The Insightful Trader

The early July pullback in gold to 1190ish has at least some people scratching their heads. My take is this. Gold ran up $100 to its all-time high of $1,268.50 as worried Europeans dumped Euros and bought gold in May. Then the European Central Bank (ECB) signaled that it will protect the Euro, and its own existence, by any means necessary, see this, and this.

And so, the Euro dissolution trade is dead, at least for now. I suspect that traders who bought gold because they feared the end of the euro, are selling gold and buying euros back.

To understand what is going on, look at the ECB’s secondary market purchases of sovereign bonds, which began in early May. I think the purchases may be a decisive element in the measures that have preserved the Euro, at least for now, and also led to gold’s pullback.

Recall that in response to the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) debt crisis the EU put together its bailout package in April. The package had an impressive headline number, $1 trillion in assistance. Many traders thought the headline number was more impressive than the substance. The euro kept falling and gold kept screaming higher.

Then in early June, it became clear that the ECB’s purchases of sovereign bonds on the secondary market were part of a continuing program, not a one time event (h/t naked capitalism). The Euro bottomed on June 7. I don’t think this is coincidence. Furthermore, gold, which made an intermediate high of $1,254.50 on June 7, can now be seen to have struggled since then, before finally selling off on July 1.

I would argue, though, that while the ECB punished gold holders in the short-term, ECB bond purchases are a positive for gold in the long-term. The purchases smack of “money printing” and amount to a backdoor aid package for the financially weak PIIGS. They peg the debt of the issuing countries to artificially high prices, and might even allow PIIGS to issue new debt at artificially low rates – assuming the ECB stood ready to buy bonds to support their prices. All of this can only lead to further debasement of the Euro versus gold.

Moreover the rebound in the Euro corresponds to at least a possible topping in the dollar. It almost has to, given the Euro’s large weight in the Dollar Index. (Hopefully this dip in the dollar will not bring to the fore, my longterm concerns about the dollar.) Some analysts suspect the Euro’s bounce mean that the risk trade is back on, and maybe it is for at least a little bit, given this week’s corresponding bounce in stocks.

The European bank stress tests also demonstrate Europe’s determination to save the Euro by propping up both the banks and financially weak PIIGS. The guidelines say that European banks may value Spanish Government bonds at 97% of par, and Greek bonds at 87%. That way the banks can, well, lie about the value of these assets and artificially prop up their equity. Of course, the banks will say that if the bonds will pay off at par (and if the EC can make that happen, they will) who needs to mark the bonds to market?

Allowing Europe’s banks to value the weak sovereign debt at such generous numbers, will also provide incentives for the banks to keep holding these bonds rather than dump them. Therefore the stress test guidelines provide a backdoor subsidy for the debt issuing countries as it would help keep their borrowing rates down. Of course, no one believes that these bonds are worth anywhere near that much.

But, in addition to the subsidy for issuing countries, the stress test guidelines matter because they indicate that Europe is following the US playbook on stress tests and bank bailouts. Last year, US regulators announced stress tests for US banks that would supposedly show that the banks would stay “solvent” under various economic scenarios.

As most readers know, these tests were ludicrously easy. Not many analysts thought that the major banks (with the possible exception of Wells Fargo, WFC) were viable at the time – not without government assistance, at least. But the stress tests provided a fig leaf to justify government help through TARP, the alphabet soup of Fed lending programs, and more lenient accounting treatments for banks’ securities holdings.

The change in bank accounting also marked the US stock market bottom in March 2009. Clearly the Europeans hope that European bank bailouts will make the financial markets happy as well. And in the short to medium term, if the US experience is any guide, the bailouts may enable the Euro bottom to hold (at least when measured against other paper currencies) longer than many people think. Even if, as in the US, European banks will continue to hold their fair share of underwater assets. In other words, short-term measures that kick the can down the road, can have important short-term results, even if they don’t solve long-term problems.

The European moves to bail out their banks tell you something else: not to worry about those reports that the Bank for International Settlements (BIS), is lending to commercial banks and taking gold as security, under repurchase agreements. Some gold traders seemed to fear that if the banks failed to make good on these loans, the BIS would dump the gold collateral on the market. My response: the EU will not let a big European bank fail anytime soon; that’s the whole point of their stress test charade. And if big European banks did start going down, I suspect the demand for gold would soar.

