The EIS portfolio is now substantially out of the stock market and in cash.
What sort of an energy investment strategy is cash? It’s 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 they’ve become severely overpriced.
I’ve come 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.
Here’s why I’ve 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 the
pain.
This action 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&P’s for example are based on conservative oil price
estimates in the $80 - $100 range, well below today’s 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:
1. Consumers 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.
