Global Market Comments
October 16, 2018
Fiat Lux
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A reader emailed me yesterday to tell me that while visiting his daughter at a college in North Carolina, he refilled his rental car with gas for $1.39 a gallon.
So I got the idea that something really big is going on here that no one is yet seeing. I processed the possibilities in my snowshoe up to the 10,000-foot level above Lake Tahoe last night.
By the way, the view of the snow covered High Sierras under the moonlight was incredible.
For decades, I have dismissed the hopes of my environmentalist friends that alternatives will soon replace oil (USO) as our principal source of energy.
I have long agreed with the views of my fracking buddies in the Texas Barnett Shale that it will be decades before wind, solar, and biodiesel make any appreciable dent in our energy makeup.
It took 150 years to build our energy infrastructure, and you don?t replace that overnight. The current weakness in oil prices is a simple repeat of a predictable cycle that has continued for a century and a half. In a couple years, Texas tea will be posting triple digits once again.
I always thought that oil had one more super spike left in it. After that, it will fade into history, reduced to limited applications, like making plastics and asphalt, probably sometime in the 2030?s.
The price for a barrel of oil should then vaporize to $5.
But given the price action for energy and all other commodities I?m starting to wonder if this time I?m wrong.
I have watched with utter amazement while Freeport McMoRan (FCX) plunged from $38 to $3. I was gob smacked to see Linn Energy (LINE), admittedly a leveraged play, crater from $32 to 30 cents.
And I was totally befuddled to see gas major Chesapeake Energy (CHK) implode from $65 to $1.
Has the world gone mad?
When the data don?t match your view, it?s time to change your view.
Maybe there won?t be another spike in oil prices. Could its disappearance from the modern industrialized economy have already begun?
That would certainly explain a lot of the recent eye-popping price action in the markets. In five short years oil has dropped 82%. It did this while global GDP grew by 20% and auto sales, and therefore gasoline demand, has been booming.
Of course, you could just call all of this a big giant reversion to the mean.
Over the past 150 years, the average, inflation adjusted price of oil has been $35 a barrel. The price for gasoline has been $2.25 a gallon, exactly where it was in 1932, and where it now is in much of the country.
I know all of these numbers because I once did a study to see if oil prices are rigged (conclusion: they are). How can the price of a commodity stay the same for 150 years?
Wait, the naysayers announce. Things don?t happen that fast.
But they do, my friends, they do, especially in energy.
Until 1849, my ancestors were the largest producers of whale oil on Nantucket Island. (Our family name,? Coffin, was mentioned in ?Moby Dick? seven times, and was a focus of the just released film, ?In the Heart of the Sea.?)
Then this stuff called petroleum came along, wrested from the ground with new technology by men like Drake and Rockefeller. The whale oil market crashed, dropping in price by 90%, and virtually disappeared in two years.
My relatives were wiped out and moved to San Francisco, which they already knew from their whaling days, and where gold had just been found.
A half-century later, this thing called an ?automobile? came along meant to replace the ubiquitous horse and buggy. People laughed. It was loud, noisy, smelly, inefficient, and expensive. Only the rich could afford them.
You had to go to a drug store to buy high priced fuel in one-gallon tins. And it scared the horses. England passed a national automobile speed limit of 5 miles per hour, as cars were considered dangerous.
Then huge oil discoveries were made in Texas and California (watch ?There Will Be Blood?), the Hughes drill bit came along, and gasoline prices fell sharply. Suddenly cars were everywhere. The horse population declined from 100 million to only 1 million today.
All of this is a long-winded, history packed way of saving ?This time it may be different?.
I have on my desktop a Trade Alert already written up to buy the (USO) May, 2016 $9 calls. Today, they traded at $1.00. I?m just waiting for another melt down in oil to take a low risk punt on the long side.
If we rocket back up to $100, as many are predicting, these calls will be worth a fortune. But you know what, oil may only peak out at $44 this time. The trade will still make money, but not as much as in past cycles.
So, you better think hard about loading up on too many oil stocks at these distressed levels. Look what has already happened to the coal industry (KOL), which has essentially gone bankrupt.
