Harry Newton's In Search of The Perfect Investment
Technology Investor. Auction Rate Securities. Auction Rate Preferreds.
8:30 AM EST Tuesday, July 29, 2008: Cash
remains king. Even in energy. Mr. Jim Kingsdale, energy czar and respected author
Investment Strategies writes:
The EIS portfolio
is now substantially out of the stock market and in cash. What sort of an
energy investment strategy is cash? Its the strategy you might want
to employ when you judge that
1. All stocks
are likely to decline, taking energy stocks down with them, or
2. Oil and/or
gas have become short term overpriced and are likely to correct , or
3. Energy stocks
have run so far that theyve become severely overpriced.
to judge that #1 above -- the risk of a general market crash taking down all
stocks -- is becoming too great to ignore. I judge #2 - overpriced energy
commodities - is a realistic risk for natural gas and a possible risk for
oil. And if the commodities do decline significantly over the next 6 - 12
months along with the bulk of stocks, I think that energy equities that look
cheap now would likely become even cheaper.
why Ive reluctantly come to believe the above is true:
Over the past
few years energy stocks have seen some severe pullbacks, but only during the
roughly 50% oil price retracement from $78 in August 06 to $49 in January
07 was there a sustained loss of value for energy stocks. Other sharp
corrections reversed quickly. The past couple of weeks have been brutal for
energy stocks and have seen only modest dead-cat bounces to assuage
of energy stocks over the past two weeks is like the post-August 2006 period,
suggesting that the oil price may have a good deal further to fall. A 50%
oil price retracement of the gain from $49 to $147, similar in size to the
one in 2006 would bring the price to just under $100. If you assume that the
SemGroup bankruptcy artificially took oil from about $130 to $147 and that
the real top was about $130, then a 50% retracement would bring the oil price
to about $90. Natural gas, which actually gained more than oil in 2008 until
recently faces increasing North American supplies so has less fundamental
support than oil.
The recent decline
in oil stocks seems unjustified on fundamentals. While the oil price did fall
over $20 from $147, which is not nothing, analysts earning estimates
for E&Ps for example are based on conservative oil price estimates
in the $80 - $100 range, well below todays price of over $120. The largest
drilling company, Transocean (RIG) is estimated to earn over $14 this year
and $17 next, with further gains extremely visible based on long term contracts.
Does that make its $135 share price too high? A bubble? Clearly not. So the
substantial declines in energy stocks seem to be anticipating further significant
reductions in oil and gas prices and perhaps further weakening of the global
economy, not any speculative pricing based on current fundamentals.
If recent weeks
energy stock losses were simply a severe correction only in energy stocks,
this might well be a buying opportunity for the group. But such is not the
case. Rather, this energy correction comes in the context of a general market
decline that has been eating away at portfolio values almost continuously
since August of 2007 . The combination of dramatic losses in energy stocks,
very weak recoveries by them, and the continuing slide in the general market
suggests to me a deeper significance than just an ordinary correction in energy
stocks. In short, I think the market may be signaling that there is an
increasing risk that economic weakness may be spreading geographically and
demographically threatening much more serious losses ahead.
Here are some
of the factors that concern me about the American economy:
are still spending despite being squeezed by stagnant wages, higher unemployment,
higher food and energy prices, tight credit markets, increasing home foreclosures
and, most important, lower home prices. It would not be surprising if we see
these factors finally result in much lower consumer spending over the next
6 - 12 months.
2. Banks are
starting to look shaky. I read just today of the closing of two small banks.
We saw the first run on a bank recently as IndyMac went under
and the TV carried images of people waiting in line to withdraw funds. Also,
I understand that IndyMacs bankruptcy used up 25% of the funding capacity
of the FDIC. A need to shore up the FDIC would put further stress on the banking
system which funds it. There has been some talk recently about making sure
your bank deposits are safe and that you have no more than the $100,000 FDIC
guarantee limit in any one account.
This whole concept
of the safety of American banks has not been discussed seriously since the
Depression. My feeling is that the American banking system may be a bit closer
to widespread public fear than one might think. I sense that the Treasury
is very aware of this risk and that its recent rapid Fanny/Freddie actions
-- anathema to standard Republican philosophy -- are a symptom that the Treasury
is concerned about containing this potential threat to the public trust.
3. Car sales,
which normally decline in a weak economy, are getting a triple whammy from
two other sources of weakness: higher oil prices that have crippled the market
for high profit larger vehicles and the less noticed depressant of an imminent
sea-change in technology as the highly publicized plug-in hybrid electrics
(PHEVs) are scheduled to come to market in 2010. I suspect a lot of
people will put off replacing their cars until they can buy these new-technology,
more efficient models, a factor that will reduce car sales even more than
during a normal recession. Note that Chrysler will no longer lease you a car
-- the company doesnt want them back in a few years.