So what’s an investor to do? Chartists note that the June top was not much higher than the previous highs in December 2009, and point to what looks like a double top.  In response to this and the July 1 gold selloffs, gold timing newsletters turned understandably bearish. Of course, the Hulbert Letter holds up this pessimistic timer consensus as a contrarian indicator, and calls it a buy signal (h/t Daily Crux). Still, if you are a long gold, the chart has to concern you.

My thinking is,  if you are a trader and you don’t like gold’s double top (not to mention its closes below the 50 day moving average), why not lighten up? The chart doesn’t tell me that gold is going higher anytime soon. But I wouldn’t sell a core position, because the European move only underscores the long-term weakness of paper money around the world.

Disclosure: long GLD, SGOL

A number of investment newsletter writers would like the peak oil theory to go away. As their argument runs, the worldwide annual rate of oil production will not peak because, higher prices will induce the invention of enhanced technologies and bring forth new oil supplies.  Some of these folks even seem to believe that higher oil prices will allow US oil production to rebound, though no one comes out and states that.

Before I deal with this “cornucopian” argument, kindly let me review my understanding of what peak oil is. The Shell Oil geologist M. King Hubbert predicted in 1956 that US onshore oil production would peak in 1970, because he believed that annual oil production in a given region follows a bell curve over time. Annual production would expand, peak, and then eventually decline. “Hubbert’s Law” says that when about half of a reserve’s original oil in place has been lifted, annual production rates  fall.

As it happened, US oil production peaked at 9.6 million barrels per day in 1970, precisely when Hubbert said it would, and except for the temporary bounce in the early 1980s from  Prudhoe Bay , it has been falling ever since. In 2008 we produced 4.95 million barrels per day, the first dip below the 5 million mark. Here are the figures:

And note well, the crude oil price in 197o was about $1.35 per barrel, depending on the grade you pick. The current price is  over fifty times higher — okay, call it “only” 10 times higher if you adjust for inflation. Despite the higher prices US production has decreased  year after year almost without  relief. I haven’t  heard the cornucopians explain that.

Of course there will always be some oil left in the ground. Hubbert did not say that US or worldwide production would go to zero any time soon. He simply said that once the peak was passed it would no longer be possible to produce at the same annual rate.

After Hubbert succeeded in forecasting the US peak, other geologists tried to forecast the worldwide production decline curve.  There is a range of predictions regarding the date when worldwide production will peak. Some experts like Princeton professor Kenneth Deffeyes even say we’ve already peaked. But within the universe of respected energy specialists, nearly all agree that world production will peak at some point (sounds obvious, doesn’t it?). Even Cambridge Energy Research Associates (CERA), which is known for optimistic production forecasts, agrees with this statement. They just predict a later peak than most others do: around 2040.  It’s hard to be a more sanguine than CERA but  the cornucopians do try.

The cornucopian argument has two glaring weaknesses. First, Mother Nature doesn’t care how much money we humans pay one another for oil. The oil that is in the ground now is the amount we get to enjoy. Higher prices make it economic to drill for oil in remoter regions and to develop new extraction methods but they don’t change the amount of oil in place.

The second weakness is a bit more subtle. Though peak oil is a geological theory, it also follows from a bedrock principle of economics, the law of diminishing returns. That principle is associated with  nineteenth century economist David Ricardo.

Ricardo declared that in agriculture, there were diminishing returns to cultivation. Farmers would first till the most fertile land, and as population grew farmers would begin working less productive land, until farming the most marginal acreage became uneconomic. The crop yields wouldn’t justify the effort needed to till such parcels, even if the farmer added additional labor, fertilizer, or irrigation.

Diminishing returns show up in oil just the way they do in agriculture. A concept called the Energy Return on Energy Invested (EROEI) illustrates the diminishing returns to oil exploration effort through the history of the oil industry.  EROEI measures the energy content of an oilfield divided by the energy needed to get the oil.

