share of global output, which is about 3.5%, also peaked in 1980, at 5.9%. Other things being equal, oil will not swallow as big a share of the world's GDP unless the price reaches $150 a barrel.”

THIS STUDY DOESN’T MAKE THE PRICE OF GAS ANY EASIER TO SWALLOW!

While this is an interesting study, this won’t make many people feel better about the current record high gasoline prices.

This is why FOXHALL CAPITAL continues to invest our client’s portfolios in global energy funds and in gold and foreign currency funds that make money when the U.S. dollar falls. We hope that these oil, gold and foreign currency funds investments will make up for a little of our client’s higher fees at the gas pump.

Until next week…

—Paul Dietrich

dietrich@foxhallcapital.com