Given the lower
car sales and the shift to lower profit small cars, it seems to me that all
three American car companies must be seen as potential if not likely bankruptcy
candidates over the next 24 months. If even one of them goes under, not to
say all three, the effect on consumer psychology would be a further market
4. Both the
financial system and sales of consumer durables is dependent on housing. Note
that as house prices decline, more and more houses become worth less than
the mortgage on them. Self interest by the owner suggests a default
on the mortgage when that happens. That is why declining house prices is like
stepping on the accelerator of the mortgage default problem in America.
of housing continues to decline every month and is projected to keep on this
track for many more months. Respected commentators suggest we are perhaps
only half way through the decline in home prices. I think this bursting housing
bubble is the most important driver for all other economic risk factors. When
housing bottoms I think we can start to make progress toward a stabilized
and then a stronger economy. But that looks like it might be a 2009 phenomenon
at the earliest.
5. The $64
question is whether an American recession (dare we say depression?)will
be a one-off event or whether it will reverberate to the global economy. Clearly
it is morphing to a number of OECD countries now. Also clear is the fact that
global strength now comes from the growth of the developing economies, particularly
China. Can China keep pulling the world economy ahead?
government wants to see growth continue. Just today it signaled a move to
loosen credit standards and stop trying to increase the value of the Yuan.
We tend to think that whatever the Chinese government wants it can ultimately
But I must note
one concern. China seems to be bumping up against both environmental and energy
limits to growth. We all know how filthy and polluted the Chinese air and
water are reputed to have become. At some point that will tend to limit growth.
But a more immediate concern is their lack of coal and the related lack of
electrical generating capacity. Electrical shortages are becoming acute, not
only in China but also in other developing countries. It is hard to grow an
economy without growing electrical output.
The second factor
- beyond general economic conditions - that an energy investor must consider
is the shape of the markets for oil and gas going forward. If the price of
oil and gas goes up from here, that would be a substantial support for energy
stocks - although it would further harm the general economy.
I have no doubt,
as readers of my site know well, that starting in 2010 and especially after
2012, oil supplies will become substantially constrained. But the period from
now through 2010 is much less clear. Ive often said that if Iraq and
Nigeria were to start producing up to capacity, there would be a much lower
oil price. Well, Iraq has begun to do that.
to Iraq the next 18 months will see significant expansions in capacity from
Saudi Arabia, Libya, and Angola. A recent Wikipedia megaprojects analysis
shows comfortable supplies in 2008 through 2010. I do not take such projects
as gospel, of course. But all the work Ive done indicates to me that
looking forward ten years at the supply of oil, the only years that have a
likely chance to be easy are 2008 and 2009.
factor in the near term oil supply is simply the fact that the oil price has
gone so high and has now been notably high for several years.
As commodity experts say, the cure for high prices is high prices.
It would not surprise me to see some of that impact over the next 18 months
as more rigs and better technologies finally succeed in getting more oil out
of older fields than previously.
Of course, there
are the well known negatives for the oil supply: the global decline rate of
about 3.5 mb/d per year, Mexico, the North Sea, and Nigeria. And now with
TNK-BP starting to look like Yukos, which could result in some production
declines from this 1.5 mb/d producer, near term Russian oil production is
also looking more questionable.
I think it is clear that we are in a long term bull market for the price of
oil. But I think it is equally clear that the market has over-shot due to
various speculative influences, not the least of which may have been increased
hoarding. As the oil price declines, some national oil companies may become
more enthusiastic about selling their oil before the price declines further.
Venezuela comes to mind, for example. Such a potential reversal of the trend
toward hoarding could push the price of oil even below the long term uptrend
line, getting it back to perhaps $75.
At some point,
if the oil price declines, the forces of OPEC may try to discipline the seller.
Whether OPEC still has that capacity or not is unclear. It might be left to
the Saudis to do by themselves. But if a global economic slowdown is raging
I think the King, who owes his security ultimately to the U.S., might be quite
reluctant to make things worse by cutting off oil supplies.
All of the above
is intended to demonstrate how an apparently low-probability scenario could
come about. Specifically, how in the world could Transocean (RIG) be anything
but a screaming buy today at $135 a share? This is a company growing at healthy
double digit rates as far as they eye can see and selling for under 10 times
current year earnings (not to mention even healthier cash flow).
And the answer
is: visualize oil at $75 and the global economy going into the pooper. Financial
panics. Personal tragedies. Lower global oil demand than the year before.
That could get RIG closer to $100.
