The right things - for the wrong reasons

By DAVID MOON, Moon Capital Management, LLC
June 3, 2007

When gasoline crossed the $1-a-gallon mark in 1979, the pumps down at Waters Grocery store in Meridianville, Ala., were like basketball scoreboards that only went to 99.

The gas pumps couldn't handle prices above 99.9 cents a gallon, so stations had to price and pump their gas by the half-gallon until new pumps could be eventually be put into place.

The old men down at Waters advised me that gas would one day be $3 a gallon. Like New Testament writers expecting the Second Coming, they expected it sooner rather than later.

In a perverted sort of way, it's a shame they never got to see their prediction come true.

Of course, despite the economic wisdom and checkers skills of those old men, they would have never predicted that within 25 years water would cost more per gallon at Waters Grocery than gasoline.

The events that eventually required pump replacement at Waters were generally thought to date back to 1973. That's when the Arab contingent of OPEC instituted an oil embargo against the U.S. and other countries that had supported Israel in the Yom Kippur war.

Oil prices increased from less than $3 a barrel to $12. Gasoline prices tripled in a matter of months.

This is pretty commonly known history.

Now, the rest of the story.

Two years prior to the oil embargo, Richard Nixon pulled the U.S. out of the Bretton Woods system of fixed foreign-currency exchange, otherwise known as the gold standard.

Since the World War II agreement to manage currency fluctuations, the U.S. dollar had been fixed at $35 per ounce of gold, thus artificially limiting price increases among commodities whose prices would otherwise be closely related to gold.

The gold standard was a de facto currency cartel among the industrialized world. From 1944 until 1971, Bretton Woods kept an artificial lid on the price of oil, creating pressure that ultimately erupted with the embargo of 1973.

You can't hold a beach ball underwater forever.

When prices began to skyrocket in 1973, the initial result was that 29 years of pent-up oil prices were unleashed.

As with all asset price corrections, however, the market overreacted and prices continued to increase.

Hardly anyone woke up one morning in 1973 with the epiphany that for 29 years oil prices had been kept artificially low and needed to rise to reflect the actual cost of production and general level of price increases over that time.

Indeed, the event that precipitated the price move was completely unrelated to the cause of the imbalance.

Corrections almost always are.

Consider the collapse of technology stock prices in 2000. In hindsight, it is easy to see that it was long overdue. In fact, I don't know of an investor who doesn't now claim to have predicted the decline, and usually at the absolute market top.

But the pin that burst the bubble wasn't some analyst who finally demonstrated that the technology market had no clothes. That would have been rational. At the extremes, the market isn't rational.

The leader of the decline was Microsoft, in reaction to a Department of Justice case against the company alleging certain abuses of monopoly power.

When the software giant began to decline, so did the rest of the tech market. The right thing happened for the wrong reason.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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