Health is Wealth - Real Vision
06 / October / 2017
Health is Wealth
GLOBAL ADVERTISING & TECH: FROM DISRUPTION TO DOMINANCE
Source: Visual Capitalist
• • • •
The disruptors have become the dominators. The total dominance of Google and Facebook in the global advertising market has reached extreme proportions: These two companies account for 20% of total global advertising. Facebook has seen an enormous rise in its advertising revenue. The major media networks of old – Bertelsmann, Viacom, TimeWarner, and CBS – have fallen by the wayside.
Buy Volatility
Say The Credit Strategist and Hedge Fund Telemetry
Tommy Thornton of Hedge Fund Telemetry has an exhaustion countdown 13 on the VIX Index as of Tuesday, October 3. This indicator shows a trend exhaustion in the downward path of the VIX. The last one saw a 54% spike in the index within days – sometimes it takes time for vol to explode, but it’s an exponential measure, so it spikes hard. Michael Lewitt of The Credit Strategist is keen on the idea, too: (December 17, 2017) $20 VIX calls were trading at $1.00 on September 19. With the VIX trading at around 10 that day (heck every day!), buying those calls offered cheap insurance against a rise in volatility for anyone willing to bet that markets will act like markets between now and the end of the year, so I bought some. If nothing else it’s a contrarian bet with current positioning and levels. Volatility can’t go to zero, right?
I have picked only the most compelling and highest conviction trade ideas of our RVP Contributors and will track them in a portfolio for you to follow.
No new Portfolio Picks this week.
Note: This is not investment advice. You understand that no content published as part of the services constitutes a recommendation or a statement that any particular investment, security, portfolio of securities, transaction, or investment strategy is suitable for any specific person
POOR HEALTH SAPS WEALTH THE COST CONUNDRUM
One of the biggest issues for the American consumer has been the astronomical increase in healthcare and health insurance costs in recent years. Consumption trends have been depressed by a lack of disposable income growth as health costs put the squeeze on household wealth: Since the ACA went into effect, all health-related costs have soared. In the past 4 years, total outlays for these services and commodities have increased over ½ trillion dollars ($540bn) to a record high of $2.78 trillion. Imagine had this been $540bn in retail sales instead. – Meridian Macro Research Eric Pomboy of Meridian Macro produced a great deep dive piece on the impacts of spiralling healthcare costs, which now stand at 15% of GDP:
PCE: Health Care + Pharmaceuticals & other medical Products ($bln, saar)
Source: Meridian Macro Research
Healthcare is essential, and no matter what, people will make it their number one spending priority; because we all know if you don’t have your health, everything else becomes extremely difficult. This means discretionary spending goes out the window when you see premiums rising. Then there is less money to spend on food, clothes, and even housing. You know that Canadian housing bubble that looks so absurd against US home prices? Well, it seems that Canadians have more to spend at the end of the month, meaning that basic affordability is roughly equal:
Real Estate to Disposable Income Ratio
Source: Highcharts.com
A crucial issue The importance of healthcare was not lost on Michael Lewitt in his latest Credit Strategist take on the US economy and markets: When you look at state pension and healthcare deficits and then look at the federal deficit hitting $20 trillion, it is clear that opponents of Obamacare repeal and replace and proponents of single payer healthcare and the redistributionist agenda that all of this represents will push America into insolvency even faster than the rest of our economic policies are doing if they have their way. With such challenging demographic headwinds, a huge debt load, and struggling consumers, the last nail in the coffin for the economy is that the healthcare sector is swallowing all the surplus gains. Michael has some pretty forthright advice on the matter for Congress:
There are three things that Congress should do immediately to start fixing America’s healthcare system: adopt malpractice reform, allow Medicaid and Medicare to negotiate drug prices with pharmaceutical companies, and allow health insurance to be sold across state lines. Congress will never do these things, however, because it is a corrupt institution bought and paid for by campaign donations from trial lawyers, pharmaceutical companies and health insurance companies. The light at the end of the tunnel? Let’s try thinking differently on this point. The US has the highest healthcare costs in the world, far in excess of those incurred by any other OECD nation: US Healthcare Costs (Blue) vs OECD (inc Canada; Red)
Source: OECD
Those high costs are a function of nothing other than poor competition and monopolistic protection. The potential for the US system to cut costs is huge: If the average US cost per capita is $10k and Western
Europe and Canada are more like $5k, then even cuts to the Swiss level of $8k could deal a serious dividend to the American consumer! The sticking point Healthcare is obviously highly politicised – will they repeal Obamacare? Won’t they? Keep an eye on the politics. When problems feel most intractable, people become most desperate – ‘It’s always darkest before dawn’, as the saying goes. If we start to see a real shift in this space, where should investors focus?
