Q2 was a tough quarter. Energy soared and financials plunged. The Long Term Opportunity Fund which appeared well-hedged and cleverly invested through May, took a nose dive in June. While we believe our investments will do extremely well in the long run, there is no doubt that we took a lot of punishment in the short run.

Oil.

Oil prices skyrocketed near $150/barrel when legitimate buyers, speculators and energy-subsidizing governments conspired (along with the continuing plunge of the value of the US dollar) to push the price of a barrel of oil to new heights. Gasoline prices shot up to more than $4.00 per gallon while the press and politicians, all too predictably, began screaming for quick fixes and villains to blame. The Democrats demanded that we punish “big oil” while the Republicans demanded offshore drilling--lots of heat without much light.

But in the midst of the chaos, something very interesting did occur: US gasoline consumption (which represents approximately half of US demand for oil) dropped dramatically. We learned, for example, that the largest highway fuel provider (i.e. truck stop) in America reported a 12% yearover-year decline in sales of some of its major fuel categories. We have all heard about America’s insatiable thirst for oil. But we just saw proof that demand for gasoline, like everything else in the real economic world, is ultimately subject to the laws of supply and demand, responding to price and availability.

We believe the price of oil will settle down in the near/ intermediate term. It is our view that prices got ahead of themselves, and despite any long-term issues regarding the crude oil supply chain, a US dollar denominated price of $150 is simply too much too soon. The American driver seems quite willing to drive less to save money. China will not be able to continue its $100 billion energy subsidies indefinitely without taking a significant toll on its own economy and currency. Maybe we’ll see $150 oil eventually, but it won’t be back right away.

Auto.

The second quarter also saw more angst from Detroit. The major auto makers continued to report precipitous declines in the sales of trucks and SUV’s. This is not really a surprise. It simply tells us that consumers will respond to actual prices in a way they won’t respond to cajoling, moralizing or propaganda. It’s hard to imagine that the Big 3 auto makers will rebound any time soon. Americans seem to have finally lost their appetite for SUV’s and trucks, the last bastion of margins for Detroit. While there is much discussion about hybrids and electric cars, it will be a long time before they will move the needle.

Financials.

The drama in the financial sector was unprecedented during the second quarter. Rumors began to flourish that Lehman was going to go under and, like Bear Stearns, get stuffed into some type of back-room forced acquisition. It’s shares dropped 55% during the period. Just as dramatic, investors worried--legitimately so, that both FannieMae and FreddieMac, the two juggernaut mortgage insurers would both go bankrupt, forcing the federal government to take them over. It was a period of unprecedented volatility in the financial sector.

Unfortunately, we are not out of the woods yet. There will certainly be more big write downs among the financials. While we’ve probably absorbed many of the biggest mutli-billion dollar write-downs stemming from the initial residential mortgage debacle, we still haven’t seen the full aftermath of the condo crisis, the consumer slowdown or commercial credit crunch. With the economy slowing and commodity prices high, the consumer will drive fewer miles and spend big dollars at the shopping mall. Furthermore, more consumers will be defaulting on their credit card bills:

This is already starting to occur. According to the Wall Street Journal, in the second quarter, delinquencies on Citigroup’s total credit-card portfolio were up nearly 12% from the end of last year to about $4.27 billion. Delinquencies on the securitized portion of that portfolio had a 16% rise during the same stretch. Additionally, rising defaults on credit-card payments, coupled with a bleaker economic outlook, are spooking investors in the market where this debt is packaged and sold. In July, issuance of credit-card asset-backed securities fell to $4.4 billion from $5.26 billion in June, according to J.P. Morgan Securities Inc.

Second quarter was quite a quarter: The S&P 500 Energy Sector index was up 21% during between 04/01/08 and 06/30/08 while the S&P 500 Financial Sector Index was down was down 21% during the same period.

Lots of Drama: This next graph shows crude oil stocks (iPath S&P GSCI Crude Oil Total Return Index) vs shares of Lehman between 04/01/08 and 06/30/08. The oil index was up 40% during the quarter while Lehman was down more than 55% during the period.

US Dollar.

Looking closely at the 5 year graph of the dollar against the euro, one can see that the dollar took a brief respite from its plunge against the Euro during the end of Q2, however, there is little reason to think that we are out of the woods. Foreign wars, spiking energy costs, national debt and a troubled economy all will be drags on the currency. Exports do appear to be picking up. That’s the good news. In the long run, we will come out of this positioned to be much more competitive.

In the meanwhile energy costs will continue to bite at our heels. Domestic wages and lower housing prices will help hold down domestic inflation in a macro sense, but food and many critical goods will be more expensive. The dollar holding world will continue to finance our national debt, but it seems likely they will want to extract more interest for this privilege.