Tuesday, December 30, 2008

Gheit - Oil Price Forecast for 2009

Fadel Gheit has a very good record of predicting the direction and level of oil prices, similar to Boone Pickens in accuracy. He is pointing to higher prices for oil in 2009 and thinks the sell-off is overdone. All this has good implications for the CanRoys. They are very much oversold right now. Pennwest, as an example, can be profitable and cash flow positive at $40 oil. Its costs will come down in 2009 as demand for oil services drops hard. Its fixed cost overhead is not very high (for administration only) and its debt load is reasonable with maturities out several years (much better than American companies like Chesapeake which is in real trouble after taking on too much debt).

The past couple years, it has become popular among the CanRoys to minimize the monthly distribution and instead direct a lot of cash flow to capital improvements and acquisitions. PWE and Daylight have been down around 50% of cash flow directed to distributions. The historical average is closer to 80%. PWE has announced it is drastically cutting back on capital projects in 2009 and selling some properties, so it can preserve cash flow to maintain distributions at the lower oil prices. This is more the historical model.

The lower oil prices should also discourage the Canadian national government from going through with taxing profits on royalty trusts. Oil is not the big treasure chest it was perceived to be by some in Parliament. We may see the Liberal party take control of Parliament soon and then change the terms of the taxation program, either lowering to 10% or maybe eliminating the Harper - Faherty program altogether.

It seems very possible by the end of 2009 the Canroys can recoup the cash flow they had in 2006 and rebound to the prices they were trading at when oil was at $60/barrel in late 2006 (after the Halloween Massacre), when stock price was around $30 for Pennwest (PWE), for example, and $17 for Pengrowth. Also, most of the Canroys are highly hedged for 2009, which will aid cash flow. Pengrowth (PGH) has an 50% of its oil sold forward at $80 for 2009 and 50% of its gas production at $10. The other Canroys have similar hedging programs in place which will stabilize dividends. The market has not factored this in by driving prices down 70% and yields up by 300%.

Here is what Fadel has to say:

MONDAY, DECEMBER 29, 2008
ELECTRONIC Q&A


How to Profit on Oil's Comeback
By NAUREEN S. MALIK


Oppenheimer's Fadel Gheit is big on independent energy producers.


OIL AND BASEBALL -- NAMELY the Yankees -- are two passions that are remarkably similar for Fadel Gheit.

While he makes his living off the first and is an avid fan of the second, the managing director of energy at Oppenheimer says both markets are subject to the "bubble." Crude-oil prices have collapsed and salaries by baseball's A-listers could be next?

"Unfortunately the sports bubble hasn't burst yet, and it will, mark my words it will," says Gheit, who thinks Alex Rodriguez should be making $3 million, not $50 million, for a job some people would take for free hot dogs.

Manager's Bio
Name: Fadel Gheit
Title: Managing director and senior analyst covering the oil and gas sector, Oppenheimer & Co.

Education: B.S. in chemical engineering, Cairo University; MBA in finance, New York University

Hobbies: Watching sports, mainly the Yankees, but also watches the Mets, Giants and Jets.As for oil, Gheit, who was a skeptic as oil breached $100 a barrel earlier this year, has turned positive while others are decidedly negative about energy at the moment. Oil prices rallied to $145.29 in early July before recently falling to the low $30-range.


Gheit, an Egyptian with chemical-engineering training, joined Mobil Oil in 1980 as oil prices touched record highs due to escalated tensions in the Middle East. He traipsed around the Arabian dessert examining oil production before jumping to Wall Street.

Gheit has seen crude oil go up because of war, revolution, and other major global events. Oil supplies in particular have been impacted, but this downturn "has to be one of the worst" because it is a global economic issue.

Oil "is not a free market," says Gheit pointing to Wall Street speculation. He has repeatedly testified in front of Congress, urging the government to create an energy plan and a better regulatory framework to oversee the market.

While that regulatory framework will take time, Gheit sees plenty of reasons to bulk up on energy stocks now.

Barron's Online: Do you think oil is sustainable at these levels?

Fadel Gheit: No, I never thought that oil prices are sustainable above $100. I never thought they were sustainable at $30 either. The global economy will recover, whether in a year or two or three. Two years of higher prices usually bring additional investment and will expand supply and curtail demand and consumption as companies and consumers try to become more energy efficient. The flip side of the coin is the exact opposite. When you have extremely low prices, that will dry up investment and it will take years for the industry to go back on track. That's why you create feast or famine because of the lack of coordination between producers and consumers, the lack of transparency in the financial market [and] basically the lack of government supervision either because of indifference or corruption.