I well remember
that in 1974 -- a year of huge stress in the stock market - a cable television
company called Viacom got down to $2 a share. Its future prospects had not
changed; they were still shining bright in the eyes of every analyst who understood
the dynamics of the cable world. And yet you could buy the stock for $2. If
you had any money.
2008 I decided to step aside from the stock market because the
credit crisis was looking more serious. In March I decided - prematurely,
I now believe - that our government was doing what was needed to resolve the
credit problems and the all clear signal could be activated.
I do not like
this market timing stuff at all. In fact I hate it. And I could well be wrong
in the call I am making. If so, the EIS portfolio will lose some profit opportunities
and will under-perform. But it wont lose real money because of the decision.
And if I am right, it will have more funds to buy more Transocean at $100
next year, the equivalent of Viacom at $2 in 1974.
is selling off its bits and pieces. It bought
Xdrive, an on-line storage company, for a rumored $30 million. Now it's selling
it for $5 million. For more on AOL's dumbness, go to
I doubt anyone will buy Xdrive. It is charging
more for one year's storage than you can buy an external USB hard drive.
is actually going well. President Maliki said he can handle it from
here on and please remove our troops. The ultimate irony is that Bush's strategy,
now succeeding, will usher in Obama as president. Meantime, an American solider
has written a beautiful song called, "If
I die before you wake." Please listen to it and tell your friends.
His images accompanying the song are gorgeous.
blows away the zeros. With inflation running
at a couple of million per cent a year,
Zimbabwe's central bank has produced a a100 billion dollar banknote. The notes
are selling for $US 80 on eBay. In Zimbabwe you can buy a loaf of bread with
the new note, if you can find a loaf of bread..
son, the genius, is an idiot: "Don't chain the bike outside
your office, it will get stolen," I warn. It gets stolen. The next
day he takes my second bike with a new $140 chain. "Don't chain
the bike outside your office, it will get stolen," I warn. "No
it won't," he says, "We have strong chain." That day,
the seat got stolen.
He replaces the
seat and attaches a chain from the seat to the bike, and takes my bike
to work today. I'm betting they'll get the wheels.
Meantime, one man decides to test if anyone in New York cares about bicycles
being stolen in front of their eyes. He steals his own bicycle three times.
For the funny sad video,
it will do 60, maybe. Two points are noteworthy
about my latest impulse purchase. First, a classic Vespa-S retails for $4,199+,
while Harry's technically-identical 150 cc China-made ZN150T-E retails for only
$1695. I bought the last one they had. Imagine a car dealer's yard with none
left. Yup, you got it. What with high gas prices, there's a boom on scooters.
The things get over 70 miles to a gallon, cost next-to-nothing to register,
requires service once a year.
classic Vespa-S -- $4,199+
Taizhou Zhongneng ZN150T-E -- $1695
the technology? Pretty damned impressive. Disc brakes front and back. Electric
start. Fully automatic transmission. Lots of storage. In a pinch, maybe 60.
But most impressive.. Drumroll ... is the insurance.
Even better, the
family is genuinely excited about its new scooter. They all want to ride it
Don't Know Everything
He'd been playing outside with the other kids for a while.
When he came into
the house and asked her, 'Grandma, what's that thing called when two people
sleep in the same room and one is on top of the other?'
She was a little
taken aback, but she decided to just tell him the truth. 'It's called sexual
Little Tony just
said, 'Oh, OK,' and went back outside to play with the other kids.
A few minutes
later he came back in and said angrily, 'Grandma, it isn't called sexual intercourse.
It's called Bunk Beds. Jimmy's mom wants to talk to you.'
A good Hasidic family is most concerned that their 30 year old son
So, they call
a marriage broker and ask him to find their son a good wife.
The broker comes
over to their house and asks what they want in a wife/daughter-in-law. They
give him a long shopping list of requirements.
The marriage broker
returns six months later. He tells them of a wonderful woman he has found. He
says she's just the right age for the son, she keeps a Glatt Kosher home, she
regularly attends synagogue and knows the prayers by heart...she is a wonderful
cook, she loves children and wants a large family. And, to crown it all off,
all this, the family is very impressed and begins to get excited about the prospects
of a wedding in the near future.
But the son pauses
and asks inappropriately: 'Is she also good in bed?'
The marriage broker
answers, 'Some say yes... Some say no.'
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
is . You can't
click on my email address. You have to re-type it . This protects me from software
scanning the Internet for email addresses to spam. I have no role in choosing
the Google ads on this site. Thus I cannot endorse, though some look interesting.
If you click on a link, Google may send me money. Please note I'm not suggesting
you do. That money, if there is any, may help pay Michael's business school
tuition. Read more about Google AdSense, click
here and here.