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Sell the Banks, Buy Oil Stocks |
Baltimore, Maryland
Wednesday, June 3, 2009
* U.S. economy right on course...to see 179 failed banks this year,
* Chris Mayer’s favorite natural gas play, plus,
* Guns, gold, geothermal and other tidbits from the Rude mailbag
below...
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Joel Bowman,
deferring to the wisdom of the Rude readership for the day...
Every now and then we turn the virtual pen over to the inimitable Rude
readership for some thoughts. Today is one of those now-and- thens.
First up, a
thoughtful email from reader J. Stewart.
“Thanks for yesterday’s
Rude Classique. Eric J. Fry’s juxtaposition of General Motors and
the Russian Government S & P debt ratings was enlightening in more ways
than he noted.
“Russia’s graceful 1990s slide did not end gracefully but with the rude
shock of [sovereign] default, much like the ‘tsunami’ all those AAA
rated banks etc. caused in 2008. Surely the point of Eric’s ‘Mind the
GAAP ---‘ chart is that the US government’s rating should have been
sliding gracefully through the “naughties”.
“Instead the US seems more likely to dive from S & P’s AAA+ orbit rather
than Russia’s CCC rookies platform. Unless S & P finds the courage to
admit and publicly correct it’s rating errors, it is a question of when,
not if the US crash dives. Surely the shock will make 2008’s ‘tsunami’
look like the splash of a paper pebble falling in a puddle.
“While Rome wasn’t destroyed in a day, nor did it have fractional
reserve banks and S & P’s dodgy ratings. And there was Constantinople.
All we have to rebuild on are are BRICs. Will they find the strength to
survive the splash when the US dives from the tower?
Thanks Mr. Stewart. We’ll keep a look out on the “C” part of the story
from our post here in Taiwan. Stay tuned.
Next up, Mr.
Stephens with some thoughts from Virginia.
“The worry that the government might try and confiscate gold is silly,
at least in this country. The only metal that the government will get if
they try to confiscate my gold is copper covered lead in 150 grains JHP.
That's Jacketed Hollow Point. I think that there are many others who
feel this way also.
“As an aside, I have discussed moving back to the Farm in Michigan and
leaving paradise in Virginia so that I might sell asparagus at the
farmers market for .25/lb in 1964 or older quarters.
“Keep up the excellent, excellent input – P.C. Stephens”
Thanks for your opinion, Mr. Stephens. We touched on the matter of guns
and gold in a recent Rude column. Now…what was it titled again? Ah yes,
check that one out here, filed under
Guns and Gold.
And finally,
this came in from Rude reader Rob Z:
“I read with interest Chris Mayer’s article on the ‘Visible
Hand’ of CO2 regulation. I’ve been wondering what he might think
about the prospects of geothermal heat pump technology as a more
efficient alternative to traditional building heating & cooling systems.
“This seems like a something that could be embraced by both government
and the private sector, as it is relatively easy to gain significant
energy savings with existing technologies, and pay for itself in a
fairly short time frame. Yet I’ve heard almost nothing about it in
current discussions of energy policy.
“BTW, I have no stake in this, I’m just curious about the investment
potential.”
Thanks Rob. We’ve actually covered geothermal energy to some extent in
these pages, mostly through our go-to energy guy, Byron King. Here’s one
of Mr. King’s columns of yore for your consideration:
Hot and Steamy.
Mr. Chris Mayer, meanwhile, is up next with today’s column, below...
---- Byron
King’s Breaking Gold Report: 448 Copies Left ----
All those people who laughed at you when you talked up gold…
Wouldn't you love to throw it back in their face starting this month?
Now's your chance. You're looking at the golden opportunity of a
generation
One simple move could mean the biggest and best opportunity to get rich
this century
I explain this ten-minute step in a special report available NOW. But
you must act soon — only 448 copies remain…Grab
Yours Here
-----------------------------------------
Sell the Banks,
Buy Oil Stocks
By Chris Mayer
It seems Mr. Market believes the financial crisis is behind us, as the
financial sector has more than doubled since its March lows. I think Mr.
