Hello everyone my name is Tom deSabla and this is my first article for Financial Sense. My thinking is informed by a libertarian perspective, and my goal overall is the maximum freedom of the individual to seek happiness in whatever way seems good to them, and does not violate the equal rights of others to do the same. As Im sure most of you know, the concepts of reciprocal rights and the concept of non-aggression against other people and nations are fundamental founding principles of the United States of America.

I hope to explore how these concepts relate to our financial health and the investing world as I go along, but for now, I want to share some of my thinking on the subjects in the title of this article namely, my analysis and predictions regarding Google, Oil Stocks, and how a possible crash might affect them going forward. Since I am not a financial genius myself, to do this, I am going to rely heavily on the knowledge of financial experts, and then simply apply what I have learned from them.

First the crash - will there be one? I think the answer is yes, no matter how you really want to look at things. Some have said were already crashing now, only most Americans just dont know it yet. Some evidence for this is the over 1/3 loss in international purchasing power in the Dow 30 Industrials since 2000, which the Mogambo brought to my attention, and he got the info from Larry Edelson, demonstrating right off how useful other peoples knowledge can be. This huge loss of purchasing power is a monstrous and highly meaningful statistic that is an amazing story in and of itself.

There is plenty of other evidence of deterioration the credit/solvency crunch; the overly indebted condition of both citizens and government; imperial overreach; cancerous government growth at all levels - I could go on, but others have explained these economic phenomena completely already. Suffice it to say that enough evidence exists to prove that we are in a very vulnerable condition right now, and it will take many years to reverse our economic decline, and thats only if we do the right things, like stabilize our currency and cut government down to size, instead of the wrong things, like raise taxes, add restrictions on capital flows, trade protectionism, and wage and price controls.

So, I conclude that there is and/or will be an economic decline/crash significant enough to factor into anyones investment decisions. Of course, there are as many different takes on what types of investments will decline, how much, and when, as there are experts, but as a baseline, Ill stick to a measure that I have a great deal of confidence in the long stock valuation (PE) cycles that have been remarkably consistent for over a century. Many have talked of these cycles, but none have explained them better than Adam Hamilton, whose Long Valuation Waves series of essays, combined with his Great Commodities Bull series, set the standard. Of course, Hamilton himself, ever modest, gives credit to Robert Schiller, of Irrational Exuberance fame.

Clearly, there are long cycles, averaging about 17 years from peak to trough, where commodities and general stock markets trend counter to each other. We are in the down cycle for general stocks and the up cycle for commodities. Although technical analysis and Dow Theory help us to determine the sub-trends within the primary trend, we already know the primary trend for general stock markets down. The Dow rose in purchasing power from about 1982 to a peak in 2000, where selling the Dow would have yielded 40 ounces of gold, and now that number is down to 18 ounces or so. The Dow-Gold relationship measures real value, and it matches Hamiltons valuation waves perfectly. Hamilton and Schiller show that market PE ratios peak with real overall stock values, regardless of nominal stock prices. PEs peaked in 2000, and so did real purchasing power.

So, now that were sure of the primary trends, lets look first at oil stocks. The fundamentals are glorious due to the secular commodities bull that is just picking up steam, and ever-increasing demand and shrinking supply to boot. Throw in new demand from the developing world, and add nominal price increases due to inflation, and it gets even better. Also, unlike gold, the oil market is harder to manipulate, and in any case, all respectable analysts agree, the primary trend cannot be manipulated away. Oil stock PE's are at the opposite end of their valuation cycle from general stocks, and they are still cheap. Stock PEs oscillate around a long-term average of 14, waxing high at 28 or even higher at market peaks like 2000, and waning down to as low as 7 at troughs, like 1982. Many respectable oil stocks, even 10 years into a secular bull market, are still trading at below-average PEs. Because oil stocks are part of the commodities bull, their PEs are on the rise just as general stock multiples are falling.