Retail One of the most hated and beleaguered sectors of the economy has been retail. The popular narrative is that ‘bricks and mortar’ is over – now we have the Amazon effect. Sure, sales are moving online, and Amazon is stealing market share, but the mass culling of retailers like Sears is also a function of a cyclical and structural decline in disposable income. Businesses don’t go bust when there is enough to go around; they go bust when they get squeezed. Retailers have notoriously high operating leverage, meaning that even a slight drop in revenue can make a profitable store swing to a loss maker.
SPDR Retail vs SPDR Healthcare and S&P 500 – Five Years’ Performance
SPDR Retail (XRT) +31% (Blue), S&P +73% (Yellow) and Healthcare (IHF) +114% (Red) Source: Tradingview.com
Retail has been such a huge laggard that any shakeup of the healthcare industry or tax code that delivers real disposable income gains could provide a major boost to the sector, which the market would likely reprice rapidly. No area of the economy can capture the lion’s share of the value forever – it is becoming too politically unpopular to see all the surplus gains generated by the economy delivered to the bloated healthcare industry.
What to avoid? Health insurance stocks. Health insurance is really a misnomer. You might take out car insurance and never collect on the policy because you can go a lifetime without an accident. Illness, on the other hand, is an inevitable fact of life – and one that becomes more inevitable the older we get. Insuring a growing number of retirees is a bad dynamic for these companies as rising premiums push more people out of the insured system, leaving the industry ex-growth with a growing claims base. Not a nice place to be.
Health insurance is fundamentally a huge short volatility strategy – you can only underwrite the inevitable losses if your premium float can generate decent investment returns in the meantime. As I examined in The Hack last week on European bonds – travel down the risk curve in search of yield is racking up some serious risks for the insurance industry.
OIL: THE SECOND COMING?
WEIGHING THE EVIDENCE
Oil has been in a multi-year bear market since 2014, driven in no small part by the rise of the dollar during that period. As the chart of the week in last week’s Hack highlighted, the correlation is compelling. A weak dollar can drive up demand for oil by making it more affordable in other countries and in particular in Asia, where demand is high. I have been a bear on oil because of the lack of real demand growth and the ongoing elastic supply of US shale to counter any OPEC cuts. However, with the falling dollar and a potential inflationary spike from China (“The Hack – “When the Dollar Goes Macro“), it is worth examining whether the facts have changed – and whether I need to change my mind. Is oil useless? Watching Jim Rogers’ recent RV TV interview got me thinking about oil and the long-term demand picture. With the rise of electric vehicles and renewable energy, is oil going to become increasingly useless and therefore valueless? Jim Rogers had some thoughts: JR: Oil is in the process of making a complicated bottom, if you ask me. Whether the bottom is at next year at 36 or – I have no idea. I’m very bad at that… The known reserves of oil are in decline. SD: You don’t subscribe to this view, which some of our futurists do, that it’s going to go the way of whale oil? It’s going to become obsolete – JR: May well. SD: – and be useless and valueless?