Q: What could per-barrel oil prices go and what is a suitable level?

A: I think oil prices over $60; $65 would be pushing it. We don't need it.

Q: Do you think OPEC is going to cut production even more?

A: Absolutely, OPEC will cut production and we will feel the impact within six weeks of production cut. These people cannot balance their budget at $50 per barrel and so they are hurting pretty badly. One of the reasons I don't want to see $30 per barrel is because I really do not want to see major disruption, regimes could be thrown out.

Q: What does this mean for profits and the marginal cost of production?

A: To operate, the cost [for oil producers] has increased by almost 16%-20% annually over the last five years. It was one of the sharpest inflationary periods in recent history and the reason is that everybody, because of the increasing oil prices, was chasing limited capacity of services, so oil-service companies were basically gouging the industry. We are hoping that the costs are going to go down, but we are talking about 10%, 15%, 20%, not 40%, 50% or 60%. We are also going to see more technology advancement because people will pay more attention to efficiency and cost efficiency.

Unless oil prices recover sharply next year, or we believe that oil prices will average $40 next year, it means that there will be about a 40%-50% drop in earnings and cash flow. Most companies will limit their capital spending to availability of funds , which may be coming from cash flow, so that means that capital spending will be down by as much as 40% [in 2009]. Longer-term projects do not get derailed once they start because any delay becomes counter productive. But new projects will be delayed.

Q: You have been touting large integrated-oil companies such as Exxon Mobil (ticker: XOM) throughout the year. Are they still a good bet?

A: Integrated oil is very simple. We believe that the dividends are safe. Companies like Shell (RDS-b) and BP (BP) offer 6%-plus dividend yield. Both stocks are down significantly this year. Shell in its history only suspended its dividend once during the Second World War. Now if you don't trust the market, but believe oil prices will not go above $40-$45, then you should own Exxon.

A company like Exxon has been underinvested for five years, not because they are stupid because they were smart. They didn't chase barrels for exorbitant price and cost. They have $40 billion cash. They can buy any independent-oil company and pay them a 30% premium without going to the bank. They can buy Apache (APA), Chesapeake Energy (CHK), Devon Energy (DVN), EOG Resources (EOG), Noble (NE). The market value of Exxon treasury stock is $205 billion. That is higher than the market value of BP, Chevron (CVX), Royal Dutch Shell (RDSA) and Conoco Phillips (COP).

Q: What about natural gas?

A: The rule of thumb is natural-gas is traded at one-tenth-to-one-eighth the price of oil. Gas is stuck in a way, because what determines where gas prices go include winter demand. The other thing is most natural-gas producers in the U.S. cannot maintain production if gas prices go below $6 per cubic feet.

Q: What are your top oil and natural-gas stock picks?

A: Right now I think the upside potential will be the independent producers. They have much higher beta. They gain the most when oil prices rise and they lose the most when oil prices go down. I think we are at or close to the bottom of commodity prices. When prices move higher, Exxon doesn't gain as much as Anadarko Petroleum (APC) or Apache or EOG or Devon.

These stocks will do much better than the S&P 500, but more importantly, we think they [will meet] the threshold of 20% returns in 12 months for an Outperform [rating]. Most of them are onshore natural-gas plays in the U.S. The exception is that Apache has 45% of its operations outside the U.S. But believe it or not, these stocks respond to oil prices.

The best asset play is Devon. Occidental Petroleum (OXY) and Devon have the strongest balance sheets. The companies most undervalued in the group, I would say are Anadarko and Pioneer Natural Resources (PXD). Chesapeake's debt level is double the size of the company. Anadarko has $10 billion debt, which they are trying to bring down as fast as they can.

Q: Refiners have been beaten badly throughout the year. Why are you now positive on names like Sunoco (SUN) and Valero Energy (VLO)?

A: The biggest upside potential is going to be in the refiners over the next two years. These stocks are down so far this year about 65%. I put a Sell rating on the refining stocks in January and they went down 75%. A few weeks ago we raised our rating on them to Outperform. The stocks so far are up about 20%.

Q: Thank you.