Market is a victim of what investor Bruce Berkowitz has called
“premature accumulation.” Compared with bank stocks, there is another
group of stocks with a much more compelling story to tell. We’ll get to
them below.
Though it may be hard to imagine a return to those March lows for bank
stocks, this credit crisis is, in the words of James Grant, “the story
of unimagined things.” First, consider that bank failures are sure to
rise.
As Grant pointed out in his newsletter, Grant’s Interest Rate Observer,
36 banks have failed this year, at a cost to the FDIC of $10.6 billion.
If that pace should continue, we’ll have 179 failed banks, the most
since 1992. That seems reasonable, especially as this crisis is much
bigger than the blip of the early 1990s.
In dollars, the costs to the FDIC would top $27 billion, the most since
at least 1990. The FDIC, too, is low on funds and will need refueling.
Such funds come out of the hide of the banks covered by the FDIC. And so
amid bank failures, the banks still standing have the prospect of higher
FDIC assessments hanging over their profit- and-loss statements.
What these might be is anybody’s guess, but as Grant points out,
delinquencies are on the rise and more losses are coming. In the first
quarter, credit card delinquencies shot up nearly 15% from the fourth
quarter. For commercial loans, delinquencies were up 21%. This latter
category of loans is bigger than subprime. Credit card debt is only
slightly behind subprime. So both categories have the potential to spell
new (and large) disasters for banks.
Somehow, the banks have to stay on a high wire in these high winds with
no safety net beneath them. Banks have very little equity, typically
only 5% or so of assets. That means a 5% drop in asset values wipes out
the equity and makes the bank insolvent. In short, the banks still have
too much leverage and can’t absorb losses...at least not without help.
And there is the rub. The banks count on the U.S. government providing
the safety net. The government has been active in propping up banks and
filling whatever holes need filling. In doing this, it has been carefree
with the value of its top brand, the U.S. dollar.
That leads many of the old market sages to bet against the dollar and to
predict high levels of inflation. Julian Robertson is one of them. You
may not remember Robertson, who most investors thought of when they
heard the name “Tiger” before Tiger Woods came along.
“Tiger” Robertson ran a successful hedge fund for 20 years, got rich and
quit in 2000 after taking heavy losses. He pooh-poohed the tech craze
and took a beating in some other risky bets and called it a day. Despite
heavy losses in the end, Robertson’s long-term track record was
exceptional. He delivered 25% annual returns for over 20 years.
In retrospect, closing his fund in 2000 was well timed, because the
markets suffered a beating over the next two years. Today, Robertson
manages his own money, winters in New Zealand, plays golf and gets
involved in a variety of philanthropic activities.
In a recent interview in Value Investor Insight, Julian Robertson, 77
years old, gave his views on the market today. He is not expecting nice
things. He predicts “unbelievably high inflation.” Remember those
interest rates of 20% in the early 1980s? Tiger said, “I can envision
that seeming like a very low interest rate compared to what might occur
in the future.”
Asked if he would own stocks in such a scenario, Robertson replied:
“Equities are certainly better than cash. In particular, I’d expect the
best things to buy to be natural resources stocks.” Robertson, in
particular, loves energy stocks.
I have to say I agree with him. As he points out, you don’t have to make
any guesses about energy prices. Just based on present-day cash flows,
the names look attractive and give you all the upside that comes from
higher prices -- be they inflationary prices or supply-
and-demand-driven prices.
I’d also point out that natural gas in particular sure looks cheap. Over
the weekend, I was reading over some recent research from Matt Simmons,
the famed energy analyst. He points out how we are running out of the
sweet, dry gas and how more and more supply comes from unconventional
sources. These sources have huge decline rates. As he puts it:
“Deep-water gas declines fast. Conventional declines fast. Tight rocks
[or shale gas] decline super fast.”
People focus a lot on the sluggish demand, but the drop-off in supply is
going to be a bigger issue. The industry has to run pretty hard to keep
the gas flowing. He also produces a number of charts that show how
drilling-intensive these basins are. These production declines occur
even in the face of increased drilling of wells.