In the 1930s, US oil production is now estimated to have yielded an EROEI of about 100; the number dropped to 30-ish in 1970 and to the range of 11-18 by the year 2000. Think about what happened when Colonel Drake drilled the first oil well in Pennsylvania,  or when Chevron (CVX) made its early Saudi Arabia discoveries. All they had to do was stick a shallow well in the ground and oil flowed freely to the surface. You’d expect a very high yield on prolific reserves that demand next to no effort to get.

As one might expect, prospectors found the easy oil first, and as one drills deeper, EROEI falls. But even in the life of what was once an easy oil field EROEI tends to fall over time. As an oil field  matures, natural pressure falls until oil no longer flows to the surface without a push. Oil companies extend the life of oilfields by injecting water or carbon dioxide to force oil toward the well bore. Another enhanced oil recovery (EOR) technique is directional drilling, where the angle of the well bore  is set to maximize the length of pipe that has direct contact with the layer of oil bearing rock being tapped.

EOR requires additional energy expenditure and so it  reduces EROEI. This increased energy expenditure increases the denominator in the oilfield’s EROEI ratio. Eventually the oilfield owner can get nothing more out of the reservoir. He has passed the point of diminishing returns like Ricardo’s farmer.

Higher prices have made resources such as the tar sands of Canada and Venezuela economic to exploit even though their EROEI is only about 5, quite a comedown from Saudi Arabia or East Texas in their glory days. Tar sands deposits are not even oilfields, at least as one normally thinks of oilfields. Typically they are more  like strip mines, where companies like Suncor (SU) and the Canadian Oil Sands Trust (COSWF) dig up a solid called bitumen. They load the bitumen into special, giant trucks, crush the big pieces into small pieces, separate out the sand and debris, and then run the separated product through an “upgrader.” The early stage processing requires substantial inputs of water and heat. Only then can the crude be refined into products such as gasoline, heating oil, and jet fuel.

The Horizon drilling rig and its tragic explosion  illustrate diminishing returns in another way. One needs elaborate and expensive equipment to drill for oil that is miles below a seabed that is itself thousands of feet below the ocean’s surface. These rigs take lots of energy and steel to make. Horizon even needed to expend energy by continuously running powerful thrusters to keep it in position. It wasn’t feasible to anchor the rig to the ocean floor in that depth of water. And in difficult locations like this, as we have been reminded, workers die when things go really wrong. So while higher prices make deepwater drilling feasible, one gets less usable energy per unit of effort than from conventional on shore oilfields, especially when all costs are factored in.  Ricardo would understand all too well.

No one doubts that higher prices promote EOR, and EOR extends the life of aging oilfields. EOR also enables midsized outfits like Denbury Resources (DNR) to work over largely depleted fields that the oil majors no longer care to bother with. I’ll also grant that higher prices make that business economic. Nor does anyone doubt that higher oil prices encourage people to substitute coal or gas for oil, to increase energy efficiency,  and develop new energy sources.

But if you want to say that US oil production has not peaked,  you have to go really far out on a limb. You have to argue that we will return to, and surpass, the halcyon days when the US could produce ten million barrels per day. Good luck selling that story.

So in my view, the total oil supply is not only finite, it gets harder to obtain with each passing year. And that’s why I continue to like oil companies with long lived reserves that are also located in poltically stable countries.  I particularly like the major players in Canada’s tar sands; of course I liked them better at May 2009 prices and said so at the time,  here. But if you have to own some stocks, these are the kinds of companies that will do well long term even if the market’s correction deepens. If stocks recover from last week’s turbulence and keep going up, so much the better.

Dislosure: Long SU

If you watch CNBC, you often hear commentators say that the small investor sits on the sidelines with oodles of cash in his money funds, and he is feeling left behind in this rally. Then you hear, either that this cash will fuel the next leg up, or, when the public gets in, that will be time to sell, because the little guy is always wrong.

And skeptical as I may be, the bulls are getting some support for this argument. According to the current Barron’s, money recently started flowing into equity mutual funds, about a year into the bull run. Not much, only about $11 billion over the last eight weeks, but the shift in direction might matter, especially with the Dow holding 11,000 today. Just to be clear, I’m not expressing an opinion on market direction here, only about the cash-on-sidelines theory itself.