JR: May well. But that’s not going to happen in my lifetime. It may well happen. But there was a lot of money made in whale oil before it all disappeared. So these things don't happen overnight. Whale oil Whale oil was once a prized commodity that nearly drove whales to extinction in the 18th and 19th centuries. The most prized oil was used for lighting and came from the head of the sperm whale – it burned most cleanly in the lamps of the day. The discovery of ‘rock oil’ in America in the 1850s gave rise to a new supply of clean-burning fuel, making whale oil obsolete. Rock oil was abundant and much easier to find and extract than whale oil was, and therefore much cheaper to produce. Oil from the sperm whale had for hundreds of years set the standard for high-quality illumination; but even as demand was growing, the whale schools of the Atlantic had been decimated…. For the whalers, it was a golden age, as prices were rising, but it was not the golden age for their consumers, who did not want to pay $2.50 a gallon – a price that seemed sure to go even higher. – Daniel Yergin, The Prize What killed the whale oil market was not that the oil fell out of favor – in fact, it was the popularity of oil as fuel that gave rise to the demand for rock oil. High prices for whale oil led people to substitute cheaper rock oil, and as the nascent oil industry grew into the massive global supply chain we see today, the need for whale oil fell away. High-price substitution It was the high price of oil in the 2008 spike and the ensuing 2009–2014 period that sowed the seeds of the current oil bear market. Large-scale solar and wind power projects – helped by a decent amount of government subsidy – are now able to compete on an even footing with oil and gas. Could the price spikes of recent years have spelled the end for oil? Nothing goes down in a straight line. Whilst the long-term future of oil demand growth looks to be weakening (see “Peak Oil Coming to a Place Near You” – The Hack), in the short run there is potential for a global inflation spike from China (“When the Dollar Goes Macro” – The Hack). Oil prices are half what they were in the last Chinese boom following the GFC, and a declining dollar could set up the conditions for higher short-term demand from Asia in particular:
Global oil demand growth (year on year m barrels per day)
Source: IEA, FT.com
China is the largest growth market for oil in the world, and it now imports more crude oil than the US does, making it the swing consumer on global markets. If the Chinese are overstimulating, this could explain the recent rally in crude. This could be breaking the perfect symmetry that Nautilus was looking for back in July:
Source: Nautilus
With the breakout above $52 in September, this mirrored pattern looks to have been breached. What kills a market ‘There is no cure for high prices like high prices’ – so goes the old saying. Indeed, those high oil prices of the past decade have set the stage for Katusa’s renewable century; but as Jim Rogers points out, known oil reserves are in decline, and we have seen a huge curtailment of investment in new exploration and production. Could we see a supply squeeze? I’m not so sure. There is such vast overcapacity in offshore rigs and shale wells that, for now, prices look to be muted by the ability of shale producers to hedge forward production. Recent price action has led to an uptick in the rig count:
Us Rig Count September 29
Source: Baker Hughes
Remember, too, that OPEC nations still have a production limit in place, keeping a lid on their own spare capacity. The dollar connection The irony of this dollar and oil discussion is that the dollar, too, has been subject to much discussion about its future irrelevance and replacement. But with the DXY in decline and loosening monetary conditions, the impetus for dollar substitution may be eroding. To break away from the dollar standard, the world would really have to see a great need to do so – dollars would have to become scarce and thus limit trade and growth. Such scarcity was part of the move away from gold-backed currencies: There wasn’t enough physical gold to back enough money to facilitate global trade. Once again, you don’t substitute for something that’s cheap. It will be an epic dollar spike that kills the dollar, not the current downtrend.
What’s the bottom line? In the short term, I still have my Portfolio Picks short oil trade, which started with oil around $48/bbl. It has been a loss to date as oil rallied into September. Still, positioning (especially Brent) for a short-term reversal appears protracted – it will be the next bottoming process that will make or break my oil call:
Brent Crude Oil: Managed Money Position
Source: Saxo Bank
I think oil stays lower for longer – price spikes look set to be met by renewed hedging by shale players. I will be keeping a keen eye on our contributors’ thoughts in the coming weeks and months to see if my short oil thesis remains valid over the medium term.