Wednesday, December 24, 2008

The Past as a Portal to the Future - Part 2

In my continuing quest for "Truth" where the economy and markets are concerned, I have been reading up on some of the more pessemistic points of view. I have never been a very good pessemist, even though I can talk a good game. By definition, the pessemistic perspective is extreme, and therefore less likely than some middle-of-the-bell-curve scenario. I am inherently a pragmatist and live in the middle of that bell curve. But even if I have a hard time following with actions the completely negative point of view, knowing it helps harden me against the possibility of it coming true. So, it is worth knowing and understanding.

I have read books by super-Bears, Robert Prechter and articles by David Tice. I am even willing to listen to or read Marc Faber, Bill Fleckenstein, Doug Kass and Jeremy Grantham, all of whom have been right to this point in time about the depth and severity of the financial crisis. But most of these guys have been calling for the 2008 market since the mid-1990s or earlier. Had I gone to cash when they first recommended it back then, I would still be down today from where I am. I find timing the market to be very difficult because of my optimism about the future. The only time I can bring myself to sell is when stocks or funds are obviously overvalued as the Techs were in 2000 at 50 or 100 PEs, or when gold was at $1000 earlier this year.

But after weighting my portfolio to large cap, low P/E, high dividend payers, I have mostly held on through this firestorm knowing that even in the deepest depressions (1930s) a consistent program of reinvesting to average down cost will eventually get one back to even. But being out of the market and getting left behind leaves almost no chance of ever catching up. As they say, "there is no bell ringing at the bottom". If the market were to rebound 25% to 11,000 in February, how many people would then invest. How many more would consider that to be a "dead cat bounce" and continue staying on the side line, perhaps as the market went higher? This is the danger of getting in and out of the market. (for readers in retirement without the requisite 10-15 year time frame to absorb the worst possible scenarios and rebuild a portfolio, cash and Treasuries should already be the game plan and hopefully is).

Here is an article that makes the case for "the worst is yet to come". The comparison, which I respect very much and might end up being true, is that we are at 1937 but with the 1930-32 plunge of 90% from top to bottom to come. The author makes the case that since so far a complete crash has been forestalled by government intervention, it must still be in our future. Of course, in the 1930-32 period, Hoover did try hard to stop the market and economic plunge, but his advisors had little historical insight to work with and none of the Federal and State social safety nets we have today. History has shown us the Hoover administration did much too little, too late to stop the plunge. Because the market and economy fell so far and so hard, it took 10 years to rebuild.

I take on faith (we don't really know if it will work) that the Feds can backstop the economic decline. It is one grand experiment we are all living. But the naysayers don't know any better that the decline can't be stopped. They are no more believable in their claims. And haven't most of the people that should go to cash already done so? The rest of us should wait it out, if we can afford to do so. Pulling out enmasse will just make problems worse as it would further collapse the capital base in the economic system. This is one of the logical fallacies of the Bears. They make the case everyone should get out because the market is about to fall. But it is the panic selling that drives the markets lower. If everyone stays put, becomes more optimistic and holds on, the market CAN'T fall. We will see if Obama and his team can change mass psychology and eliminate the panic impulse that creates Depressions. My bet is they can. But if they can't, I will wait patiently for the fever to run its course.

Here is the article with its accompanying charts.

http://www.howestreet.com/articles/index.php?article_id=8243

Friday, December 19, 2008

To My Good Blog Buddy, Nirav

(Note: Nirav's post tried to make the case that Deflation is just a mirage made up by government flunkees to fool us into believing massive printing of dollars is needed. This would lead to Hyperinflation that would sink our economy. Instead, Nirav wants to see big tax cuts and dramatically lower government spending, along with increased consumer saving and decreased spending. He comes from the Jim Rogers school of economics). http://livingoffdividends.com/2008/12/18/the-deflation-scam/#comment-26971

Nirav, I had a hard time understanding the point of this post Nirav, I had a hard time understanding the point of this post.

The title declares that Deflation is a Scam. This implies it is something made up or false, maybe a government conspiracy. But nothing in the post makes the case for any of that. Your data from the Government show that we have experienced a -12.9% contraction on “All Items” through November. That is the definition of deflation. Are you saying those numbers are made up or falsified? The same data show that in some areas, like Education, there has been some small inflation. But overall, we are experiencing a currency deflation.

It would really be quite hard for you to convince me or probably most others, anything else. We can see it all around us, whether it is gas prices, home prices (and eventually rent as vacant homes create competition for apartments), utilities; even food will come down since raw ingredients like grain have dropped a lot in six months.