In other words, it’s a pretty quick treadmill. As Simmons says,
“Americans can only rely on unconventional gas plays to keep supply flat
if…
• Rigs, pumping service trucks, vacuum trucks, etc. were limitless...
• Water remains “free”...
• Gas prices stay high...
Well, that last one is certainly not true now. It’s a bit of a debate
just how profitable shale gas is and what the true costs to produce it
are. There was a good piece by Ben Dell at Bernstein Research earlier
this year about this topic. He dug into the economics of the Haynesville
Shale and found they were less compelling than some operators were
letting on, where some were claiming 100% rates of return at $7.50 gas.
He concluded that “The overall economics are marginal around $6/mcf and
attractive only from $8/mcf up. This is in line with much of the U.S.
base and suggests that the longer prices remain at circa $4/mcf, the
bigger the correction will be when the drop in rig count works its way
through.”
In other words, this confirms what Simmons is saying. We’ll need natural
gas prices a lot higher than today’s circa $4 gas to keep production
flat. Something around $6-8 seems a more reasonable long- term price for
natural gas.
Again, that assumes we don’t get the rampant inflation we’re likely to
see. When we get that -- and I do think it is only a matter of when --
even $8 natgas will be too cheap.
That’s one reason to favor natural resource stocks. You can make a
compelling case for them as is. And that case only looks stronger
against a backdrop of ever cheapening money as the banks continue to
bleed and the government prints more.
My favorite natural gas producer is still Contango Oil & Gas (MCF:amex).
I wouldn’t hesitate to recommend another name at the right price. I’ve
got several new resource ideas in the mix and look forward to writing to
you soon about what I find. Stay tuned…
Joel’s Note:
Usually there’s a $995 per year barrier between non- subscribers and the
specific information Chris provides readers of his Mayer’s Special
Situations research service. But not right now... well, not for
executive series readers, anyway.
We’ve managed to convince our publishers to allow Executive Series
readers a one-month trial of Mayer’s Special Situations, including all
the bells and whistles that goes along with a regular subscription...for
just $1.
Basically it’s a risk-free way you can “test drive” one of our best
performing investment services. $1...one-month. Simple.
Interested parties can proceed DIRECTLY to the order form page
right here.
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[Rude Endnote:
Asian and European markets dipped and ducked overnight as separate
measures across the continents digested their own data dispatches.
Here in Asia (well, call it Australasia), the Aussie All Ordinaries
faired among the better performers today. The markets Down Under bounced
1.6% after missing the “official” definition of recession by a whopping
0.4%. Phew! The Aussie dollar rallied too, making your editor’s trip
home later this year that little bit more expensive.
Elsewhere in the region, Hong Kong’s Hang Seng resumed its upward trend
after a brief profit-taking break yesterday. The island’s index added
another 1% while Japan’s Nikkei 225 managed a 0.4% gain.
Over in Europe things weren’t looking so celebratory last we checked.
London’s FTSE was off almost 2% a few minutes ago while measures in
Germany and France were down more than 1% and 0.5% respectively.
The weaker U.S. dollar, which fell to its lowest level against the euro
for the year this week, is still supporting higher commodity prices.
Gold was up a smidge overnight and this morning fetches you 982 of those
green dollar bills. Similarly, over in the crude pits, a barrel of oil
still hovers around the $68 mark.
Finally today, we’re running a free webinar this afternoon. In it,
resident commodity analyst, Alan Knuckman shares a limited risk strategy
to make average gains of 71% over the next three weeks as the bond
bubble bursts. This has been a pretty hot topic recently, as you’re
surely aware.
The webinar is pretty easy to view too (even your technologically inept
editor managed to get the last one wired). Just add your address to the
mailing list
right here
and we’ll send viewing instructions momentarily. Easy.
Aside from that, we’ll be back tomorrow with more Rude musings.
Until then...
Cheers,
Joel Bowman
The Rude Awakening
aussiejoel@the-rude-awakening.com |