You could well be buying into the buggy whip industry circa 1900.
There?s Got to Be a Better Way to Make a Living
If I warned them once, I warned them 1,000 times!
The Australian dollar (FXA) is going to fall.
That?s why I cautioned my Aussie friends to sell their homes, get the money the hell out of the country, and pay for their overseas vacations in advance.
As long as it is a de facto colony of China, the fortunes of the Land Down Under are completely tied to economic prospects there.
It is almost a waste of time looking at the Reserve Bank of Australia?s data releases. They have become a deep lagging, and really irrelevant indicators. You are better off going to the source, and that is in Beijing.
And therein lies the problem.
It is highly unlikely that the government in China has any idea what their economy is actually doing. Sure, they pump out the usual figures on a reliable basis like clockwork. These are educated guesses, at best.
Even in a perfect world, collecting numbers from 1.3 billion participants is a hopeless task. The US is unable to do these with any real accuracy, and we have one quarter of their population and vastly superior technology.
For what it is worth, Chinese President Xi Jinping has promised that his country?s GDP growth will not fall below a 6.5% annual rate for the next five years. At this pace, China is still creating more economic activity that any other country in the world.
Which leaves us nothing else to rely on but commodity prices to look at, far an away Australia?s largest earner. These are suggesting that the worst has yet to come.
Virtually the entire asset class hit new six year lows yesterday. I had to go to the weekly charts to see how ugly things really are.
Australia?s largest exports are iron ore (26%, or $68.2 billion worth), coal (KOL) (16%), gold (GLD) (8.1%), and petroleum (USO) (5.7%). When the world?s largest consumer of these slows down, so does demand for these commodities.
BHP Billiton Ltd. (BHP), the largest producer of iron ore, has seen its shares plunge 57% from last year?s high.
But wait! It gets worse.
I have written at length about the transition of China from an industrial to a services based economy. You would expect this, as the Middle Kingdom has virtually no commodity resources of its own, but lots of smart people.
In a nutshell, they wish they had America?s economy. Where services now account for a staggering 68% of all economic activity.
This is why China?s future lies with Alibaba (BABA), Baidu (BIDU), and JD.com (JD). It does NOT lie with its steel factories and coalmines, which by the way, recently announced layoffs of 100,000, the largest in history.
To learn more about the structural remaking of China, please click here for ?End of the Commodities Super Cycle?.
There is one bright spot to mention. Australia is making a transition to a services based economy of its own. Tourism is rocketing, as is the influx of flight capital from the Middle Kingdom.
Walk the streets of Brisbane these days, and you are overwhelmed by the abundance of Asians coming here to learn English, attain a high education, or start a new business. When I came here 40 years ago, they were virtually absent.
How low is low?
It doesn?t help that the governor of the Reserve Bank of Australia, Australia?s central bank, Glenn Stevens, despises his nation?s currency.
He has used every rally this year to talk down the Aussie, threatening interest rate cuts and quantitative easing.
The hope is that a deep discount currency will allow the exporters to maintain some pricing edge on the commodities front.
The market chatter is that the Aussie will take a run as low as $0.55, the 2008-09 Great Recession low.
Whether we actually get that far or not is a coin toss.
And will even $0.55 below enough for Glenn Stevens?
Noted Aussie Dollar Hater
So far in 2015 the Indian stock market has handily beaten that of the US, by 10.6% compared to 5.3%.
?The India election result is the biggest development to affect emerging markets over the last 30 years.? That is what retired chairman of Goldman Sachs Asset Management and originator of the ?BRIC? term, Jim O?Neal, told me last week.
Indeed, the stunning news has sent long term country specialists scampering. In my long term strategy lectures I have been titillating listeners for years with predictions that India was about to become the next China.
With half the per capita income of the Middle Kingdom, India was lacking the infrastructure needed to compete in the global marketplace. All that was needed was the trigger.
This is the trigger.
With a new party taking control of the government for the first time in 50 years, the way is now clear to carry out desperately needed sweeping political and economic reforms. At the top of the list is a clean sweep of corruption, long endemic to the subcontinent. I once spent four months traveling around India on the Indian railway system, and the demand for ?bakshish? was ever present.
