Il Castello di Venere

Il Castello di Venere
April 11, 2011
David R. Kotok


From the top of Il Castello di Venere at Erice, we are 96 miles from Tunisia. The Trapani-Birgi airbase in Sicily has now become the staging area for NATO operations against Gaddafi. AWACS planes and fighter jets on missions to Libya are frequently visible. The roar of their engines resonates for miles and transforms Sicily’s otherwise tranquil countryside.

Thirty thousand North African refugees have made their way to Italy. Since Italy has given permission for admission, refugees from Libya, Tunisia, and surrounding countries seek to secure passage and cross the Mediterranean. When they reach Italian soil, at times by the hundreds, these refugees have gained access to the entire European Union, and eventually disperse throughout its 27 countries. Needless to say, this controversy has its own political implications within the European Union.

Sicily is a crossroads in the center of the Mediterranean. In antiquity, it was the center of the world. Oil made from olives moved around the Mediterranean as part of a dense web of commercial activity. In those days, the interest rate was 50%. The late Sidney Homer’s famous work, A History of Interest Rates, describes how investors would finance the ship and the olive crop for half the result, after recovering their initial capital. Risk was high in those days, long before the advent of subprime mortgages. A storm or band of pirates could wipe out the entire investment.

We are now dealing with a different type of oil. The impact in Europe is clear, as the price of gasoline in Sicily is the equivalent of $9 USD per gallon. The euro is very strong, and tourism is down. The unemployment rate in Sicily – officially – is logged at nearly 40%. However, there is an underground economy in Sicily, so the true unemployment rate is probably something less.

With the Mediterranean as the backdrop, I sit for lunch with Joe Mason, fellow member of the GIC, Professor of Finance at Louisiana State University, and personal friend. We talk about oil, gasoline, and where this is all going to lead. Joe suspects that $5 USD per gallon of gas will be the sticker-shock price. We may not reach it; no one can be certain. However, he believes such a price would be temporary, because it would alter behaviors. I ask Joe if $4 USD per gallon was in the cards, and he responded with, “I expect $4 plus, or even plus-plus.”

Our discussion moves on to the regulatory issues involving energy in the United States. The results are mixed at best. We are still not drilling in the Gulf of Mexico. We still do not encourage the infrastructure needed to capture domestic self-sufficiency in natural gas. For this to be possible, Washington has a long road to travel. Why? The regulatory morass and bureaucracy is what bogs us all down.

During GIC meetings and conversations I had in Rome, we explored sovereign debt and energy impacts. We also talked about the need to restructure the indebtedness of countries and other entities that must reorganize and balance their revenues versus their expenses. How can political systems change and adapt without crisis? The outlook is mixed to bleak.

From seven hundred meters above sea level, we gaze down at the plain of Sicily and the ancient walls of Erice, which were built by the Esuli Trojans 2700 years ago. We think about Africa, less than one hundred miles from where we stand. We consider what the next oil-price and energy shock might bring.

We have had discussions about the evolution of political instability, political change, and energy shock from Sub-Saharan Africa. Elections are underway; turmoil is becoming more evident in places like Nigeria, Cameroon, and the Ivory Coast. As we have written many times, this is not over. Will there be resiliency in the face of a second oil-price shock coming out of Nigeria? We think the answer is likely to be no, at the present price level. At Cumberland, we remain overweight in energy. We remain vigilant about oil and oil-price shocks. We are observing the world firsthand, secondhand, and through data. The outlook suggests $5 USD per gallon gasoline is possible.

David R. Kotok, Chairman and Chief Investment Officer

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