The Peril of Duration Investing for the really, really long term Where do you expect to be in a hundred years? Almost everyone reading this report will probably be dead unless a cyborg bionic future allows us to live for many more centuries – so that we may remember the distant past and maybe even learn from our mistakes. Well, if we are going to die, why not leave some assets behind for our descendants? What could stand the test of time – perhaps a 100-year bond? The long, long game In The Hack June 30th we examined Argentina’s 100-year bond: A nation that has defaulted on its debt more times than it has won the World Cup just sold $2.75bn of 100-year bonds with a yield of 7.9%. This goes to show the enormous appetite for long-duration USD bonds – note that no country in a region synonymous with defaults has ever gone 100 years without defaulting. So maybe putting away some savings into that sovereign issue isn’t such a good idea – after all, ‘leopards don’t change their spots’. But surely someone must have a cast-iron long-term investment. What you need is a nation renowned for their fiscal rectitude, a nation of strong, industrious people who will ensure that your great-grandchildren get every last coupon and the principal returned – what about Austria? The Austrian gamble The Austrian government has just sold some 2% bonds, raising EUR 3.5bn on an issue that was 3x oversubscribed. What is interesting about this issue is that the bond is due in 2117! Investors are locking in 2% a year for 100 years – this is how bad the European bond situation has become. Last week I suggested you could own an Italian subordinated bank bond for 2% a year for five years – a risky proposition! It seems sovereigns, too, can issue all kinds of questionable paper due to the ECB’s giant QE programme.
Michael Lewitt of the Credit Strategist brought this to my attention:
European fund managers submitted 65% of the orders, suggesting a serious brain drain from that business since investors are 100% guaranteed to lose money on these bonds on a real basis. Further, based on the history of Europe, it is not far-fetched to ask if Austria will even exist as a sovereign nation in 100 years. Every one basis point change in yield will move the price of this piece of paper by 43 cents or 0.43%, but who’s counting when the entire issue doesn’t even qualify as cheap toilet paper. The Faustian bargain between the ECB and money managers continues unabated in the Eurozone. Aside from the default risk, why is 2% a year for 100 years such a bad deal? Duration As Michael says, the tiniest change in yield causes huge fluctuations in the value of this bond. This is a stunning play on low rates and low volatility. Investors are essentially betting that over the next 100 years EZ interest rates will not rise above their current levels and in fact are likely to go down. Can we really expect 100 years of sub-2% Eurozone inflation and negative nominal interest rates? If ECB rates normalised to 2–4%, this bond would be worth cents on the euro of its par value, while the Austrian government would enjoy paying 2% on the EUR 3.5bn they pocketed. It’s not hard to see why issuing these bonds has become appealing to cash-strapped governments – financial repression ensures they receive a bid from yield-hungry investors. In some sense the Argentine bond is less crazy than the Austrian one, given its much higher yield of ~7% – whilst it is long-dated, it is less sensitive to underlying interest rate trends. Obviously, Argentina is paying 7% due to credit quality: Argentine credit is B-rated, and Austria is AA+. Still, at least Argentina has room for improvement in its credit metrics – Austria was downgraded from AAA by S&P in 2013. The twilight zone If this looks like madness, that’s because it is, but it shows how far down the rabbit hole central banks have taken us in their complete shift away from economic orthodoxy. Everything the last generation of investors learned about fundamentals during the ‘great moderation’ is going out the window. Expect to see more of these issues from governments in the coming years – and we will know things have gone truly crazy when a corporate tries its luck at this game!
Ding DONG – The Danes call time on oil production News that Danish oil company DONG Energy (Danish Oil and Natural Gas) is changing its name to Ørsted may seem unsurprising, but it demonstrates a key shift in European and global energy tastes. The name Ørsted is taken from a Danish scientist who pioneered in electromagnetism, and the company wants to be perceived as a green energy producer. As Marin Katusa noted in his recent RVP report on renewables, the economics of going green has become increasingly appealing, especially in the power sector. Whilst DONG CEO Henrik Poulsen talks of climate change and global ecosystems, he also states that ‘2017 will be remembered as the year when offshore wind became cheaper than black energy’. With oil prices in a lull, think how attractive this alternative energy could be if prices firmed. More tech fines in the EU: Amazon edition Just last week we looked at big tech as an emerging pariah, and now the EU enforces a EUR 250mn fine of Amazon for tax avoidance related to a deal it received in Luxembourg that the EU says amounted to state aid. Next stop, Ireland, where the commission wants EUR 13bn from Apple for back taxes! With governments desperate for cash and tech giants dominating industries, how many more investigations and fines can we expect before some regulator tries to take a major scalp? Until next time,
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Health is Wealth
GLOBAL ADVERTISING & TECH: FROM DISRUPTION TO DOMINANCE
Source: Visual Capitalist
• • • •
The disruptors have become the dominators. The total dominance of Google and Facebook in the global advertising market has reached extreme proportions: These two companies account for 20% of total global advertising. Facebook has seen an enormous rise in its advertising revenue. The major media networks of old – Bertelsmann, Viacom, TimeWarner, and CBS – have fallen by the wayside.