A reviving and reborn India has massive implications for the global economy, which could see growth accelerate as much at 0.50% a year for the next 30 years. This will be great news for stocks everywhere. It will help offset flagging demand for commodities from China, like coal (KOL), iron ore (BHP), and the base metals (CU).
Demand for oil (USO) grows, as energy starved India is one of the world?s largest importers.
A strengthening Rupee, higher standards of living, and relaxed import duties should give a much needed boost for gold (GLD). India has always been the world?s largest buyer.
The world?s largest democracy certainly delivers the most unusual of elections, a blend of practices from today?.and a thousand years ago. It was carried out over five weeks, and a stunning 541 million voted, out of an eligible 815 million, a turnout of 66.4%. That is far higher than elections seen here in the United States.
Of the 552 members in the Lok Sabha, the lower house (or their House of Representatives), a specific number of seats are reserved for scheduled castes, scheduled tribes, and women. Gee, I wonder which one of these I would fit in?
Important issues during the campaign included rising prices, the economy, security, and infrastructure such as roads, electricity and water. About 14% of voters cited corruption as the main issue.
Some 12 political parties ran candidates. The winner was Hindu Nationalist Narendra Modi of the Bharatiya Janata Party (BJP), who led a diverse collection of lesser parties to take an overwhelming majority. For more details on this fascinating election, please click here at http://www.ndtv.com/elections.
It is still early days for the Bombay stock market, which has already rocketed by a stunning 20% since the election results became obvious last week.
This could be the beginning of a ten-bagger move over coming decades. Managers are hurriedly pawing through stacks of research on the subcontinent they have been ignoring for the past four years, the last time emerging markets peaked.
In the meantime, the action has spilled over into other emerging markets (EEM), their currencies (CEW), and their bonds (ELD), which have all punched through to new highs for the year.
I?ll be knocking out research o specific names when I find them. Until then, use any dip to pick up the Indian ETF?s (INP), (PIN), and (EPI).
After the market closes every night, I usually don a 60 pound backpack and climb the 2,000 foot mountain in my back yard.
To pass the time, I listen to audio books on financial and historical topics, about 200 a year (I?ve really got President Grover Cleveland nailed!). That?s if the howling packs of coyotes don?t bother me too much.
I also engage in mental calisthenics, engaging in complex mathematical calculations. How many grains of sand would you have to pile up to reach from the earth to the moon? How many matchsticks to circle the earth?
For last night?s exercise, I decided to quantify the impact of this year?s oil price crash on the global economy.
The world is currently consuming about 92 million barrels a day of Texas tea, or 33.6 billion barrels a year. In May, at the $107.50 high, that much oil cost $3.6 trillion. At today?s $53.60 low you could buy that quantity of oil for a bargain $1.8 trillion.
Buy a barrel of crude, and you get one for free!
This means that $1.8 trillion has suddenly been taken out of the pockets of oil producers, and put into the pockets of oil consumers. Over the medium term, this is fantastic news for oil consumers. But for the short term, things could get very scary.
$1.8 trillion is a lot of money. If you had that amount in hundred dollar bills, it would rise to 180 million inches, 15 million feet, or 2,840 miles, or 1.2% of the way to the moon (another mental exercise).
The global financial system cannot move this amount of money around on short notice without causing some pretty severe disruptions.
For a start, there is suddenly a lot less demand for dollars with which to buy oil. This has triggered short covering rallies in the long beleaguered Japanese Yen (FXY) and the Euro (FXE), which are just now backing off of long downtrends. The fundamentals for these currencies are still dire. But the short term trend now appears to be an upward one.
The US Federal Reserve certainly sees the oil crash as an enormously deflationary event. The use of energy is so widespread that it feeds into the cost of everything. That firmly takes the chance of any interest rate rise off the table for 2015. The Treasury bond market (TLT) has figured this out and launched on a monster rally.
Traders are also afraid that the disinflationary disease will spread, so they have been taking down the price of virtually all other hard commodities as well, like coal (KOL), iron ore (BHP), and copper (CU). For more depth on this, see yesterday?s piece on ?The End of the Commodity Super Cycle?.