There is no question that we are experiencing deflation right now, today. The only question that can be debated is really more a speculation: will we experience deflation tomorrow? I commented in my last post that the government is TRYING to create inflation. It is working very hard to push people away from cash. By definition, that is the only way out of deflation. Any increase in price, even just to get us back to zero price change, would be defined as inflation (or maybe “dis-deflation”?)

Because inflation is the only way out of this mess, it is better to just plan for it (invest in the correct stocks and commodities, and probably not bonds), rather than make arguments that we shouldn’t have inflation. Almost all economists agree that some amount of inflation is required in a healthy economy. Inflation means growth. It means there is demand for the economy’s goods and services. It is excessive inflation that is a problem (over 5% maybe?) not inflation itself. Deflation ALWAYS means a sick economy. It is never desirable for declining aggregate prices since it means too little demand for the amount of goods and services the economy can produce at optimum production.

And what does any of this have to do with tax policy? A deflation is not a tax event nor is an inflation. “The head of the International Monetary Fund, Dominique Strauss-Kahn, warned that advanced nations will be hit by violent civil unrest if the elite continue to restructure the economy around their own interests while looting the taxpayer.” Huh??? That statement by someone name Strauss-Kahn(S-K for short? I don’t have much regard for economists with the IMF) makes little sense. Is S-K a Republican or conservative? What does he/she mean by “restructure the economy around their own interests while looting the taxpayer”? That is non-sensical.

The assertion by some that a Republican controlled government would “restructure the economy for their own interests”, though I would not agree with the notion, is at least logical. Republican’s generally favor “supply side” economics that reward the captains of industry (high tax bracket) with the hopes of “trickle down” benefits to the proletariat workers. I understand how this could be perceived as “looting the taxpayer” in the way of S-K’s thinking.
But the new Democratic Administration and Congress, which support and are driving our current economic strategy, are trying to reflate and support the massive financial restructuring TO BENEFIT the proletariate, NOT the elite. The Dems are for socialism, if anything. Obama himself said he wants to redistribute wealth from the rich to the poor. So, current policy favors the poor. Seems hard to get to Civil Unrest from here.

Now a good deflation, that is how we get civil unrest. High unemployment goes with deflation, almost by definition: as prices fall because of declining demand, business cuts back its production to decrease supply; to cut back production it lays off workers; fewer paid workers creates lower demand leading to even lower prices; and so on. Once there is 15% or more unemployment with many literally out in the streets with nothing to do: well you know the saying about idle hands. Check out the civil unrest in France the past few years for a reference.

So, stop worrying so much about inflation. It is the least of our worries right now. To get to hyperinflation requires the destruction of a country’s productive assets, ala Germany after WW1. Then, any printing of money is hollow, since it can’t be exchanged for anything tangible (like the dollar can be for desirable American assets like Pebble Beach). As long as money is exchanged for assets, even if impaired, it is not devalued by the action. This is why TARP is not really “printing money” as many proclaim. Something was received in kind for the capital infusions, namely assets, either ownership for taxpayers in the company (80% in a a couple cases) or in securities held, like RMBS’s or CDO’s (which contrary to popular opinion, do have some value).

It is much easier to pick good investments during inflation than right now during a deflation. Do you know even one good asset class right now? The answer is no, unless you cite the horrible US dollar (that no one wants, until right now, when it is all anyone wants). I welcome inflation. 5%, no problem, in fact GREAT; 10%, I can still find lots of ways to make money; 20%, okay, there is a limit, but we saw in 1980 how we get out of that one.

Wednesday, December 17, 2008

A Turning Point in the Bond Markets

"It is always darkest just before the dawn." This very old and somewhat trite saying, is nevertheless very true (unless the moon happens to be high in the sky at 4am). It goes for our financial markets and the economy as well. We are in the deepest economic decline since the Great Depression. And if not for quick action by our Federal government, we might even exceed the depths of "The Greatest". Whether you agree or disagree with the philosophy of a central bank that interposes itself into market workings, it is hard to deny it is having some effect.

Yesterday, Ben Bernanke shocked the world by dropping the overnight Fed Funds rate (rate at which banks can borrow very short term from the Fed) to 0-0.25%. Basically, free money. In one way, this is just recognition that is where the short term Treasury rates are anyway. No point in keeping the overnite rate at 1.0% when the 3 month and 6 month Treasury bonds are yielding 0.01% and 0.2% respectively as of today. For these rates to be good investments, the currency MUST deflate (each dollar be worth more at a later date). But more likely, the buyer of such Treasuries just is making sure he still has tomorrow what he has today.

