A dove fluttered into our al fresco grande salon on Jumby Bay, confused and then panicked. Its noisy flap flappings filled the air. Then it darted to the upper far corner of the room, circled once, still flapping, spied a tiny upper window and crashed it head-on. The dove fell in a heap to the white marble floor.
In my cupped hands, its body quivered once. Then the eyes shut and the dove expired. This drama took no more than 30 seconds. A bit non-plussed, two couples resumed their chicken salad luncheon. Copper was hitting another daily new high at $4.36 a pound. I was saying the world was discounting 9 percent GDP growth in China and heady world-wide commodity inflation for the new year.
Exactly 90 days later copper ticked at $4.36 a pound, again, in a range of $4.10 to $4.62 during the first quarter. I identified with the panicky dove, commodity inflation, particularly oil, was my pivotal scary variable in the investment setting, prospectively a headwind killer likely to disorient players like me, no more than a sparrow in the wind.
The oil problem for the world and the U.S. stock market is here and now. Oil quotes ratcheting up wreck the bullish scenario of economic recovery for us and the world. For money managers with pro-cyclical portfolios of industrials, tech houses and raw materials producers oil spells trouble. There is no good place to hide short of building cash reserves, but I’m not ready.
The market is cheap on $100 oil but not $130 quotes. Higher quotes call into question $100 earnings forecasts for the S&P 500 Index. Housing sticks in the dumps and consumers save more and buy less. For everyone, the cost of doing business rises inexorably.
Strangely, oil equities, particularly internationals, only discount $95 a barrel oil. In the back of every institutional investor’s mind is the concept of demand destruction, 2008 its latest and most dramatic proof. Oil broke to under $40 a barrel from over $140.
I have parsed the supply and demand for oil until I’m blue in the face, talked with analysts and read all the think tank forecasts which don’t vary markedly. Everyone sees the demand side up at least 1.5 million barrels a day this year, maybe more if worldwide GDP holds near 4 percent.
China, alone, accounts for 35 percent of incremental demand this year. Chinese central bankers raise interest rates and bank reserve ratios but their GDP seems irrepressible. Close-in students of the Chinese economy just raised GDP forecasts from 8 percent to 9 percent this year and model more of the same in 2012.
In my neck of the woods I’ve seen gas pump meters showing $3.99 a gallon for high octane fuel. This is the pressure point for drivers who at 4 bucks, ditch pickup trucks in the back yard and drive the little lady’s 2-door sedan that gets 36 miles to the gallon.
Detroit grimaces. The lucrative mix of SUV’s and light trucks morphs into more demand for compact cars. Both Ford and GM rest 20 percent off months – ago highs. I discount parts shortages from Japanese suppliers as the reason to turn negative on Ford and GM.
Gas at 4 bucks is a leading indicator of family discontent. Consumer sentiment numbers just sloughed off. For guys in work boots fuel bills eat up 8 or 9 percent of their personal income. With corn selling near $7 a bushel (I remember $3) food price inflation, particularly meat and grain products, is just around the corner.
The world can live with $100 a barrel oil today but not better than it tolerated $30 oil a decade ago. Energy conservation is finally ingrained in our psyche and makes slow but steady progress, like lower cigarette consumption. I discount electric cars as a way of life but “Consumer Reports” annual car issue (a must read) denotes dozens of small cars that impress, including Ford’s Fiesta and the Chevrolet Cruze.
The Fiesta gets 33MPG, the Cruze 26MPG. In road testing and reliability Ford and GM showed big gains according to CR. In a 16-million car year which is normality, Ford earns over $2 a share and GM approaches 4 bucks. Credit upgrades and dividends wait in the wings.
The supply and demand for oil worldwide is scary stuff because nobody ever gets it right for very long. Now more than ever with the Mideast enflamed. Yes, OPEC members opened their spigots to cover up to 1.2 million barrels a day of outage from Libya, but who covers the next million barrels? I dunno.
Estimates of reserve Saudi capacity range from 3 to 4 million barrels a day, but all of this cannot be turned on overnight. Russia is flat and the U.S. is lower by 800,000 barrels thanks to the moratorium on drilling permits. In total, new OPEC oil supply is flat.
We could eat through OPEC’s spare capacity within 2 years. The oil market would react within one year in this scenario. It’s not hard to see $120 oil around the corner. After all, Brent crude, denominated in dollars, is at $115, and much of the world’s production is priced by Brent quotes.
I’m willing to grant non OPEC production moves up half a million barrels a day for a couple of years. Later on, Iraq’s production could kick in 2 million more barrels. This is why oil futures remain in backwardation 3 to 4 years out at $105. Futures markets generally outsmart think tank pencil pushers.
I’ve added to my oil portfolio, more Conoco and
, if for no other reason then to hedge bets on Ford and General Motors. My bigger concern is the dollar. Oil is denominated in dollars and dollar weakness adds to our trade deficit, detracts from GDP, impinges on personal consumption expenditures and exerts an inflationary bias everywhere in the economy, particularly imports.
Our economy is best described as a self generating recovery after its huge winding down in 2008-09. Unemployment currently is a lagging indicator as is new home starts, capacity utilization, even industrial production, more a coincident factor, but not hours worked or wages, still lagging.
A spike in oil prices for whatever reason-futures over-speculation or more mideast flare-ups is not priced into the market. It was easier pricing in Japan’s tragedy and Portugal’s banking can of worms. Somebody needs to tell me why the euro is steady at $1.41. I don’t get it, as yet.
I’m a fully invested player fingering my Greek worry beads. About the last variable oil services stocks are discounting is a recession likely to push oil prices below the marginal cost of production which is now around $85 a barrel.
seems irrepressible.
Maybe the slowdown happens after Brent crude hits $140 a barrel and they take GM out to be shot. Lest we forget: Oil demand last year rose 2.8 million barrels per day, the second highest recovery in 30 years.
Martin T. Sosnoff is chairman and founder ofAtalanta/Sosnoff Capital, a private investment management company with more than $11 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser. He was a columnist for many years at Forbes magazine and for three years at theNew York Post. Sosnoff owns personally and Atalanta Sosnoff Capital owns for clients the following stocks cited in this commentary: Ford, General Motors, ConocoPhillips and Apache.