Buy Volatility
Say The Credit Strategist and Hedge Fund Telemetry
Tommy Thornton of Hedge Fund Telemetry has an exhaustion countdown 13 on the VIX Index as of Tuesday, October 3. This indicator shows a trend exhaustion in the downward path of the VIX. The last one saw a 54% spike in the index within days – sometimes it takes time for vol to explode, but it’s an exponential measure, so it spikes hard. Michael Lewitt of The Credit Strategist is keen on the idea, too: (December 17, 2017) $20 VIX calls were trading at $1.00 on September 19. With the VIX trading at around 10 that day (heck every day!), buying those calls offered cheap insurance against a rise in volatility for anyone willing to bet that markets will act like markets between now and the end of the year, so I bought some. If nothing else it’s a contrarian bet with current positioning and levels. Volatility can’t go to zero, right?
I have picked only the most compelling and highest conviction trade ideas of our RVP Contributors and will track them in a portfolio for you to follow.
No new Portfolio Picks this week.
Note: This is not investment advice. You understand that no content published as part of the services constitutes a recommendation or a statement that any particular investment, security, portfolio of securities, transaction, or investment strategy is suitable for any specific person
POOR HEALTH SAPS WEALTH THE COST CONUNDRUM
One of the biggest issues for the American consumer has been the astronomical increase in healthcare and health insurance costs in recent years. Consumption trends have been depressed by a lack of disposable income growth as health costs put the squeeze on household wealth: Since the ACA went into effect, all health-related costs have soared. In the past 4 years, total outlays for these services and commodities have increased over ½ trillion dollars ($540bn) to a record high of $2.78 trillion. Imagine had this been $540bn in retail sales instead. – Meridian Macro Research Eric Pomboy of Meridian Macro produced a great deep dive piece on the impacts of spiralling healthcare costs, which now stand at 15% of GDP:
PCE: Health Care + Pharmaceuticals & other medical Products ($bln, saar)
Source: Meridian Macro Research
Healthcare is essential, and no matter what, people will make it their number one spending priority; because we all know if you don’t have your health, everything else becomes extremely difficult. This means discretionary spending goes out the window when you see premiums rising. Then there is less money to spend on food, clothes, and even housing. You know that Canadian housing bubble that looks so absurd against US home prices? Well, it seems that Canadians have more to spend at the end of the month, meaning that basic affordability is roughly equal:
Real Estate to Disposable Income Ratio
Source: Highcharts.com
A crucial issue The importance of healthcare was not lost on Michael Lewitt in his latest Credit Strategist take on the US economy and markets: When you look at state pension and healthcare deficits and then look at the federal deficit hitting $20 trillion, it is clear that opponents of Obamacare repeal and replace and proponents of single payer healthcare and the redistributionist agenda that all of this represents will push America into insolvency even faster than the rest of our economic policies are doing if they have their way. With such challenging demographic headwinds, a huge debt load, and struggling consumers, the last nail in the coffin for the economy is that the healthcare sector is swallowing all the surplus gains. Michael has some pretty forthright advice on the matter for Congress:
There are three things that Congress should do immediately to start fixing America’s healthcare system: adopt malpractice reform, allow Medicaid and Medicare to negotiate drug prices with pharmaceutical companies, and allow health insurance to be sold across state lines. Congress will never do these things, however, because it is a corrupt institution bought and paid for by campaign donations from trial lawyers, pharmaceutical companies and health insurance companies. The light at the end of the tunnel? Let’s try thinking differently on this point. The US has the highest healthcare costs in the world, far in excess of those incurred by any other OECD nation: US Healthcare Costs (Blue) vs OECD (inc Canada; Red)
Source: OECD
Those high costs are a function of nothing other than poor competition and monopolistic protection. The potential for the US system to cut costs is huge: If the average US cost per capita is $10k and Western
Europe and Canada are more like $5k, then even cuts to the Swiss level of $8k could deal a serious dividend to the American consumer! The sticking point Healthcare is obviously highly politicised – will they repeal Obamacare? Won’t they? Keep an eye on the politics. When problems feel most intractable, people become most desperate – ‘It’s always darkest before dawn’, as the saying goes. If we start to see a real shift in this space, where should investors focus?