The precipitous fall in energy investments everywhere will be felt principally in the 15 US states involved in energy production (Texas, Oklahoma, Louisiana, and North Dakota, etc.). So, the consumers in the other 35 states should be thrilled.
However, the plunge in energy stocks is getting so severe, that it is dragging down everything else with it. ALL shares are effectively oil shares right now. In fact, all asset classes are now moving tic for tic with the price of oil.
Throw on top of that the systemic risk presented by the ongoing collapse of the Russian economy. The Ruble has now fallen a staggering 70% in six months, and there is panic buying of everything going on in Moscow stores. The means that the dollar denominated debt owed by local firms has just risen by 70%. Any foreign banks holding this debt are now probably regretting ever watching the film, Dr. Zhivago.
Russian interest rates were just skyrocketed from 10.50% to 17%. The Russian stock market (RSX) is the world?s worst performing bourse this year. How do you spell ?depression? in the Cyrillic alphabet?
And guess what the new Russian currency is?
IPhone 6.0?s, of which Apple is now totally sold out in Alexander Putin?s domain!
Thankfully, this is more of a European than an American problem. But nobody likes systemic risks, especially going into illiquid yearend trading conditions. It?s a classic case of being careful what you wish for.
Of the $1.8 trillion today, about $430 billion is shifting between American pockets. That amounts to a hefty 2.5% of GDP.
Money spent on oil is burned. However, money spent by newly enriched consumers has a multiplier effect. Spend a dollar at Wal-Mart, and the company has to hire more workers, who then have more money to spend, and so on. So a shifting of funds of this magnitude will probably add 1% to U.S. economic growth next year.
Unfortunately, we will lose a piece of this from the obvious slowdown in housing. Deflation means that home prices will stagnate, or even fall. This is a major portion of the US economy which, for the most part, has been missing in action for most of this recovery.
Ultimately, cheap energy as far as the eye can see is a key element of my ?Golden Age? scenario for the 2020?s (click here for ?Get Ready for the Coming Golden Age? ).
But you may have to get there by riding a roller coaster first.
Oil at $53?
My inbox was clogged with responses to my ?Golden Age? for the 2020?s piece, particularly my forecast that the US was moving towards complete energy independence. This will be the most important change to the global economy for the next 20 years. So I shall go into more depth.
The energy research house, Raymond James, put out an estimate this morning that domestic American oil production (USO) would rise from 5.6 million barrels a day to 9.1 million by 2015. That means its share of total consumption will leap from 28% to 46% of our total 20 million barrels a day habit. These are game changing numbers.
Names like the Eagle Ford, Haynesville, and the Bakken Shale, once obscure references on geological maps, are now a major force in the country?s energy picture. Ten years ago North Dakota was suffering from depopulation. Now, itinerate oil workers must brave -40 degree winter temperatures in their recreational vehicles pursuing their $150,000 a year jobs.
The value of this extra 3.5 million barrels/day works out to $121 billion a year at current prices (3.5 million X 365 X $95). That will drop America?s trade deficit by nearly 25% over the next three years, and almost wipe out our current account deficit. Needless to say, this is a hugely dollar positive development.
This 3.5 million barrels will also offset much of the growth in China?s oil demand for the next three years. Fewer oil exports to the US also vastly expand the standby production capacity of Saudi Arabia.
If you want proof of the impact this will have on the economy, look no further that the coal (KOL), which has been falling in a rising market. Power plant conversion from coal to natural gas (UNG) is accelerating at a dramatic pace. That leaves China as the remaining buyer, and their economy is slowing.
It all makes the current price of oil at $95 look a little rich. As with the last oil spike three years ago, this one is occurring in the face of a supply glut. Cushing, Oklahoma is awash in Texas tea, and the Strategic Petroleum Reserve stashed away in salt domes in Texas and Louisiana is at its maximum capacity of 727 barrels. It is concerns about war with Syria and Iran, fanned by elections in both countries that took prices to $112 in the fall.
