As a Harley-Davidson enthusiast, I am very sensitive to ridiculous gas prices at the pump. Fortunately it’s winter up here in Canada so the bikes are hibernating and not guzzling fuel, but in a few weeks I expect to share the misery of my brothers in the south when I head to Arizona to rent a bike and ride around (without my helmet…woopee) with some friends.
As I’ve mentioned in prior comments, the current run-up in prices is a bit of a conundrum to me. Back in 2007-2008 there actually was a chronic shortage of crude as developing countries began to become sizeable users of the stuff. Their economies were growing beforehand of course, but suddenly these developing economies were big enough to have a real impact on total demand. There was lots of talk of running out of supplies (gibberish) and the ‘peak oil’ theory, but surprise – with higher prices came more supply. You can see the drop in inventories in the graph below.
The decline was unexpected, and ‘maverick’ investors who bought early into the oil and gas sector (when it was out-of-favour) enjoyed quite a windfall for some time. Great rewards come to those betting on the unexpected.
How is it different today? There’s no shortage of crude, but there’s a whole army of investors (hedge funds, institutional and retail) betting that a similar shortage will occur due to developments in the middle east. This is the exact opposite of what I consider a ‘good’ bet.
It would have been smart to bet that demand can do nothing but improve from the depths of the recession (i.e. bought large in mid-2010), but right now you’re just at the tag end of a massive herd praying for a supply disruption. As I cover ad nauseum in my book (now gone to press) A Maverick Investors Guidebook, getting caught up in a stampeding herd is a recipe for disaster.
It really is different this time. The near collapse of the financial system emptied the bowels of the global economy (wow, that was graphic) and paralized traffic of every sort – money, tankers, cars, trucks, and airplanes were at a standstill, thereby demolishing the demand for oil. This time though, the only roadblock to global growth is the oil price itself.
Last time it was a destruction of wealth,but today it is more of a redistribution of it. Oil producers are in effect taxing all businesses that use energy (and governments get their fair share of the windfall in the form of real taxes), which will exert some strain on the profitability of those businesses. I mentioned in an earlier blog that investment dollars have been leaving emerging markets since the beginning of the year (fyi – the newspapers are just discovering this with their usual lag of several months). Developing economies are typically buyers and not suppliers of energy – and hence they will be hurt proportionately more by these excessive (based on speculation) prices for energy. If I were one of those conspiracy theorists, I might conclude it’s all one big master plan by oil companies and the government to make those U.S. dollars worth more so interest rates in the U.S. can remain low until their budget deficit can be brought under control.
The bottom line is that while last time the market (and oil prices) ratcheted higher, it was all on the back of an asset-backed security pyramid – a house of cards that eventually toppled.
This cycle has legs, but as always the trick will be to avoid the herd mentality and identify sectors and stocks that really stand to benefit once the speculative excess embodied in oil prices abates. We won’t find them mentioned in the press or discussed at investment conferences – since they’re off the radar screen – but those are the areas we’ll find ‘good’ bets. If you can think of some – leave them in a comment for me. I will try to do likewise.