First, as a matter of simple accounting (or arithmetic), there never was and never will be cash on the sidelines in the way many people discuss it. Think about this: if I buy stock with cash, the seller now has this cash. Is HE now holding cash on the “sidelines?” In any case, the cash still exists, the owner of it changed. Thereafter if the investor who sold the stock to me, buys other stocks with it, then a third party will have the cash. And so on.

Secondly, I’m not sure that the small investor’s target asset allocation is as heavily weighted toward stocks as it used to be. In other words, a smaller maximum percentage of investors’ money fund balances will go to stocks than in the past; more assets will be reserved for safety.  In this video (h/t Barry Ritholtz) David Rosenberg states that for nearly all of this rally, cash had been not only standing pat, but flowing OUT of equities. One key reason is demographic. As we baby boomers get older, our risk tolerance naturally decreases. Our appetite for stocks goes down and our appetite for fixed income goes up, because we have a shorter time horizon, with less time to make up for losses than we did when we were younger. And so advisors who specialize in asset allocation (which is most of them, since the old fashioned brokers who knew something about stockpicking are long gone) just about have to tell many of their clients to re-balance, out of equities.

These facts rest against a well-known backdrop, that stocks have had two bad crashes in the last decade, and the SPX is trading about 200 points lower than it did ten years ago in April 2000. Buying and holding stock index funds has been a losing long-term strategy for most investors who are active now, but bonds have been in a VERY long bull market that dates from the early Eighties. In other words, stocks have burned you and bonds haven’t. The “easy” trade is to buy the asset that has treated you well for as long as you can remember. That’s Treasurys. (I didn’t say, buying T-bonds is the right trade, but we’ll get to that.)

Furthermore it would seem that institutions are already committed to stocks. In this chart it seems like the institutional investors – at least those who run mutual funds –don’t have much more ammunition to throw into equities. Of course new fund inflows, presumably from individuals, could change this.  And as long as companies can benefit by slashing costs without running out of customers for their goods, stock buybacks can help goose stock prices too.

Of course there is one caveat regarding mutual fund cash percentages. Funds always have to have some cash on hand to satisfy redemptions. And if the market pushes up the value of the fund’s portfolio, and cash measured in dollars stays constant, the portfolio’s cash percentage falls. So this could be part of the reason for current low percentage levels of mutual fund cash.

But back to the video, which recorded a debate between Rosenberg and bond bear James Grant. Rosenberg said that portfolio rebalancing will support demand for bonds, and he also says that the Japanese experience (banking crisis, bank bailouts, economic stagnation, and easy ability for the government to borrow huge amounts) bodes well for the Treasury getting its bonds sold even the unprecedented amounts it now seeks.

Grant took the other side (as I did here):  Japan is a poor analogy for us, because it is an export powerhouse. With a large current account surplus, the Japan of the “Lost Decade” didn’t need the kind of international help we do, to get bonds sold. Japan’s GDP and the Nikkei average stagnated in the 1990s but its world-class exporters forged ahead as if nothing had happened (to pick the auto industry, for example, look at Nissan, Honda, and Toyota).

Having said all that, I wouldn’t be surprised if the Fed were thinking the same way as Rosenberg. On the one hand, by keeping rates low, the Fed is forcing institutions out on the risk curve, and this pushed stocks up. But on the other, the Fed could be thinking that fund flows from individual savers will support bonds; the Euromess, which for the moment makes America look good by comparison, could amplify those flows. The Fed and the Treasury can have their cake and eat it, or so that argument would run. I’d be more willing to buy the argument if the Treasury didn’t need to raise trillions of dollars of fresh cash annually to fund deficit spending, while additionally rolling over the $4.5 trillion or so  in debt that will mature over the next four years. Is there that much investable money in the world, or will the Fed have to print it? Rosenberg bets that there is, but I am reluctant to take the Japan analogy as far as he does.

Sooner or later, bond rates almost have to go up (do they really have much room to go down?). Assuming Treasury can raise its funds, it will almost certainly have to begin paying more for them in the next several years. Some of us remember that before the secular decline in rates we have enjoyed since 1981, there was a secular increase in rates that lasted  from 1941 to 1981. By the end of that bond bear market people called bonds “certificates of confiscation.” I would expect at least some kind of replay eventually.