The past few weeks have also put to bed any notion that Gold is the world's safe haven currency. There has never been a time, probably not even the 1930s, when such a currency has been more in demand than right now. Yet, what do the world's investors flee to in times of absolute financial terror? Gold?.... No way....US Treasuries, instead. The irony is that the more money the Feds print, the more expensive it gets as measured by higher priced / lower yield US Treasury bonds. What a deal the Feds have (and by extension, we taxpayers). This anomaly is allowing the Fed and Treasury to buy up all the toxic mortgage and corporate debt at almost no cost to the taxpayer, at least not yet!

What this all suggests is that we are at another bottom of sorts, a yield bottom. Or to take the inverse, we are at a Treasury bond market top. Tops and bottoms when they can be identified, always make for a good time to evaluate a position and make changes to it. There are two possible routes in the bond world that make excellent sense at this time. One, go short the Treasury bonds by selling short Treasury ETFs, like (IEF), or by buying Ultrashort Treasury ETFs like (PST).

Another really good strategy at a yield bottom like now, is to go to the other end of the credit quality spectrum and buy the hated high yield (junk) bonds that now at historic spreads (differentials) to Treasuries. Even James Grant, a super-contrarian who called the credit and market crash years before it happened, likes high yield corporates and senior bank notes at this stage (see below). Today's high yield bonds are at a 20% spread over Treasuries (which is to say they are yielding right about 20% with Treasuries near zero). The normal spread of high yield corporates over Treasuries is around 6-7%, and the spread was as low as 4% in 2006. There will eventually be a reversion to the mean. Moving from 20% spread to 7% spread should result in at least a double for the high yield market. In the meantime, reinvest the 20% annual dividends to buy more fund shares.

I am counting on the Fed fiscal and monetary actions to turn around the economy, forestalling any wide spread defaults on corporate debt. I personally have loaded up on junk funds. I am buying into the Fidelity Advisor High Income fund (SPHIX). Another good mutual fund I have owned in the past (in 2002-03 before the recovery in that cycle) is Vanguard's High Yield, (VWEHX). A new low cost IShares ETF is also available under the ticker (HYG). I have done a comparison and all three trade in lockstep and have a similar yield around 12% as of today (a little lower than the junk bond universe because the quality is somewhat better in these funds). So, pick your favorite fund company and go with it.

Here is what James Grant said yesterday about a similar class of investments, senior bank loans, which have been heavily sold as a result of the hedge fund unwind. Senior bank loans were part of the "carry trade" play, with hedge funds borrowing short term, low interest loans like Japanese bonds, and then buying higher yielding funds like the senior bank loans. As hedge funds were forced to meet redemptions the past six months, Seniors and High Yields, were sold off indiscriminately:

Grant Says Forced Sales Create Opportunities in Bonds

By Carol Massar and Gabrielle Coppola
Dec. 17 (Bloomberg) --

Investors seeking safety in Treasuries may be missing out on opportunities created by forced selling in credit markets, according to James Grant, editor of Grant’s Interest Rate Observer.
Investment-grade corporate bonds are paying record yields relative to benchmark rates, “in this time of zero yield elsewhere,” Grant said today in a Bloomberg Television interview. Residential mortgage-backed securities and bank loans secured by assets are also attractive now because money managers forced to dump the securities to meet investor redemptions have made them artificially cheap, he said.

Yields on investment-grade bonds relative to benchmark rates have hovered near record highs as investors shun all but the safest debt in the deepest economic crisis since the Great Depression. The Federal Reserve cut its benchmark interest rate to as little as zero yesterday, further reducing yields on Treasuries, to try to ease the yearlong recession.

“Of course there’s trouble, that’s why there’s a bear market,” Grant said. “But that’s when you’re supposed to be interested in value. It’s not when everyone’s happy.”

The average yield over benchmark rates on investment-grade corporate bonds was 651 basis points yesterday, 5 basis points shy of the record high set Dec. 5, according to Merrill Lynch & Co.’s U.S. Corporate Master index. A basis point is 0.01 percentage point.

