Oil and Natural Gas Crushed Again


Today market sold off more broadly as the Fed’s July meetings were released (15 minutes early ooops) and it is a mixed message – go figure. 

On the one hand they say we are getting closer to the conditions needed to raise rates, which supports my thesis that they are looking for a reason to get off the zero bound in September.

On the other hand they say we need stronger employment and higher inflation, which supports the idea that there will be no rate increase in September and maybe not in 2015.

On top of all this, folks are finally seeing what I’ve been saying about China, which is they are in trouble. China needs to write down a lot of real estate, give it to folks to get them into the ghost cities and start building domestic infrastructure. When they do that, it’ll crush some real estate firms and banks, but so what, they’ll just devalue the Yuan or something. Seriously, China’s stock market correction hasn’t gone full circle yet. It will. 

China’s real impact on commodities is apparent. Copper is getting crushed. According to Glencore it won’t turn around until China starts building again. I have to think that’s going to happen by spring. Until then, copper could be rough. We’ll see how that affects one of the companies on my list of favorites. I suspect we get to buy it soon and then will just have to wait for the calendar to make us money.

Oil and natural gas got crushed today as the title says. The slaughter is a classic sell on short-term pain by over-emotional investors who turn into bad traders when volatility sets in. 

At some point oil and gas turns hard to the upside. I already have money pouring in from millionaire investors who have been sitting heavy in cash for months and in some cases well over a year. They know that whatever is happening in energy is overdone. They don’t care that they might have to wait a bit to make money. They just know that in a few years they’ll probably have crushed the market by accumulating energy. 

Why do they think that? It’s simple math. The conventional wells on the planet deplete at a rate of 3-4% per year. The current surplus is about 3-4%. Capex on new wells is drying up. In fact, production growth finally turned over. Pretty soon there will be no production growth. Once that occurs, which could be as soon as Q1 2016, we’ll see oil and gas prices start to rebound. Saudi Arabia knows this. How? Because the highest cost producers are shutting down. 

Who are the highest cost producers? Well, it’s not the U.S. frackers that many think the Saudis are attacking. It’s the deep sea drillers. They need oil about $100 to be economic. Many frackers can make money with oil prices in the $50s and $60s.

Besides being in the middle for cost, the frackers have an advantage others don’t. They are fast. They can reactivate oil production within 30 to 60 days. They also can re-frack now. That is, they can go to a well, do new explosions at different settings and get a new flood of oil, sometimes almost as good as the original blasts. 

So, the Saudis in my opinion are in my opinion almost ready to help with the bringing oil prices back up to the $70s. While many don’t think that’s exciting, they’re wrong. The U.S. drillers still standing and with the best rock will come out of this hot. When? I think sometime next year already. That’s why I’m using this downturn to accumulate oil and primarily natural gas stocks. If you don’t know why natural gas, read my MarketWatch article: 4 Reasons for a Boom in Natural Gas Stocks.

So, with all this volatility creating value opportunities, I want everybody to remember this from Warren Buffett’s 2005 letter:

“I consider there to be three basic ideas, ideas that if they are really ground into your intellectual framework, I don’t see how you could help but do reasonably well in stocks. None of them are complicated. None of them take mathematical talent or anything of the sort. [Graham] said you should look at stocks as small pieces of the business. Look at [market] fluctuations as your friend rather than your enemy—profit from folly rather than participate in it. And in [the last chapter of The Intelligent Investor], he said the three most important words of investing: “margin of safety.” I think those ideas, 100 years from now, will still be regarded as the three cornerstones of sound investing.” 

Even though we have a good quantitative analyst on board, just remember, in the end, value wins. It always has, it always will. So, although I don’t know where the bottom is, I do know there’s more to buy, not sell, every time Mr. Market makes stocks cheaper. Have the courage to buy a tiny bit at a time every few percent down and to buy a lot when the selling dries up. If you are stuck in a bad asset allocation, for example owning a lot of utilities, take this as an opportunity to rotate into beaten up long-term winners.

Kirk