As far as Treasurys go, I would short TLT if it gets close to resistance at 91. A trader would want to stop out somewhere above 92.50  but I think  it’s worth trying to hold longer term, if you can stand the news driven zigs and zags which are sure to keep coming.

Disclosures: Long TBT, short TLT

The stock market, as we all know, has made one of its quickest and largest recoveries ever in history, over the past year. This move has been aided in great part, by an abundance of cheap money. Since the Fed and the Treasury have turned on the spigots, standing in front of this uptrend in hopes of a reversal back to newer and lower lows, has been an exercise in futility.

As we close in on the important 62% Fib level on the S&P, as well as several key resistance areas on the DJI, we are starting to see signs that the market has become over bought in the near term from a technical perspective. After a brief respite from it’s climb in January, the market has resumed it’s recovery with a vengeance, now having gone nearly 30 days without even a 1% pullback, much less a more serious correction. And it has done this with declining volume throughout the entire move up for the past year. So caution has become the new watchword as traders and investors wait for the so-far, never coming pullback.

The end result is you have three groups of participants in the game now: those who bought into the move in the early phase and are extremely happy, those who have missed a large part of the move up are but are now eagerly awaiting a pullback so that they can get into the game and thirdly, those who think the whole move up is simply a correction in a major new downtrend and can’t wait to pounce once selling begins, hopefully soon, since some are probably already underwater on short positions. Of these three groups, 2 of the 3 are eagerly looking for topping signs or if not finding many lately, reasons why it should be topping soon.

One of the more prevalent reasons I’ve heard lately, besides certain overbought indicators, has been the recent climb in interest rates to a small degree and the expected greater increase as governments all over the world, but especially ours, have a lot of refinancing to do, as well as plenty of new, in our case. So the pervasive argument is that as rates move higher, this will make stocks less attractive. There is no doubt  that we could be close to breaking a 20-30 year general down trend in interest rates, but I think a look at the charts below may surprise you.

US Treasury 20 Year

Click Here for a larger image

As you can see in the chart above I’ve highlighted the areas where the 20 year rates were moving up. You can also see the SPX in the top of the chart and it’s performance while rates were moving up. I can see no correlation in the past 20 years that rising rates had a negative effect on the market. Now obviously at some point, if we reached rates like in the late 70s and early 80s with rates above 10%, then it may become a different story.

Below we have similar results looking at yields on the 10yr notes.

US Treasury 10 year

Click Here for larger image

The net result that  is that those thinking a move up in rates will be  the trigger for a pullback they’ve been looking for may be disappointed. We may certainly get a correction soon, but I don’t believe it will be because of interest rates. Now there are always those that may argue that traditionally when rates move up it’s because the economy is growing.  Therefore it’s normal that the market moves up then also but that this time it’s for a different reason that rates are moving up, more supply than demand. I think we’ll know soon enough.

In a story that smells awfully like a press agent’s plant, New York Times blogger William Cohan apparently decided it’s time to rehabilitate Robert Freeman. Once the partner in charge of Goldman Sachs’s (GS) risk arbitrage department, Freeman pleaded guilty to one count of mail fraud (the case was actually about insider trading) and served four months’ jail time in 1990.

Cohan tries to prove that Freeman was the victim of a prosecutorial “witch hunt.” Is he also trying to say that public opinion is also tarring GS unfairly now? Hard to say, but why else would anyone bring up Freeman of all people, twenty years after the fact?

No one doubts that Rudolph Giuliani, then a crusading US Attorney, played hardball and made some crucial errors in going after white collar crime on Wall Street. Nevertheless, Freeman admitted to breaking the law on insider trading, and the case seemed pretty clear.

Therefore I don’t see how Cohan can call Freeman’s prosecution a “witch hunt.” The more accurate metaphor would be a “fishing expedition” that expanded perhaps too far afield from its central targets: uber risk arbitrageur Ivan Boesky and Michael Milken, the wildly successful junk bond promoter at Drexel Burnham Lambert. Freeman proved to be unlucky but not exactly innocent. A guilty bystander, as it were.