My oil industry friends tell me this fear premium has added $30-$40 to the price of crude. This is why I have been advising readers to sell short oil price spikes to $110. The current run up isn?t going to take us to the $150 high that we saw in the last cycle. It is also why I am keeping oil companies with major onshore domestic assets, like Exxon Mobile (XOM) and Occidental Petroleum (OXY), in my long term model portfolio.
I wanted to get the low down on clean coal (KOL) to see how clean it really is, so I visited some friends at Lawrence Livermore National Laboratory. The modern day descendent of the Atomic Energy Commission, where I had a student job in the seventies, the leading researcher on laser induced nuclear fission, and the administrator of our atomic weapons stockpile, I figured they?d know.
Dirty coal currently supplies us with 35% of our electricity, and total electricity demand is expected to go up 30% by 2030. The industry is spewing out 32 billion tons of carbon dioxide (CO2) a year and the great majority of independent scientists out there believe that the global warming it is causing will lead us to an environmental disaster within decades.
Carbon Capture and Storage technology (CCS) locks up these emissions deep underground forever. The problem is that there is only one of these plants in operation in North Dakota, a legacy of the Carter administration, and new ones would cost $4 billion each. The low estimate to replace the 250 existing coal plants in the US is $1 trillion, and this will produce electricity that costs 50% more than we now pay. In a gridlocked constrained congress, this is a big ticket that is highly unlikely to get picked up.
While we can build a wall to keep out illegal immigrants from Latin America, it won?t keep out CO2. This is a big problem as China is currently completing one new coal fired plant a week. In fact, the Middle Kingdom is rushing to perfect cheaper CCS technologies, not only for their own use, but also to sell to us. The bottom line is coal can be cleaned, but at a frightful price.
Coal?s Popularity is Fading Fast
My inbox was clogged with responses to my recent prediction of US energy independence. This will be the most important change to the global economy for the next 20 years. So I shall go into more depth.
The energy research house, Raymond James, put out an estimate that domestic American oil production (USO) would rise from 5.6 million barrels a day to 9.1 million by 2015. That means its share of total consumption will leap from 28% to 46% of our total 20 million barrels a day habit. These are game changing numbers.
Names like the Eagle Ford, Haynesville, and the Bakken Shale, once obscure references on geological maps, are now a major force in the country?s energy picture. Ten years ago North Dakota was suffering from rampant depopulation. Now, itinerate oil workers must brave -40 degree winter temperatures in their recreational vehicles pursuing their $150,000 a year jobs.
The value of this extra 3.5 million barrels/day works out to $122 billion a year at current prices (3.5 million X 365 X $96). That will drop America?s trade deficit by nearly 25% over the next three years, and almost wipe out our current account surplus. Needless to say, this is a hugely dollar positive development.
These 3.5 million barrels will also offset much of the growth in China?s oil demand for the next three years. Fewer oil exports to the US also vastly expand the standby production capacity of Saudi Arabia.
If you want proof of the impact this will have on the economy, look no further than the coal ETF (KOL), which has been falling relentlessly in a rising market. Power plant conversion from coal to natural gas (UNG) is accelerating at a dramatic pace. Public utilities love ditching all the potential liabilities that come with coal. That leaves China as the remaining buyer, and their economy is slowing.
It all makes the current price of oil at $95 look a little rich. As with the last oil spike four years ago, this one is occurring in the face of a supply glut. Cushing, Oklahoma is awash in Texas tea, and the Strategic Petroleum Reserve stashed away in salt domes in Texas and Louisiana is at its maximum capacity of 727 million barrels. It is concerns about war with Iran, fanned by elections in both countries that have taken prices up from $77 since the fall.
My oil industry friends tell me this fear premium has added $30-$40 to the price of crude. This is why I have been advising readers to sell short oil price spikes to $110. The current run up isn?t going to take us to the $150 high that we saw in the last cycle. It is also why I am keeping oil companies with major onshore domestic assets in my long-term model portfolio, like Exxon Mobile (XOM) and Occidental Petroleum (OXY).
