Rudi's View | Jun 19 2008
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck, Editor FNArena
How about you don’t buy any oil stocks at all? Maybe, if you missed out on the recent strong run for share prices of oil producers, and of other energy related sectors such as coal seam methane gas, you should simply accept that you are arriving at this party at the eleventh hour and it is therefore better to accept that you have missed out on the opportunity. Better luck next time.
However, if you are holding various shares in oil and energy related stocks, it might be a good thing to start taking another good look at them and re-consider whether the stocks you are holding have much substance to offer. Chances are that if you bought those shares recently, or you jumped on some micro-caps with many years left before any genuine prospect on having a cash flow generating project in operation, you could be the last sucker in the queue. You know, the one who decided to jump on the bandwagon, just like everyone in front of him, only to find out when you eventually look over your shoulder, there are no buyers left.
Sucked in!
Recent research conducted by experts at Barclays Capital and State Street Global Markets has confirmed what I suspected all along: fund managers and other professional investors have been switching funds out of assets like base metals, precious metals, bonds and even corporate equity. No prizes for guessing where the bulk of those funds ended up: yes, in the oil market.
Meanwhile global media –especially financial television stations- seemingly cannot get enough of the subject. Will crude oil reach US$200 per barrel? Is it fundamentals based or are speculators responsible? Why don’t the Saudis increase production by more? It’s China, isn’t it? Which oil stocks should we buy?
If my observation is correct, and I have a few email addresses at my disposal to back up my findings, even the amount of spam emails over the internet has increased significantly over the past week or so, most with the aim of attracting investor interest for an unknown energy company nobody has ever heard of, or paid any attention to. But soon, the emails assure us, soon its share price will surge too!
Next in line will be my neighbours, the nephew I never knew existed, the butcher around the corner, and, last but not least, your regular cabdriver.
I am even willing to bet that by the time all this is over, only a small amount of people will have made lots of money, while many more will have lost part of theirs. History is my guide.
Since 1869, the world price of oil has averaged US$21 per barrel in 2006 dollars with a median of US$16.71 per barrel. Since 1970 though, the average has risen to US$32 per barrel and the median to US$26.50 per barrel. But what has been genuinely eye-catching, is the rapid evolution in yearly price averages since 2004. Crude oil averaged US$20-something between 2000 and 2003 (and below US$20 throughout most of the nineties), it made a step-jump in 2004 to a yearly average of US$37 per barrel. The following year the average jumped to US$50 per barrel, the next year it averaged US$58.30. Last year, the average increased to around US$64 per barrel.
Now let’s have a look at some more recent price averages: the year-to-date average oil price currently stands at US$108 – nearly 69% above the 2007 average. The average price over the past three months stands at US$118; more than 84% above the 2007 figure. Over the past thirty days crude oil has averaged US$130, more than 100% above the average price of last year.
One does not have to be an oil-skeptic to doubt whether all this is sustainable. Personally, I have no problems with any of the arguments I hear from the market bulls: there is not much room for error as the market is tighter than ever; supply has not kept pace with strong demand; it has become more expensive to put new sources into production; oil is in a long term uptrend; etcetera.
I would tend to agree with most of it if oil was still priced at US$80 per barrel, or at US90 per barrel, maybe even at US$100 per barrel. But at US$130-plus I start doubting whether all those who continue repeating the “oil is in a long term uptrend” mantra won’t be hoping their readers, viewers and customers have short memories in a while from now.
Let’s have a look at what happened in some other commodity markets in recent years. All of these markets are believed to be in a “long term uptrend” and all of them equally had a bullish market story to underpin sharp movements in prices. Of course, investors only played a minor role in all these market developments (not).
The price of coffee spiked 25% within five weeks in late 2007/early 2008. Everyone started talking about a new paradigm for the world’s most popular legal drug. There were plenty of reasons cited why coffee was now unmistakably in a long term uptrend: the most convincing of them all was that traditional tea drinkers in Asia had started drinking espressos and cappuccinos. A few weeks later the price was back at its price level from early December 2007 – where it still is today.
Bottom line: coffee IS in a long term uptrend, but of those investors who jumped on the bandwagon between December and January many are still licking their wounds today.
Remember rice? It was not that long ago international news agencies couldn’t publish enough stories about how Asian customers were plucking the shelves empty at Wall-Mart stores throughout the US to send bags of rice to their relatives in Asia. The market price for rough rice futures spiked in April this year, marking a doubling of the price in six months only. Half of the world’s population seemed on the cusp of starvation. Within weeks the price of rise had fallen by 25%.
Platinum, zinc, nickel, lead and tin, among others, have similar stories to tell. Lead is currently trading at around US$1850 per tonne; nearly 60% below its peak of November 2006, and the forecast is for lower prices ahead. The price of Nickel surged above US$51,000 per tonne in May last year. Today, Nickel trades at around US$24,000 per tonne, supported by unexpected gas-supply problems in Western Australia (limiting production at key Nickel mines in the state), but the price is nevertheless about 53% below last year’s peak.
Here’s one key factor to take into consideration: were crude oil to fall back to US$100 per barrel, this would still mark a seismic shift compared with prices paid in the past. But US$100 is more than 30% below the current price level. It is not inconceivable that, should oil futures fall back this dramatically, share prices of oil companies will correct even more.
It is still possible that oil futures might reach for US$150 –or higher; one can never tell with these investor manias. I would be inclined to think that the higher the price will ultimately climb, the deeper the fall will be that follows. While shorter term focused investors might still want to trade the oil market for its momentum, longer term buy and hold oriented investors might do themselves a big favour by keeping in mind that buying the right trend, in combination with the wrong timing, simply equals investment losses.
In case of any doubt: see price developments of the commodities mentioned above.