Here are the facts that matter, whether Cohan likes it or not:

As Cohan states, risk arbs in those days did a great deal of research on the phone, trying to ascertain the latest news, the small details, the so called “color” of the deal related stocks they were trading. New color could cause a significant move in the stock, and sometimes provided clues that researchers could assemble into a mosaic of intelligence on whether deals would close.  On the other hand, arbs could take things only so far: SEC rule 10b-5, forbids trading on “material, non public information.”

In the case that ended his GS career, Freeman bought shares of Beatrice Foods, which Kohlberg, Kravis, Roberts (KKR) was in process of taking private in 1986. After Freeman bought, rumors leaked that the deal was not working out. So Freeman did his job and hit the phones to learn what he could. He spoke with Bernard “Bunny” Lasker, a former NYSE chairman, who suspected the rumors were true. Freeman cut his stake in Beatrice. Then Freeman talked to Marty Siegel, an investment banker who represented KKR. (Siegel eventually went to jail for selling inside information to Boesky.)

Siegel confirmed that the Beatrice deal was in trouble, with the now classic line, “Your Bunny has a good nose.” At which point, Freeman sold his Beatrice call options (and some more of his stock, too depending on which account you read), in clear violation of the law. When KKR announced it was reducing the cash portion of its offer for Beatrice, the share price fell. Freeman may have had reason to fear for the option position: if the calls were short dated and near or out of the money, they might have gone worthless on the news.

Wall Street firms have elaborate controls to prevent trading on inside information when they have it. I suspect GS procedure would have required Freeman to tell the firm’s lawyers about his chat with Siegel, at which point GS would likely have considered itself to be “restricted” in its trading of Beatrice shares until the information became public. (If any readers worked at GS then you are welcome to weigh in about this.)

Furthermore, key court precedents established that trading on inside information is forbidden when that information was obtained in a “breach of duty.” That’s common knowledge among Wall Street professionals.  In this case, Siegel, a banker who represented KKR, betrayed KKR’s confidence by passing privileged information to Freeman. As clear a case of a breach as you can find. And yes, Cohan omits this issue from his article.

What Freeman did was illegal and really, really stupid. Yet notwithstanding all this, Cohan says that Freeman deserves a presidential pardon. Yeah, right.

One of Cohan’s whoppers – and this one destroys the credibility of his whole article – has to do with his treatment of Marty Siegel – and by extension, Giuliani. Cohan insinuates that Siegel was an entirely unreliable witness and that Giuliani went out and arrested all the subjects of his insider trading investigations, including Freeman, based on Siegel’s say-so, without corroboration.  Was Giuliani really that foolish? Well, no, not really.

Along with Drexel banker Dennis Levine, Siegel turned state’s evidence on Ivan Boesky, who was certainly dirty. Boesky in turn helped finger Milken (a prosecution that leaves me uncomfortable to this day) and many others. The Boesky and Milken cases were among the biggest white collar prosecutions of the decade, front page news that went far beyond the world of finance. After winning these cases Giuliani ran for Mayor of New York and won. Incredibly, Cohan omitted any mention of Boesky or Milken.

In other words, Cohan failed to tell his readers that Siegel had hit pure gold for Giuliani. Giuliani had every reason to take Siegel seriously.

Having said that, Cohan correctly judged that Giuliani overreached. Giuliani blundered badly by failing to corroborate Siegel’s assertions sufficiently before arresting Tim Tabor and Richard Wigton, both of Kidder Peabody, and then Freeman. Neither Tabor nor Wigton went to trial – the cases fell apart before that – but neither man worked on Wall Street again. Giuliani had ruined them.

So Cohan may well be right when he says that  Giuliani did everything he could to nail Freeman once the Tabor and Wigton cases proved weak. A contemporaneous Times editorial concurred, saying that Freeman was “abused.” But odious as these facts are, they don’t erase what Freeman did.

Cohan also tries to dance around Freeman’s guilt by saying that Freeman got caught only because his subordinate was given immunity in exchange for testifying against Freeman. But that’s standard procedure in any investigation: prosecutors threaten little fish with stiff sentences to get evidence against big fish. More cogently Cohan notes that several other allegations against Freeman proved false. Which may be why even the judge who sentenced Freeman termed him, “basically decent.”

