Peak Oil? We have enjoyed mocking peak oil prognosticators for many years. The tired Malthusian argument that the world would run out of Fossil Fuels each of the last several decades gets old especially when technology has enabled the US and potentially the world to increase Oil and Gas production at a parabolic rate in recent years with massive untapped potential once “The Price Is Right”. Oil prices have reached 5+ year lows this week and gasoline at the pump is fast approaching $2/gallon. That would equate to a $170 Billion annual savings for consumers from the summer peak for drivers. The savings are far greater than that factoring in petroleum uses and multiplier effects throughout the economy. Sounds great!
When is the last time crashing energy prices boosted stock prices or the economy? Sharp drops in Oil coincide with falling stocks and a slowing economy over the short to medium term.
Plunging energy prices can be a negative – while they are collapsing when they are falling for weakening economic reasons. Its very positive long term that Oil and Gas production are increasing – especially in the US – but the biggest new trigger for lower Oil is the perception that the Global economy is slowing more and per capita demand is falling. Economic GDP forecasts for the Globe outside the US have been revised lower in recent weeks and a strong Dollar due to growth disparity of the US and Europe is compounding the Oil doldrums.
Some want to credit OPEC for orchestrating the perceived Oil tsunami. If OPEC had the ability and will to manipulate prices then we would have Oil at $200 a barrel instead of submarining $60. OPEC is on its deathbed. If they had the will to curtail their supply and revenue they would only be gifting it to non OPEC producers. If they keep production normal, as they are now, then lower Oil prices hurt their budgets as well. Oil drilling projects have long lead times and lower prices are unlikely to hurt production anytime soon. Oil prices would need to be held in the sub 60 or sub 50 zone for a very long time to damage the secular fracking boom. Such a success means they could never allow a long term rise in price to recoup their losses as fracking or clean energy would just come right back. What OPEC hopes for is really what we all hope for: the pain of lower prices will eventually lead to a world economy growing at a faster pace and consuming more Oil. Next time you see Oil over $100 you will see a much stronger economy here and around the globe.
If there is one market that we have guided investors with short and long term clarity it has been Oil. Since the summer of 2013 we have reminded investors often to Sell Oil expecting lower prices each time Oil ventured into the $100 to 110 a barrel zone. When prices peaked over $107 a few months ago we noted the record Producer selling and record Hedge Fund buying that would inevitably lead to a major price decline as positions were unwound (see above chart). While a price low is due soon, there is still room in coming months for more contracts to be liquidated.
The bad news news is lower energy prices will hurt 12% of the US economy, lead to debt defaults in Venezuela and possibly Russia and possible panic over deflationary debt implosions. The good news is deflation fears will cause China and Europe to embrace more aggressive stimulation policies much faster and the economic growth from a lower cost basis. It’s a question of timing. Bad now, great later!
Today the US is transcendent: an oasis of strength in a world of weakness. Japan, UK and Ireland have adopted our aggressive monetary policies. Germany and China have resisted, but Oil led deflation may turn the tide. What has led to this historic Oil plunge is the parabolic US production surge combined with the austerity of China and Europe. As energy falls so have interest rates, food prices and industrial metals.
Short term Oil prices plunging for 6 months is harmful , but longer term it leads to a new leg higher as in 1982, 1992 and 2009 as cheaper credit in a lower inflation economy adds an unexpected stimulus. It appears that energy deflation will force an effort to inflate the global economy in 2015.
In the above chart we can see the hourly result of stock prices as it becomes apparent that oil prices are not just lower, but collapsing upon the new perception that Europe and China have stated they will not take action this month to stimulate their slower than expected economies and potential debt defaults grow.
One of best warnings we shared with readers was the huge divergence of Junk Bonds and Stock prices the past month. Once Junk Bond prices had a lower high while stocks had a higher high it was a warning that a top in stocks was within about 2 weeks historically. On December 5th when the divergence became far more pronounced we warned of not just a pullback, but a surprise correction on the day of the final record high in stock prices.
The above track record chart shares some quotes we made at key points over the past 7 months that should have been helpful in navigating stock price action that followed.
For now we will await oversold indications, but as we have said the odds are for at least a short to medium term bottom before the end of December. Long term we will leave the equity portfolio at 90% in the stock market using the the SP 500 as the benchmark while traders are in cash. While a 2008 Oil deflation bankruptcy panic is a black swan possibility, we continue to expect this secular Bull market in stocks to continue into the 2017 – 2019 time frame basis cycle proxies with an economic acceleration beginning in 2015 once the Oil collapse levels and “real” stimulus in Europe and or China is adopted. It typically takes a 4 to 5 year Global acceleration phase before secular economic uptrends reverse under the pressure of interest rate inversions and resource scarcity.
Who is the most powerful economic influence on the world economy? US Fed’s Janet Yellen, ISIS, Russia’s Putin and ECB’s Mario Draghi are all reasonable guesses, but we rank Germany’s Angela Merkel as top dog with 2nd fiddle played by Chinese President Xi Jinping. As long as China and more importantly Germany keep austerity in place, a true global recovery from the 2008 mortgage debt debacle will fail to take hold. We have been expecting a weaker Eurozone to push Merkel to adopt QE. She is loathe to do so, but the deflationary pressure from falling energy against just 0.62% 10 Year Bond Yields may change her mind in the 1st quarter 2015. Should that occur we would expect a commodity rally and rising interest rates. Stocks will surge initially, but slow once the realization that a secular rising interest rate trend has begun. The good news is the longer austerity is maintained in China and Europe the greater the pent up demand and the longer the Global growth cycle can continue.
An upcoming post will examine interest rates and jobs.
President, Exec Spec
Disclaimer and Notice: Nothing herein, including any attachments, should be construed as an offer to sell or as a solicitation of an offer, or a recommendation, to buy any interest in any investment or other product. This may contain information on investments that are high risk and have substantial risk of principal loss. It is for informational purposes only. Statements in this communication that are not statements of fact are merely opinions or forward looking statements from a potentially biased source(s) that involve known and unknown risks, uncertainties and other factors that could cause actual future results to differ materially from any prior or projected results. Statements in this communication may be inaccurate and/or unsuitable for you. You must perform your own due diligence. Your investment decisions should always be made based on your specific financial needs, suitability, objectives, goals, time horizon and risk tolerance. Any decision is at your sole discretion and at your sole risk. You are advised to consult with your individual investment and tax professionals before making any investment. Past performance is no guarantee of future results.