Retail One of the most hated and beleaguered sectors of the economy has been retail. The popular narrative is that ‘bricks and mortar’ is over – now we have the Amazon effect. Sure, sales are moving online, and Amazon is stealing market share, but the mass culling of retailers like Sears is also a function of a cyclical and structural decline in disposable income. Businesses don’t go bust when there is enough to go around; they go bust when they get squeezed. Retailers have notoriously high operating leverage, meaning that even a slight drop in revenue can make a profitable store swing to a loss maker.
SPDR Retail vs SPDR Healthcare and S&P 500 – Five Years’ Performance
SPDR Retail (XRT) +31% (Blue), S&P +73% (Yellow) and Healthcare (IHF) +114% (Red) Source: Tradingview.com
Retail has been such a huge laggard that any shakeup of the healthcare industry or tax code that delivers real disposable income gains could provide a major boost to the sector, which the market would likely reprice rapidly. No area of the economy can capture the lion’s share of the value forever – it is becoming too politically unpopular to see all the surplus gains generated by the economy delivered to the bloated healthcare industry.
What to avoid? Health insurance stocks. Health insurance is really a misnomer. You might take out car insurance and never collect on the policy because you can go a lifetime without an accident. Illness, on the other hand, is an inevitable fact of life – and one that becomes more inevitable the older we get. Insuring a growing number of retirees is a bad dynamic for these companies as rising premiums push more people out of the insured system, leaving the industry ex-growth with a growing claims base. Not a nice place to be.
Health insurance is fundamentally a huge short volatility strategy – you can only underwrite the inevitable losses if your premium float can generate decent investment returns in the meantime. As I examined in The Hack last week on European bonds – travel down the risk curve in search of yield is racking up some serious risks for the insurance industry.
OIL: THE SECOND COMING?
WEIGHING THE EVIDENCE
Oil has been in a multi-year bear market since 2014, driven in no small part by the rise of the dollar during that period. As the chart of the week in last week’s Hack highlighted, the correlation is compelling. A weak dollar can drive up demand for oil by making it more affordable in other countries and in particular in Asia, where demand is high. I have been a bear on oil because of the lack of real demand growth and the ongoing elastic supply of US shale to counter any OPEC cuts. However, with the falling dollar and a potential inflationary spike from China (“The Hack – “When the Dollar Goes Macro“), it is worth examining whether the facts have changed – and whether I need to change my mind. Is oil useless? Watching Jim Rogers’ recent RV TV interview got me thinking about oil and the long-term demand picture. With the rise of electric vehicles and renewable energy, is oil going to become increasingly useless and therefore valueless? Jim Rogers had some thoughts: JR: Oil is in the process of making a complicated bottom, if you ask me. Whether the bottom is at next year at 36 or – I have no idea. I’m very bad at that… The known reserves of oil are in decline. SD: You don’t subscribe to this view, which some of our futurists do, that it’s going to go the way of whale oil? It’s going to become obsolete – JR: May well. SD: – and be useless and valueless?