Here’s an intriguing nugget Cohan noted but didn’t pursue. Apparently Freeman’s position limit was $50 million. Yes, quaint as it looks now GS partners really cared about sums that size back then, especially when all of them were potentially liable for the firm’s mistakes. Yet Freeman risked $66 million on Beatrice including his stock and options positions. Did Freeman’s partners know of the limit violation before the investigation?

If not, one could understand how Freeman might have been driven to sell Beatrice options before the bad news hit the wires: fear that his partners would see that Freeman’s excessive risk taking brought with it excessive losses, which is exactly what position limits are designed to prevent. Or maybe Freeman got prior permission to exceed the limit, but wanted to avoid embarrassment when his big bet went bad. Either way, the risk of an insider trading scandal was greater than that of a trading loss, but even very smart traders make mistakes under pressure.

GS lawyers defended Freeman, but then, according to Cohan, Freeman copped his plea to avoid further anguish for his family when Giuliani threatened to bring racketeering charges. So Freeman served only four months; Judge Pierre Leval suspended the rest of the one year sentence and fine him $1 million. The Times actually approved of that sentence when it came down, saying that Freeman deserved “a taste of prison” but also citing Giuliani’s “outrageous tactics.” My sentiments exactly, but that was back in the day when the Times was more able to call things as it saw them.

As for Goldman, it came up smelling like a rose. Giuliani never brought charges against the firm, and so it was spared the fate Giuliani had visited on Drexel Burnham. But in hindsight it would likely not have gone any other way.

GS management committee member Robert Rubin, also Freeman’s boss and mentor, moved up to vice chairman in 1987 during the Freeman investigation (in 1990 he became the firm’s co-head) and Rubin never paid for any of the things that went wrong on his watch. These would include the insider trading at GS, the financial deregulation Rubin championed as Treasury Secretary,  and the de facto bankruptcy at Citigroup (C) where Rubin was vice chairman. Just a thought.

No, the Supreme Court hasn’t ruled lately on these two issues to my knowledge, at least not directly. But unless you’ve been living in a cave, you know that last Thursday, the 21^st, the Court struck down longstanding restrictions on corporations’ political campaign spending. The headline highlights some likely results.

The Citizens United decision allows corporate (and union) donors to pay for ads that will run within 30 days of a Presidential primary or 60 days of a general election. Previously such spending was barred by the McCain-Feingold campaign finance reform law.

As political spending increases, its recipients in old media will benefit. I’ll tell you which companies are best positioned, but it’s too early to say just how much more they can make.

Some restrictions on campaign spending remain. Corporations cannot donate directly to candidates, though they can donate to issue oriented political action committees (PACs) that are at least nominally independent of candidates and their parties. Also, the sources of a PAC’s funding have to be disclosed.

A few numbers illustrate the new potential for political ad spending. A combined total of $5.3 billion was spent for the Congressional and Presidential elections of 2008. By way of contrast, Exxon (XOM) earned $45.2 billion in 2008 on that year’s record oil prices, and $13.2 billion for the first nine months of 2009. Goldman Sachs (GS) will pay out $16.2 billion for wages and salaries, or $498,000 per employee, and still record $13.4 billion in profit for 2009 after making these payouts. My point is, many major corporations can afford to break expenditure records on any given race if they care to.

And many of them have reason to care. For example, if  five votes on a congressional committee stand between you and, say, an arcane tax law change that would yield $40 million annually, what’s $15 million of campaign spending?  One heck of a good investment. Or, take environmental law. To pick an outsize but obvious hypothetical, even $100 million in campaign funds would be chump change for, say,  Chevron (CVX), if in return it got to extract a billion barrels of oil in the Alaska National Wildlife Refuge and earn profits, of, say, $10 per barrel.

But who needs hypotheticals? Last week the President proposed a tax on repurchase agreements, a form of collateralized lending used by large financial institutions. He also proposed bank size limits and talked about preventing banks from using federally insured deposits to finance speculative trading, the so called “Volcker rule.”