Energy independence is also making a huge contribution to the US jobs picture. According to energy guru, my old friend, Daniel Yergin (you must read his Pulitzer Prize winning book on oil, The Prize), energy has created 1.7 million jobs in the last 5 years, and will double that in the next three. It has also created $60 billion a year in new revenues from taxes and oil leases for the US Treasury. Ironic as it may seem, the job that pushes the headline unemployment rate down to the Fed?s vaunted and magical 6.5% target could be for a roustabout.
Does This Make It 6.5% Yet?
NOTE TO READERS: There is a short letter today because I spent the entire weekend writing Trade Alerts, which you will receive right at the Monday morning opening.
Last Friday, China announced a $150 billion reflationary public works budget designed to arrest the current free fall in the country?s GDP growth rate. The move came totally out of the blue and caught many China bears by surprise.
The National Development and Reform Commission has approved 60 new projects, led by railways, roads, harbors, and airports. While the plethora of plans is stretched over several years, it is clear the Politburo is trying to help the Communist party through its handover of power later this autumn. This has major implications for the global economy.
Cheng Li, research director at the Brookings Institution, said Beijing slammed on the brakes too hard last year to break the back of the property boom. Home prices are now off as much as 25%. So the Middle Kingdom appears to be back-peddling on these measures as fast as it can.
The immediate impact on financial markets was almost as great in the U.S. as it was in the Middle Kingdom, which saw Shanghai rocket 5% in a single day. It was off to the races for anything commodity related, including Caterpillar (CAT), copper (CU), Freeport McMoRan (FCX), US Steel (X), coal (KOL), and other materials sectors, all of which have been in a vicious bear market since 2011. It also calls into question the prudence of my short position in the Australian dollar, which has added two cents since the announcement.
We will have to wait a few more days to see if this move is real and sustainable, or just another short covering dead cat bounce. But this is what bottoms look like, and if it is, the ?BUY? opportunities in the entire space are huge. These are almost the last cheap stocks left.
Hmmm. Looks Like the Economy is Slowing Too Fast
My inbox was clogged with responses to my ?Golden Age? for the 2020?s piece yesterday, particularly my forecast that the US was moving towards complete energy independence. This will be the most important change to the global economy for the next 20 years. So I shall go into more depth.
The energy research house, Raymond James, put out an estimate this morning that domestic American oil production (USO) would rise from 5.6 million barrels a day to 9.1 million by 2015. That means its share of total consumption will leap from 28% to 46% of our total 20 million barrels a day habit. These are game changing numbers.
Names like the Eagle Ford, Haynesville, and the Bakken Shale, once obscure references on geological maps, are now a major force in the country?s energy picture. Ten years ago North Dakota was suffering from depopulation. Now, itinerate oil workers must brave -40 degree winter temperatures in their recreational vehicles pursuing their $150,000 a year jobs.
The value of this extra 3.5 million barrels/day works out to $134 billion a year at current prices (3.5 million X 365 X $105). That will drop America?s trade deficit by nearly 25% over the next three years, and almost wipe out our current account surplus. Needless to say, this is a hugely dollar positive development.
This 3.5 million barrels will also offset much of the growth in China?s oil demand for the next three years. Fewer oil exports to the US also vastly expand the standby production capacity of Saudi Arabia.
If you want proof of the impact this will have on the economy, look no further that the coal (KOL) and rail stocks (UNP) which have been falling in a rising market. Power plant conversion from coal to natural gas (UNG) is accelerating at a dramatic pace. That leaves China as the remaining buyer, and their economy is slowing.
It all makes the current price of oil at $105 look a little rich. As with the last oil spike three years ago, this one is occurring in the face of a supply glut. Cushing, Oklahoma is awash in Texas tea, and the Strategic Petroleum Reserve stashed away in salt domes in Texas and Louisiana is at its maximum capacity of 727 barrels. It is concerns about war with Iran, fanned by elections in both countries that have taken prices up from $75 in the fall.
My oil industry friends tell me this fear premium has added $30-$40 to the price of crude. This is why I have been advising readers to sell short oil price spikes to $110. The current run up isn?t going to take us to the $150 high that we saw in the last cycle. It is also why I am keeping oil companies with major onshore domestic assets, like Exxon Mobile (XOM) and Occidental Petroleum (OXY), in my long term model portfolio.