JR: May well. But that’s not going to happen in my lifetime. It may well happen. But there was a lot of money made in whale oil before it all disappeared. So these things don't happen overnight. Whale oil Whale oil was once a prized commodity that nearly drove whales to extinction in the 18th and 19th centuries. The most prized oil was used for lighting and came from the head of the sperm whale – it burned most cleanly in the lamps of the day. The discovery of ‘rock oil’ in America in the 1850s gave rise to a new supply of clean-burning fuel, making whale oil obsolete. Rock oil was abundant and much easier to find and extract than whale oil was, and therefore much cheaper to produce. Oil from the sperm whale had for hundreds of years set the standard for high-quality illumination; but even as demand was growing, the whale schools of the Atlantic had been decimated…. For the whalers, it was a golden age, as prices were rising, but it was not the golden age for their consumers, who did not want to pay $2.50 a gallon – a price that seemed sure to go even higher. – Daniel Yergin, The Prize What killed the whale oil market was not that the oil fell out of favor – in fact, it was the popularity of oil as fuel that gave rise to the demand for rock oil. High prices for whale oil led people to substitute cheaper rock oil, and as the nascent oil industry grew into the massive global supply chain we see today, the need for whale oil fell away. High-price substitution It was the high price of oil in the 2008 spike and the ensuing 2009–2014 period that sowed the seeds of the current oil bear market. Large-scale solar and wind power projects – helped by a decent amount of government subsidy – are now able to compete on an even footing with oil and gas. Could the price spikes of recent years have spelled the end for oil? Nothing goes down in a straight line. Whilst the long-term future of oil demand growth looks to be weakening (see “Peak Oil Coming to a Place Near You” – The Hack), in the short run there is potential for a global inflation spike from China (“When the Dollar Goes Macro” – The Hack). Oil prices are half what they were in the last Chinese boom following the GFC, and a declining dollar could set up the conditions for higher short-term demand from Asia in particular:
Global oil demand growth (year on year m barrels per day)
Source: IEA, FT.com
China is the largest growth market for oil in the world, and it now imports more crude oil than the US does, making it the swing consumer on global markets. If the Chinese are overstimulating, this could explain the recent rally in crude. This could be breaking the perfect symmetry that Nautilus was looking for back in July:
Source: Nautilus
With the breakout above $52 in September, this mirrored pattern looks to have been breached. What kills a market ‘There is no cure for high prices like high prices’ – so goes the old saying. Indeed, those high oil prices of the past decade have set the stage for Katusa’s renewable century; but as Jim Rogers points out, known oil reserves are in decline, and we have seen a huge curtailment of investment in new exploration and production. Could we see a supply squeeze? I’m not so sure. There is such vast overcapacity in offshore rigs and shale wells that, for now, prices look to be muted by the ability of shale producers to hedge forward production. Recent price action has led to an uptick in the rig count:
Us Rig Count September 29
Source: Baker Hughes
Remember, too, that OPEC nations still have a production limit in place, keeping a lid on their own spare capacity. The dollar connection The irony of this dollar and oil discussion is that the dollar, too, has been subject to much discussion about its future irrelevance and replacement. But with the DXY in decline and loosening monetary conditions, the impetus for dollar substitution may be eroding. To break away from the dollar standard, the world would really have to see a great need to do so – dollars would have to become scarce and thus limit trade and growth. Such scarcity was part of the move away from gold-backed currencies: There wasn’t enough physical gold to back enough money to facilitate global trade. Once again, you don’t substitute for something that’s cheap. It will be an epic dollar spike that kills the dollar, not the current downtrend.
What’s the bottom line? In the short term, I still have my Portfolio Picks short oil trade, which started with oil around $48/bbl. It has been a loss to date as oil rallied into September. Still, positioning (especially Brent) for a short-term reversal appears protracted – it will be the next bottoming process that will make or break my oil call:
Brent Crude Oil: Managed Money Position
Source: Saxo Bank
I think oil stays lower for longer – price spikes look set to be met by renewed hedging by shale players. I will be keeping a keen eye on our contributors’ thoughts in the coming weeks and months to see if my short oil thesis remains valid over the medium term.