Market ‘Anomalies’

Forced selling may be distorting prices for secured bank loans. Senior bank loans that are higher up in the capital structure of a bank, meaning owners of the bonds would be paid before other debtors in the event of a default, are trading at lower levels than junior portions of the structure, he said. That means safer loans are cheaper than their riskier counterparts.

“All these anomalies are part and parcel of the liquidation in the credit market,” Grant said.

“That’s why we’re bullish on credit, because so many things simply don’t add up.”

Grant is the founder of Grant’s Interest Rate Observer, a financial journal. He was a columnist for Barron’s before founding the Observer in 1983.

Monday, December 08, 2008

Comparisons between 1930 and 2008

It is very clear we are in an historic economic period. As I have said (maybe too many times?) before, "History Repeats (or at least it rhymes)". But which period are we comparable to? The 1930s or the 1970s? This is the big question because the proper investment (and survival) strategy are almost opposite.

The 1930s was a period of terrible deflation leading to economic Depression. There are a lot of parallels between then and now. Are we headed back to the 1930s, or worse? Some would have us think so, in which case sell everything and go 100% to cash and hide it under the mattress.

On the other hand, this period could be more like the 1970s. Again, there are many reasons to think so. And the strategy in this case would be to buy everything possible that is a real asset. Paper money (cash) just becomes more worthless every day with inflation and a stagnant economy. Real assets will grow in value at least as fast as inflation reduces the value of a dollar.

I won't try to answer the question because there is not enough information to know for sure (and if I really knew this answer, I could name my price). But I did find some interesting academic notes on the subject from an Eric Rauchway, an economics professor at UC Davis and author of a noted book on the Great Depression. You can read his notes or hear his podcast at this web link:

http://www.econtalk.org/archives/2008/12/rauchway_on_the.html

If you don't want to take the time to listen or read in entirety, here are a few bullets that compare the 1930s to now, paraphrasing the author / interviewee, Rauchway:

  • Fed raised interest rates, first in 1928 to attract foreign investment; Followed by drop in consumer spending. Immediate transfer via the uncertainty mechanism to the real economy.
  • Parallel, recent drop in automobile purchases after Fed raised rates in 2006 to cool economy;

  • 1930: people afraid they will lose their jobs;
  • 2008: Bankers afraid they will lose their jobs and be unable to pay their bank borrowings back. Strange that Treasury Secretary Henry Paulson is angry about that, given the history. Nice parallel with the 1930s.

  • Hoover administration created the Reconstruction Finance Corporation in 1932,
  • Similar to the Troubled Assets Relief Program (TARP) in 2008.

  • RFC originally going to lend money to banks to prop them up. Realized that this is not going to work and they have to recapitalize the banks. Hoover doesn't like the idea of buying bank stocks (nationalizing) in return for the capital (big mistake, as it helps bring public support on board and eliminates moral hazard).
  • We recently went through in a few weeks what we went through from January 1932 to March 1933 back then. We sped it up, and we accepted bank equity or warrants in exchange for capital. However, the speed discomfits consumers. Banks now are rather cautious in lending, as a result of speed and uncertainty. Consumers are not yet spending.

  • In the 1930s, Fed administrators were frustrated that the banks weren't lending after being recapitalized; RFC said it would lend in their stead, only to find that there weren't enough qualified borrowers.
  • Maybe we'll recover much quicker too (because the bank recap was sped up). Uncertainty about what may happen next is offsetting, (though and is holding back lending). Lending encouragement is working as shown by declining spreads between various lending classes like mortgage rates and Treasuries. We must avoid being too conservative in our qualification of borrowers and must make borrowing very attractive with excellent rates and terms;

But here are ways the two periods are quite different, to the benefit of the current period:

  • Hoover signed the Smoot-Hawley Tariff Act, with some zeal. Contrary to the myth that he was a laissez faire ideologue. Not a stand-idly-by guy.
  • So far we have avoided any protectionist legislation, like rescinding NAFTA. Protectionism shuts off a need source of capital flow.

  • Hoover became increasingly desperate through 1932. At some point you have to say Hoover should have been doing more. Hoover tried to coordinate businessmen to prevent a drop in wages. Ineffective, can't get enough businessmen to agree.
  • We now know that direct government control of the economy does not work. Nixon proved again in 1972 with wage-price freeze. Get around it by letting companies laying people off--pay higher wages but hire fewer people. This keeps consumers buying, if fewer consumers;

  • In early 1930s, unemployment was about 25%, annual figures: just shy of that in 1932, about that in 1933.
  • From that experience we know now that unemployment is necessary, so wages will fall to a point to entice firms to hire workers; but if people don't have jobs, economy won't recover, people don't have any money to buy things, so firms have no money to pay for more employees. Circular flow of macroeconomics understood and hard to navigate politically.

