The real reason gas prices will skyrocket (and what it means for your portfolio)

Where is the price of gas going from here? The prognosticators are out in droves on this one. Recently, Phil Flynn wrote that the era of gas over $3 a gallon is almost over, that the price will soon drop beneath this threshold. That claim was in response to a recent forecast from AAA, who said that our current thousand day stretch of gas over $3 a gallon constitutes a new price floor. Meanwhile Jeff Siegel, managing editor of Energy and Capital Newsletter, claims gas could go as high as $8 a gallon in the next few years. In our opinion, Siegel is the closest to the truth, but for the wrong reasons.

Siegel’s reasoning, and that of most market commentators, is couched in terms of market demand and supply. Tensions in the Middle East could jeopardize supply, he says, however we would retort that the new domestic supply expected to come on line may balance that out. We would also add that demand could actually decrease due to green technology and alternative fuels. Mainstream investors are balancing these factors against each other and guesstimating the overall impact, up or down, that they will have on price.

But they are all missing the forest for the trees.

Yes, we are going to be pulling more oil out of U.S. ground, thus creating more domestic supply, but oil is fungible in the global market. If the price goes up over there, it will affect the price over here. Yes, the powder keg in Syria/Iran/Where-Ever-istan is bound to blow up eventually and then it is really off to the races for gas prices. And as prices go up, people will continue to seek alternatives in green technology and other fuel sources. But we’ve not done very well with that so far. Donny Ferguson, Senior Communications Adviser to Rep Steve Stockman, quips that if politicians really wanted to close Guantanamo Bay prison, they would declare it to be a green technology company and it would close in six months. Ouch.

The real reason Siegel’s “dire” prediction is the most correct: inflation.

Adjusted for inflation, gas prices have been surprisingly flat, with the current $3.52 a gallon translated to only about $1.20 in 1979 dollars. Priced in terms of gold, gas is actually down and fairly flat.

Compared to inflation, all other market factors are trivial – yet that’s all they talk about.

But if you’re an economist who worships the Fed and takes what the Bureau of Labor and Statistics says as God’s honest truth, there is no inflation. Not really.

Officially, inflation is hovering below 2%, right in the range the Fed needs it to stay to maintain credibility; right where Congress needs it to stay so they can weasel out of Cost of Living Adjustments for seniors on Social Security and other beneficiaries. And if it goes up, they will simply change the methodology of the calculation as they did in the 80’s, again in the 90’s and (to a lesser extent) do seasonally all the time.

So, yes, we should expect to see $8 a gallon gas and it will have plenty to do with the Middle East, but not for the reasons Siegel and others think. Once we lose the military battle to keep oil trading exclusively in dollars, the dollar will lose its privilege as reserve currency of the world, and yes, then it will be off to the races for gas prices indeed.

But one must think about this correctly in order to make the correct moves. If thought of in terms of gas prices going up, investing in oil futures might be very appealing. If thought of in terms of price pressures greening the market, one might invest in green tech. The more accurate way to think about it is that the dollar will be going down – dramatically. Understanding the difference and how to spot it should radically change investment strategy.

Perhaps when that $8 gallon for gas becomes $50 or $100 or $1,000, Siegel and others will understand that it is not the undersupply of oil so much as the oversupply of dollars that really matters. Will it be too late to rebalance his portfolio by then?

More importantly: Might a misunderstanding of the market and its vulnerabilities wipe out your portfolio?