So, oil stocks are in a secular bull and they are still cheap. But what happens to them during an economic collapse? Since, in the end, oil stocks are driven by crude oil prices, the real question is, what happens to crude demand? First, theres a big difference between crude consumption and the demand for other industrial commodities like base metals and copper. If we have an economic collapse, people may stop building things and maybe might not need any new steel and copper for a while. The metal that has already been mined gets used to build things; it doesnt need to be replaced over and over again every week. Oil, by contrast, is repeatedly consumed in ever-greater quantities by products and machines that already exist, and that kind of demand is much harder to reverse. Also, just because U.S. demand growth might slow, or even halt, doesn't mean that world demand will stop rising. It never has. Further, any reduction in U.S. demand due to economic collapse would only be temporary, and would be easily offset by increasing foreign demand. High prices and profitability are assured. Dont throw the oil stock baby out with the base metals bathwater.

Some people warn against playing around with Google for a number of good reasons. As for going long, that would be out of the question for any contrarian or value investor due to a $700 stock price, a high PE of 55, and the secular general stock downtrend we find ourselves in. Not to mention the likelihood that most of the gains to the long side have already been had. As for going short, the negatives are again, high stock price, the likelihood of needing to use margin, monetary inflation and possible manipulation to the long side. Using options makes it easier to achieve real leverage, but Google options are obscenely expensive and the time value disappears so rapidly that the timing of the trade must be near perfect. Despite all these issues, I have been tracking the stock and believe that there is money to be made on the short side.

First, lets remind ourselves of what we know, and see if we can make any useful predictions. First things first, GOOG is trading at 55x earnings right now. Ok, but what does that mean, and how does it help us? Well, lets step back in time, Google used to trade at 80x earnings two years ago, so the multiple is falling, just as Hamilton and Schiller predicted. I think its perfectly reasonable to say that Googles multiple will continue to fall until the valuation cycle reverses some ten or so years from now. In other words, I dont see GOOG trading at a lofty PE of 50 for years-on-end while general markets are languishing and valuations are dropping to and below fair value at 14. So, what would a reasonable valuation target be for Google? Considering that its a tech type of stock, it may never plumb the depths of valuations below 14, but I believe that 21 is a lock.

Now, to reach lower valuations, the company can either increase earnings or have a lower stock price, or some combination of the two. In the case of Google, given the current world economic circumstances, and given the companys growth to date, I just dont see the kinds of earnings increases needed to drive that multiple down. Theyll be lucky to sustain the earnings they have now. That multiple is coming down, and the stock price is going to be doing the heavy lifting to get it there. So, we know many things of value here; we know were in a secular bear because valuations are falling; we know that Google is not bucking that trend, and we have a pretty good idea where the valuation will end up, and a fair idea when it will get there. Not bad.

So, if the Google PE of 55 is headed down to at least 21, and if were going to see a lot of stock price drop to get there, what can we expect? Well, with earnings frozen, to reach a PE of 21, Google would need to trade at $264. Yes, thats right $264. I told you there was money to be made. So, barring earnings increases, that sucker is headed below $300, and even if Im way off and it only falls to a PE of 28, and earnings continue to increase (or are inflated), were still looking at some big price drops over the next several years. These valuation drops are one of the surest things you are ever going to get a chance to bet on. Nothing trumps them, and they are definitely going to happen - not steadily, but in fits and starts. If you can use technical analysis and are patient, you can probably catch these fits with some well-timed put options. These down moves only take a few days, so take your profits and close out before time value losses mount. Happy hunting.

Conclusions: General stock PEs will continue to fall for years, and Google is no exception. Knowing that gives us an edge. Obviously, a real economic collapse would hit Google like a ton of bricks, because people tend to pare down to the essentials during tough times, and advertising on Google wont be essential when gas is $22 a gallon and people dont have jobs but still have to drive around to find jobs or else they become homeless. This also explains why oil will continue its secular bull market until there is an oil well being drilled or a power plant built everywhere you look, and every single person you meet urges you to buy gold and oil, and based on my experiences, that day is still a long, long way off. No force on this planet can stop these valuation cycles except maybe a nuclear war. Barring that, oil and oil companies will continue to shine as long as world demand exists, even if, as is likely, the U.S. sinks into a depression and takes Google down with it. Cold comfort maybe, but knowledge is power, and cold comfort is better than no comfort at all.

Go Ron Paul!

Tom deSabla is not an investment advisor, has no training as an investment advisor, and is not telling anyone what to do with their own money. You trade at your own risk, and are responsible for doing your own due diligence in researching your investments and speculations. Options are very risky, and should only be traded if you know what you are doing and what you are risking.

Your investment decisions are strictly your own, and Tom deSabla assumes no responsibility or liability whatsoever for them.