Citizens United gave banks new weapons to fight proposals like these. If, come election time, a tough bank regulation bill gets close to enactment (though it’s not likely to get too close, in my view), look for anti-regulatory commercials. They’ll be brought to you by PACs with names like “Depositors for a Sound Banking System.”

Having said all that there are two reasons why I could be wrong about the increase in campaign spending I expect. First,  interest groups already know how to exert influence while working within the pre Citizens United rules. Therefore, it’s possible that the new decision won’t change much.

Secondly, politicians understand the new, post Citizens United campaign economics and many of them will begin to censor themselves, even more than they already do. Expect even some of the bravest to pander to the money that talks on key issues, rather than face deep pocketed opposition. As former Treasury Secretary Paulson once said, “If you’ve got a bazooka and people know you’ve got it, you may not have to take it out.”

So, how to play this? Ad agencies and broadcasters should expect a noticeable, recurring revenue increase during election cycles. I don’t know how anyone could predict exactly how large a bump they will get, and what effect that bump will have on earnings per share, because we are in new territory here. If this type of play interests you, look for pure media companies with heavy domestic exposure and put them on a watchlist.

CBS (ticker symbol, also CBS) would be an obvious beneficiary of this trend; the other networks are part of large conglomerates. Therefore new political ad revenue at those broadcasters might not have much effect on parent company net income. If you want to stretch a point, however, you might also look at News Corporation (NWS), since its Fox News division contributes a disproportionate share of profits to NWS.

Among ad agencies, billboard owner Lamar Advertising (LAMR) would seem to be among the purest domestic plays that could benefit from increased political ads, but be forewarned, it is losing money due to the recession and has a leveraged balance sheet. Two ad majors, Interpublic Group (IPG) and Omnicom (OMC) would seem to be safer bets, but both of them generate around half of their revenues from abroad. IPG has more domestic exposure than OMC.

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The recent winter blast across much of the country will only continue the recent trend in energy prices that are putting pressure on an already squeezed American consumer. After dropping dramatically in the latter half of 2008, energy prices, led by oil have, have rebounded significantly aided by a weak dollar.

The increases have been significant, and perhaps more so now than in 2008, in regards to the impact on discretionary consumer spending. Let’s look at recent moves in the past year. Oil, which bottomed at $35 in December of 2008, has now, without much fanfare from the administration or the talking heads on TV, climbed to over $80 per barrel. Crude oil imports averaged about 8.5 million barrels per day in the latter half of 2009.

The result has been that gas prices have made a huge move upward to nearly $2.20 per gallon wholesale in the past year from a low of $.82 a year ago. This is closing in on a 200% increase in just over a year. According to the EIA, we use about 380 million gallons/day in gasoline. Just in direct costs to the consumer, that’s a huge cost increase in the past year when many are already stressed financially. That’s $456,000,000 per day increase out of the US consumers pockets. That’s a lot of discretionary income up in smoke daily. This doesn’t include indirect costs for food products, transportation costs of products, electricity, etc.

Natural gas prices, which were the lone bright star in energy costs through the end of summer have spiked from a low of $2.65 in September to close at nearly $6 yesterday. Though at least our supply situation is much better in nat gas, as more users switch, primarily many of the utilities and recent winter weather, have caused a serious spike in prices in just the past 30 days. So when you factor in that many of the newer homes built in the past decade use natural gas for heating, that’s another hit to the consumer as well as those who use other forms.

Increasing energy prices are one of the most regressive taxes on consumers, affecting those who can least afford them the most significantly, yet not a peep out of anyone in the current administration, who have purposely pursued a weak dollar policy in order to cover our growing indebtedness. We’ve seen a definite move upwards in longer term interest rates the past 30 days which have a direct effect on mortgage rates.

So my question is, who and what is going to lead this economy out of recession, as unemployment remains high, foreclosure levels are at record highs and will probably continue, see here, and now a further squeeze as energy prices are once again seriously affecting consumers pocketbooks. Yet no one is even talking about the effect that these energy prices are actually having on the consumers. The Fed, led by Ben, says they’re keeping an eye out for inflation. I suggest they go to the grocery store and stop on the way home for a fill-up at their local gas station.