The Peril of Duration Investing for the really, really long term Where do you expect to be in a hundred years? Almost everyone reading this report will probably be dead unless a cyborg bionic future allows us to live for many more centuries – so that we may remember the distant past and maybe even learn from our mistakes. Well, if we are going to die, why not leave some assets behind for our descendants? What could stand the test of time – perhaps a 100-year bond? The long, long game In The Hack June 30th we examined Argentina’s 100-year bond: A nation that has defaulted on its debt more times than it has won the World Cup just sold $2.75bn of 100-year bonds with a yield of 7.9%. This goes to show the enormous appetite for long-duration USD bonds – note that no country in a region synonymous with defaults has ever gone 100 years without defaulting. So maybe putting away some savings into that sovereign issue isn’t such a good idea – after all, ‘leopards don’t change their spots’. But surely someone must have a cast-iron long-term investment. What you need is a nation renowned for their fiscal rectitude, a nation of strong, industrious people who will ensure that your great-grandchildren get every last coupon and the principal returned – what about Austria? The Austrian gamble The Austrian government has just sold some 2% bonds, raising EUR 3.5bn on an issue that was 3x oversubscribed. What is interesting about this issue is that the bond is due in 2117! Investors are locking in 2% a year for 100 years – this is how bad the European bond situation has become. Last week I suggested you could own an Italian subordinated bank bond for 2% a year for five years – a risky proposition! It seems sovereigns, too, can issue all kinds of questionable paper due to the ECB’s giant QE programme.
Michael Lewitt of the Credit Strategist brought this to my attention:
European fund managers submitted 65% of the orders, suggesting a serious brain drain from that business since investors are 100% guaranteed to lose money on these bonds on a real basis. Further, based on the history of Europe, it is not far-fetched to ask if Austria will even exist as a sovereign nation in 100 years. Every one basis point change in yield will move the price of this piece of paper by 43 cents or 0.43%, but who’s counting when the entire issue doesn’t even qualify as cheap toilet paper. The Faustian bargain between the ECB and money managers continues unabated in the Eurozone. Aside from the default risk, why is 2% a year for 100 years such a bad deal? Duration As Michael says, the tiniest change in yield causes huge fluctuations in the value of this bond. This is a stunning play on low rates and low volatility. Investors are essentially betting that over the next 100 years EZ interest rates will not rise above their current levels and in fact are likely to go down. Can we really expect 100 years of sub-2% Eurozone inflation and negative nominal interest rates? If ECB rates normalised to 2–4%, this bond would be worth cents on the euro of its par value, while the Austrian government would enjoy paying 2% on the EUR 3.5bn they pocketed. It’s not hard to see why issuing these bonds has become appealing to cash-strapped governments – financial repression ensures they receive a bid from yield-hungry investors. In some sense the Argentine bond is less crazy than the Austrian one, given its much higher yield of ~7% – whilst it is long-dated, it is less sensitive to underlying interest rate trends. Obviously, Argentina is paying 7% due to credit quality: Argentine credit is B-rated, and Austria is AA+. Still, at least Argentina has room for improvement in its credit metrics – Austria was downgraded from AAA by S&P in 2013. The twilight zone If this looks like madness, that’s because it is, but it shows how far down the rabbit hole central banks have taken us in their complete shift away from economic orthodoxy. Everything the last generation of investors learned about fundamentals during the ‘great moderation’ is going out the window. Expect to see more of these issues from governments in the coming years – and we will know things have gone truly crazy when a corporate tries its luck at this game!
Ding DONG – The Danes call time on oil production News that Danish oil company DONG Energy (Danish Oil and Natural Gas) is changing its name to Ørsted may seem unsurprising, but it demonstrates a key shift in European and global energy tastes. The name Ørsted is taken from a Danish scientist who pioneered in electromagnetism, and the company wants to be perceived as a green energy producer. As Marin Katusa noted in his recent RVP report on renewables, the economics of going green has become increasingly appealing, especially in the power sector. Whilst DONG CEO Henrik Poulsen talks of climate change and global ecosystems, he also states that ‘2017 will be remembered as the year when offshore wind became cheaper than black energy’. With oil prices in a lull, think how attractive this alternative energy could be if prices firmed. More tech fines in the EU: Amazon edition Just last week we looked at big tech as an emerging pariah, and now the EU enforces a EUR 250mn fine of Amazon for tax avoidance related to a deal it received in Luxembourg that the EU says amounted to state aid. Next stop, Ireland, where the commission wants EUR 13bn from Apple for back taxes! With governments desperate for cash and tech giants dominating industries, how many more investigations and fines can we expect before some regulator tries to take a major scalp? Until next time,
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