Against the Grain: Why I am Bullish on Oil

Some people who know me will have heard me passionately explain why I think electric vehicles (EVs) are the future. I believe both EVs and renewables’ uptake will likely accelerate over the next few years and is inevitable for economic reasons, due to the declining costs of the new technology relative to the old.

Why then; political, and environmental reasons aside, am I now bullish on oil?

Before we dig into the four components underpinning my thesis, let us set the scene by looking at the world’s oil consumption by country:

Source: U.S. Energy Information Administration (EIA)

From 2000 to 2017, despite the OECD’s best efforts to make reductions, their demand for oil has only declined by 2.1%. Over the same period, demand for oil among non-OECD countries has grown by 79.8%. China and India, two rapidly growing emerging markets, have seen their oil demand grow by 189.4% and 99.1% respectively, and these countries are now the second and third largest consumers of oil in the world.

Now that we have established the largest markets for oil consumption, let us examine the end uses. Based on the U.S.’ data, we can see that the predominant use for oil continues to be transportation fuels:

Source: U.S. Energy Information Administration (EIA)

Motor vehicles account for 45% of U.S. oil demand, with jets for another 8%, signifying that over half of the oil demand stems from these transportation fuels. According to the EIA, 68% of U.S. petroleum consumption is utilized by the transportation sector, suggesting that the remaining consumption of 15% comes from diesel fuel.

With the above in mind, my premise boils down to 4 potential drivers:

  1. Stabilization or a rebound in oil prices: The pandemic’s impact on oil demand has resulted in Brent declining 35% year-to-date (as at 13/11/2020) and the virus may continue to act as a headwind in the near term due to national lockdowns being re-enacted. Nevertheless, it is rational to assume that prices are likely to stabilize once COVID-19’s economic impact dissipates.
    Furthermore, over the last few years, there has been continued, and in many cases accelerated, reduction in capital expenditure across the oil industry. According to one estimate, capital expenditures are expected to reach a 13 year low. This suggests that growth in demand, beyond pre-pandemic levels, will unlikely be met with new supply in a timely manner. Therefore, in this scenario, oil prices will likely be pushed higher.
  2. Continued growth in non-OECD countries: As highlighted earlier, emerging markets are the key growth driver behind oil demand over the last 17 years, largely driven by China and India. In my view, this is unlikely to change in the near term despite China’s best efforts to shift to cleaner forms of transportation and energy. In fact, China’s demand for oil has already started to reflect its improving economic position since the country’s restrictions eased. I believe emerging markets will continue to outpace developed markets’ economic growth, suggesting oil demand will likely come roaring back once the pandemic’s economic effects subside.
  3. Comeback in inflation benefiting commodities: with record low interest rates globally, in addition to aggressive money printing (“QE”) and loose fiscal policy across the developed world, inflation is likely to start rising sooner than most expect. Firstly, this will impact the prices of oil, given the historic link between inflation and commodity prices (which is also why I am bullish on gold). Secondly, oil and gas stocks, which are largely labelled as ‘value’ stocks, are historically more likely to outpace ‘growth’ stocks in an inflationary environment.
  4. Depressed sentiment: I personally like to use extreme sentiment as contrarian indicator. While it seems investors can never seem to own enough tech stocks, especially the cloud names, the low valuation of oil and gas names suggests that the sector’s sentiment is towards the opposite end of the spectrum (valuations, of course, can always go lower/higher for much longer than we can fathom). It also appears that many investors and lenders are throwing in the towel when it comes to the oil and gas sector, after over 6 years of poor performance (down over 60% since the start of 2014).
    Interestingly, even the European Integrated Oil Companies (IOCs) are shifting their investments away from oil and gas and toward renewables, an area I believe they are unlikely to have any durable competitive advantage in. This will further limit oil supply growth.
    Current sentiment offers an attractive entry point to gain exposure to the oil and gas industry ahead of several potential catalysts.

As a result of my views, I initiated a position in the Vanguard Energy ETF (ticker: VDE). After Pfzier’s positive COVID-19 vaccine announcement, I added to my position throughout the week. I will continue to add to my VDE exposure and as I see confirmation of my thesis, I will look to gain exposure to specific names within the energy sector.

I particularly like that this U.S. focused ETF currently pays a dividend yield of around 5%, while I wait for the rebound in the oil sector. This is valuable given it is likely to be a multi-year play. As ever, there are no guarantees when it comes to investing.

Full disclosure: I am long VDE.

Disclaimer: The information posted above are my own personal views at the time of publishing and should not be construed as investment advice. My personal views do not necessarily reflect that of my current or past employers’. This material does not take into account your particular investment objectives. Investors should consult their own financial or investment adviser before investing or acting upon any information provided. Past performance is not indicative of future results.

Two Reasons to Be Bullish on Gold

Entering 2020, following a 10-year equity bull market (which was abruptly ended by Covid-19 in March), many investors were questioning the merits of owning gold within their portfolios given the significant out-performance of all the major stock market indices. As worries mounted over the spread of coronavirus, financial markets experienced sharp price declines with many investors quick to liquidate gold to cover margin calls. This initial credit contraction, where investors liquidated their gold holdings to repay their leverage, resulted in the metal declining for two weeks, adding further doubt to its “safe haven” status. Despite this, gold is currently up around 10% year-to-date, outperforming all major stock market indices, clearly demonstrating the metal’s value as a safe haven and as a valuable portfolio diversifier.

Since my October 2016 blog post, where I touched upon gold being one way to protect against depreciating currencies, gold has risen 35% while the S&P 500 is up 41% with dividends re-invested in USD terms (excluding dividends: 32%). Although a short period of time, it emphasizes Warren Buffett’s point that the “magical metal was no match for the American mettle” and eschewing stocks for gold is not a wise strategy. Nevertheless, when compared to other major stock markets (with dividends reinvested), gold has significantly outperformed in USD terms (Euro Stoxx 50 is up 2.9%, Hang Seng is up 16.9% and the Nikkei is up 18.2%)*.