  • Difference then vs. now: no unemployment insurance, no deposit insurance, no old age pensions--state level and some private stuff, but tapped out by 1931 or 1932. Agricultural difficulties of the 1920s also used up some of these social welfare resources (in farm states).
  • Now there is an extensive social welfare safety net at the state and national level; Feds can create money if needed, to keep people fed and sheltered; can also provide funding to states if needed and can provide medical care and food stamps, programs not in place in early 30s.

  • In 1930s as people lost jobs, they drew money out of their savings, putting pressure on the banks. Banks already suffering because foreign debt was going into default (post WW1); stock related debts (margin accounts) going into default; municipalities and states going into default. No brake, no way of softening the blow.
  • Today we have FDIC deposit insurance, hence eliminates runs on banks. Banking system won't collapse.

  • In 1930s, there is a stark contrast between Hoover in 1930 and Roosevelt in 1933 (with hindsight). Hoover doesn't do anything to stop the bank runs. People's savings just vanish, no recourse. Lack of confidence in the system with no deposit insurance, people wondering if their bank will be next.
  • We have many protections in place today to avoid bank runs as witnessed recently, especially Indymac

An even earlier depression in 1894, was the worst depression before the Great Depression. It was 40 years before the 1930s Depression (notice the 40 year cycle?) and somewhat fresh in people's minds, pretty horrible, but we don't have good measures. What happened to banks in 1894? There were pressures on banks.

There is controversy over how bad the unemployment was and how contraction of the money supply contributed to the 1894 Depression. But in 1930s, the money supply contraction can't be laid at Hoover's feet--the Federal Reserve was at fault for that. They created money on one hand to recapitalize failing banks, but took it away with the other, believing if they didn't it would create uncontrolled inflation (which we now know is better than uncontrolled deflation and is the stated goal of Bernanke and probably L Summers to come).

Hoover did increase spending, limited by institutions of the day (or lack thereof) and circumstances. But the Federal government wasn't big enough in the early 1930s to have a big effect on the total economy. Hoover tried to create big increases of public works by working with the state governments. But too little, too late, not enough stimulus."

These are the conclusions, in short, of Eric Rauchway. They are even better understood by Ben Bernanke and also by new, incoming Chair of the Council of Economic Advisers, Christina Romer. She is said to be more an authority on the Great Depression than Bernanke.

Logically, the best way out of excess debt is inflation. Inflation allows the debt to be paid in ever cheaper dollars, at the expense of the lendor, of course. But that is a story for a later day. So, if Bernanke and Romer have learned from the 1930s and do everything that it is said Hoover, and then FDR did not do, namely not doing enough to stimulate the economy, I think it is a solid bet they will ere on the side of over-stimulation which will lead to inflation and a run in hard asset prices.

Friday, December 05, 2008

Tough Sledding in the Markets and Economy

The jobs report came out this AM and it is not good, even very bad news. Job cuts of 533K were announced for November and October was revised up (down) to 320K from 240K; September was revised up to 403K from 284K. That is a lot of job loss the past 3 months, the worst since Q2 of 1980 when Paul Volcker shocked the economy into submission with 20% interest rates.

But those of us who follow the market daily are not too surprised by this bad employment "print". The stock market has been crashing anticipating very bad economic news, serving its function as oracle of the economy. And some of us (me) have seen job cuts at our own place of employment based on painful forecasts for 2009. So there is a very good chance the lousy numbers are already "baked in the cake" of the stock market. Today's (Friday's) early stock market action certainly suggests that, as the DJI is only off by 90 as I write now, but still well above the lows from mid November.

All of the economic slowness, global recession and the resultant strength of the dollar is just hammering energy, much to the displeasure of my portfolio. But at the same time, the government policy makers around the world appear prepared to "throw the kitchen sink" at the economy to get it going again. This will mean a recovery in 2009, maybe beginning as early as Q2. As soon as the world economies recover, the demand for energy will return and drive oil prices back up, though maybe not to $150 since the hedge funds have been hit hard and leveraged speculation in the near future is unlikely. But I think we could all live with $75-80 oil which more accurately reflected the rising demand and tight supply of early 2007. Prices in that range are economically sustainable and would create a stable environment for the Canroys.

I am swallowing hard and holding on to my energy shares, knowing that there will someday be an economic recovery and when it comes, there will also be some inflation to pay for all the money pumped into the economy. Higher economic demand accompanied by mild inflation will be a good environment for commodities and energy.

Here is more on oil:


$25 Oil Could Happen Before a Return to $100
December 05, 2008

By Matthew Hougan

http://seekingalpha.com/article/109393-25-oil-could-happen-before-a-return-to-100?source=article_lb_articles


Jim Wiandt says that oil will go to $100/barrel before it hits $25/barrel. I'm not so sure.

The reason I'm confident that the Dow Jones industrial average will top 10,000 before it hits 6,000 is that stocks are a leading indicator. They anticipate recoveries, typically turning upward 6-9 months before the economy as a whole. We are already one year into the recession, so I'm guessing we are getting close to the point where stocks will turn the corner. When you add in the fact that valuations and yields are the most attractive I've seen in my adult investing life, the outlook for equities is quite good.

Oil, on the other hand, reflects mostly immediate, near-term supply and demand. If the economy gets worse before it gets better, stocks might see the light at the end of the tunnel, but oil won't. It can't. Prices will keep falling as demand deteriorates in real time and the current supply glut gets worse.
Remember, oil is expensive to store. For the most part, it won't just sit around waiting to be used if there is a lack of demand. (Some can be stored, but not that much). It must be sold and used at whatever the current clearing price is.
And we have yet to see the magnitude of supply cutbacks in the oil market that we've seen in aluminum, copper and other commodities. The world is continuing to pump out millions and millions of barrels of oil.

Here are a few facts to consider:

  • Oil has averaged a nominal price above $50/barrel in just three years in the history of the world: 2005 ($50.04/barrel), 2006 ($58.30/barrel) and 2007 ($64.20/barrel).
  • On an inflation-adjusted basis, oil has averaged an annual price above $50/barrel for just 12 of the 62 years of the post-war era.
  • The average inflation-adjusted price of oil in the post-war era is $33.65/barrel.
  • Oil traded below $25/barrel as recently as 2002.

As the saying goes, "This time it's different" are the four most-expensive words in investing. So why not $25/barrel oil?


I was amazed during the recent oil price retreat how quick people were to say that $100/barrel was the "right" price for oil. $100/barrel is off the charts historically, and completely neglects both the supply and demand impacts that high oil prices have.

To put it another way, stock prices are now trading where they were in 1997. What's to say oil shouldn't be trading where it was in 2002?
The truth is, I have no idea where oil prices are headed. But I don't think it's a gimme that they're going back to $100/barrel. In fact, if you gave me 2-1 odds, I'd bet they hit $25/barrel first.

P.S.: One more thought about oil. Even if you strongly disagree with me and think crude oil is a screaming buy, please be careful before you buy a crude oil futures ETF like the US Oil Fund (NYSEArca: USO). Oil is in a violent contango. A fund like USO faces a 3% monthly headwind from contango right now, meaning oil prices must rise about 3% each month just to offset the losses from rolling contracts forward. Until that situation is reversed, investing in crude oil futures could be challenging... even if I'm wrong about crude oil prices.

Monday, December 01, 2008

Will Liberals Finally Unseat Tories?

Those of us in America with investments in Canroys have been more than disinterested bystanders when it comes to the Canadian Parliament. PM Harper's Tory (Conservative) party decided in October 2006 to break promises to its constituents and begin taxing the profits of Canadian Royalty Trusts. This devestated the valuations of all Canroys. The oil and gas trusts, which are also treated as non-taxable trusts in America (under the concept of Master Limited Partnerships), were especially hard-hit as there was no precedent for taxing the income of asset trusts.

Those of us invested in Canroys were outraged, though the Americans among us could do nothing about it. But the Canadians can, and apparently will. In today's Globe and on the CBC website, I found an article that the Liberal and NDP (New Democratic Party) parties have agreed to form a coalition that will force out the ruling Tory party, Finance Minister Flaherty and PM Harper. While there is no guarantee that the Liberals will roll back the law change regarding taxation of Canroys, there have been indications that the taxes will at least be modified. At this time of decreasing oil prices, we need all the help we can get to support the price of Canroy shares.

Here is the article in total:

http://www.cbc.ca/canada/story/2008/11/30/canada-coalition.html?ref=rss