I am not in the “sell-everything-now and buy gold” camp, nor a “gold bug”. I do, however, believe gold plays a valuable defensive role in portfolio diversification. Looking forward, my view is there are two major reasons to own some gold over the medium term:

  1. Increasing money supply driven by central banks “quantitative easing” programs, combined with rising government deficits to fund fiscal stimulus programs will at some point, result in meaningful inflationary pressures. To illustrate the magnitude of these programs, the U.S. Federal Reserve balance sheet now exceeds a record $6 trillion and continues to expand at a rapid pace. Furthermore, Congress has approved a $2.2 trillion stimulus package, the largest in its history, with further packages likely to follow to prop up the economy during this crisis. Other G20 governments are pursuing similar fiscal strategies during the unprecedented lockdowns forced by the pandemic as shown by the chart below:

Covid 19 fiscal stimulus
Source: Statistica.com

I believe, at some point, debasement concerns will come to the forefront. Investors are likely to shift their focus onto the size of the major central banks’ balance sheets and the unsustainable fiscal deficits of some the developed (and developing) countries’, as well as their ever growing debt burdens. Similar events occurred in late-2008 when gold under-performed as credit contracted, before rallying to new highs as the Fed’s quantitative easing program took hold.

  1. Gold’s 0% yield, usually a disadvantage over owning bonds, suddenly becomes an advantage in an environment with real negative bond yields. To stretch for higher yields, investors are currently being forced to go further out the risk curve, exposing themselves to higher probabilities of default, resulting in situations where the risk/return profile is not prudent. To add to the difficulties of finding attractive yields, the Federal Reserve has started buying corporate bonds, in addition to High Yield Corporate ETFs, further suppressing yields that investors would otherwise demand to lend to borrowers of that nature. These lower yields risk being wiped out in real terms if inflation rises meaningfully.

    Negative yielding bonds
    Source: Reuters

These two reasons above suggest that gold is a good place to park a portion of an individual’s capital.

Note: Gold is commonly purchased through price tracking funds such as State Street’s SPDR Gold Trust, commonly known by its ticker ‘GLD’ or BlackRock’s iShares Gold Trust ‘IAU’. The two ETFs currently manage over $56 billion and $22 billion in assets, respectively.

Full disclosure: I am currently long GLD.

* Returns are as of market close on 16/04/2020

Disclaimer: The information posted above are my own personal views and should not be construed as investment advice. This material does not take into account your particular investment objectives. Investors should consult their own financial or investment adviser before investing or acting upon any information provided. Past performance is not indicative of future results.

Triumphant Trump Rally: Will it last?

The financial news media for months predicted a crash in the stock market if Donald Trump were to win the elections. As was confirmed in the early hours of November 9th, Donald Trump has been elected the next President of the United States of America yet the U.S. stock market is at fresh all-time highs. Continue reading “Triumphant Trump Rally: Will it last?”

Brexit: Historic Pound-ing Continues

Last week the British Pound touched a historic low against a basket of global currencies according to the Bank of England. The uncertainty around Brexit has resulted in an almost 18%* decline in the Pound versus the U.S. Dollar since the start of the year, a 31-year low. The process has been volatile, including the 2-minute flash crash. Even more incredibly, the Sterling has been pounded against the Euro by as much as 22%* since the turn of the year. Continue reading “Brexit: Historic Pound-ing Continues”

Powerless Pension Providers: Low Yields, High Pressure

Many in society currently live under the assumption that even if they do not save much throughout their working years, they can rely on their pension pot during retirement. Recent developments however, have flagged up the struggles pension providers currently face.  Continue reading “Powerless Pension Providers: Low Yields, High Pressure”

Battle for Online Supremacy: Amazon vs. Walmart

Online shopping is a key secular trend that is expected to become increasingly important for all retailers. Last week marked an important stage in the battle for e-commerce market share with Walmart’s $3.3 billion acquisition of Jet.com. Jet.com is a 2-year old start-up founded with the aim of taking on Jeff Bezos’ Amazon, the largest online retailer in the world and currently valued at around $360 billion.  Continue reading “Battle for Online Supremacy: Amazon vs. Walmart”

Magic of Compounding: Grow Your Savings

In Lost Savings Habit we discussed the prospect of younger generations ditching savings as a result of record low interest rates. According to a recent survey, a quarter of UK households would have to rely on loans or ask family and friends for help when faced with an unexpected bill. Young people may not receive adequate education about one of the most important factors they are going to have to deal with during their lives: money.  Continue reading “Magic of Compounding: Grow Your Savings”

Seismic shift led by Google and Facebook

Last week marked an important moment for rankings of the top 5 largest U.S. companies by market capitalization. For the first time ever, the list now belongs exclusively to technology companies. At the summit is Apple with $561 billion in market capital. Completing the list is Alphabet (Google’s parent company), Microsoft, Amazon and Facebook. Continue reading “Seismic shift led by Google and Facebook”

Lost Savings Habit

In my last article, Negative Interest Rates: Who’s Interested?, I touched upon the potential negative impact the current interest rate environment can have with regards to asset bubbles and large debt burdens. However there is also scope to focus on the impact low interest rates can have on the average household. Continue reading “Lost Savings Habit”

Negative Interest Rates: Who’s Interested?

Wednesday marked a key moment for the German 10-year government bonds (or bunds as they are known). While they have been trading at negative yields for a while now, it was the first time that a new Bund was issued at a negative yield. This implies that investors now effectively pay Germany to borrow their money. Continue reading “Negative Interest Rates: Who’s Interested?”