Tailpieces Blog Post 263

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Is It Time to Invest in Oil Shares?


Oil prices have recovered to top $50 a barrel – the level above which marginal producers such as American shale miners can start restoring production, even considering expansion. Is it again an industry to invest in?

Energy bears argue that long-run secular trends are in their favour. The whole thrust of government policies worldwide is towards abandoning fossil fuels and promoting renewables. There is still an enormous glut of spare production capacity. Demand may be recovering, but growth is weak. Even polluters such as China are showing increasing determination to abandon coal, to prefer natural gas to dirtier oil. “The industry,” says one analyst, “is stuck with too much refining capacity, too pipelines and too much supply.”

Energy bulls point out that fossil fuels still account for an overwhelming proportion of energy demand and will continue to do so for a long time to come because economies have such dependence on them. The International Energy Agency estimates that the world will need to invest $20 trillion in oil and natural gas supplies over the next 20 years. There’s no sign that resources will be available on such a scale as producers are cutting their capex in the face of an avalanche of anti-fossil fuel forecasts and propaganda.

A major supply/demand imbalance lies not far down the track. That will mean higher prices and a bonanza for companies that have spent enough on sustaining, even increasing, their resources.

Investment bank CLSA suggests giants like Exxon Mobil, which has held its dividend (a lush 7½ per cent) while its rivals have been cutting theirs; the Chinese major CNOOC (itsgrowth momentum intact”); and promising juniors such as Australia’s Beach Energy.

Are Electric Car Stocks a Better Choice?

It’s easy to argue that we’re seeing a bubble in electrics. The stock-market value of Tesla, the electric-car pioneer, is as much as all seven of the world’s biggest established car manufacturers. However The Economist argues that positive fundamental factors “can explain more than a fair chunk of what is going on.

Since November 9, when news broke of an effective Covid-19 vaccine, cyclical assets such as commodities have surged in value, signalling market expectations that businesses generally are going to improve. Container freight rates have risen to all-time highs. Oil prices have topped $50 a barrel.

Interest rates are low and expected to stay that way for years. Markets suggest that future inflation is likely to remain low, too. The rise in share prices alone, heralding the return of growth and profits, “is probably not enough to indicate a mania.”

Eoin Treacy says that despite much talk about bubbles and late-stage activity, “not everything is in a bubble.” Valuations remain attractive in the world’s highest-growth economies, which also have the best demographics. Dollar weakness will make them relatively attractive.

The UK, Europe, Japan, Taiwan, South Korea, Vietnam, Thailand, Indonesia, Singapore, India and China all have stock markets that are breaking out of long-term ranges on a constant-currency basis. “Base formation completions generally signal the beginnings of new bull markets.

“The conclusion… there is clear evidence a mania is evolving – but there is no evidence it has reached its peak.”

The Outlook for Precious Metals

Factors favour another good year for gold, says the Swiss bank UBS – negative interest rates in real terms, accommodative central bank policies, dollar weakness. Gold is also benefitting from the reflation theme and higher oil prices. Although there’s a lot of optimism about the economic lift to be expected from the rollout of vaccines, the negative impact on gold has already been adjusted for in prices.

Canada’s RBC says that gold shares are well-positioned to withstand a period of fluctuating prices and in fact their valuations don’t yet factor in the prospect of continuation of current higher prices.

Silver has been outperforming gold from the same factors, as well as the strength in base metals and in commodities generally. The platinum group metals hav e been boosted by supply disruptions in South Africa, the world’s largest source.

Bloomberg’s Mike McGlone says the precious metals and copper are likely to outperform equities this year as they did in 2020, when gold rose 26 per cent in dollar terms.

Prices of the extremely rare but important metal rhodium are soaring – up from $2,500 to $17,800 an ounce in just two years.

Rhodium is found with platinum and palladium, but in tiny proportions. Four-fifths of global demand is for use in auto catalytic converters, where it is better than other catalysts at destroying nitrogen oxide pollution.

Car companies in Europe and China are using ever-more rhodium to meet tougher clean air legislation. Shares of the largest producers – all operating in South Africa and listed in Johannesburg – such as Northam Platinum and Impala Platinum, have rocketed.

Will the Greenback Continue to Weaken?

Longer-term forces are stacking up against the world’s reserve currency, says the FT’s Michael Mackenzie.

The dollar has been falling for several months in trade-weighted terms under pressure from increasing trade and budget deficits, with expectations that ultra-lo w interest rates are set for an extended stay.

The Chinese currency has been strengthening, buoyed by a surge in exports and foreign institutional investment flows into Chinese bonds. Beijing may be moving away from the dollar-denominated assets that for years have been helping to plug US trade deficits.

International investors are moving out of the greenback into alternatives – not only the renminbi but also gold, the euro, the Japanese yen and the Australian dollar. An improving global economy may ultimately trigger sharp foreign outflows from Wall Street. “After a nearly decade-long rally for the dollar, global investors are overweight US equities that look expensive compared with the rest of the world.”

Although the dollar is still overvalued in terms of most other currencies. it has been weakening for several months. Europe, the UK, Japan and emerging markets, and commodities, have been rallying when their currencies strengthen, which suggests a significant flow of investment assets away from the US,



Growth prospects: The majority of consumer electronics companies at the industry’s recent annual conference see the car as the next big market they can break into, Eoin Treacy reports. Driver assistance, in-car entertainment and traffic management software are all on the menu.

Apple is in talks with Hyundai about manufacturing its cars, so it appears to be intent on pursuing an original equipment model. At today’s valuations one is taking a big bet that they will be as successful with cars as they were with phones – and that Apple will take 10 per cent of global market share within the next 15 years.

It represents a massive leap into the unknown and a product will not be available for sale for at least another four years. At the same time, competition in the sector is reaching fever pitch.

Travel and tourism: Although air travel will almost certainly recover this year as social distancing policies are eased, the industry is not expecting a quick recovery. Its representative body expects global spending to be just half what it was in 2019.

Although analysts generally anticipate a bounceback in short-range holiday travel, they’re less confident about the business sector. Firms that have grown accustomed to Zoom meetings may be less keen to splash out on high-priced tickets for long flights. That would have ominous implications for airlines. In the case of the transatlantic, business flyers account for only 10 per cent of total custom but pay ten to 12 times as much per ticket as economy passengers.

Sexual politics: I was surprised to see that the mass media failed to mention, in its ecstatic coverage of Joe Biden’s first day in office, that what he regarded as important enough to deserve inclusion in the 17 executive orders of anti-Trumpism was one dealing with transgenders. He restored Obama-era regulations allowing biologically male transgender athletes to compete in women’s sports. As the scientific evidence is clear that males generally have greater muscle mass, bone structure and lung capacity than females, this amounts to imposing a general advantage for the handful of athletes who are transgender over millions of females.

Leadership in science: China’s success in landing a spacecraft on the moon – only the third country to get there, collect surface samples and return to earth – has highlighted intense effort to develop its science base.

Back in 1965 the US allocated 11.7 per cent of federal spending to research and development; by 2019 the proportion had fallen to 2.8 per cent. China has come from far behind, but has been closing the gap rapidly. Its national spending on R&D grew at an average annual rate of 17 per cent between 2000 and 2017.

A shorter working week: The move by the global giant Unilever to put its New Zealand staff on to a four-day working week – for a five-day salary – is an idea that has started to interest businesses. It’s claimed that the no-Fridays strategy makes employees happier without loss of productivity. In fact a study by Henley Business School showed that firms that introduced the strategy actually reduced their costs equivalent to 2 per cent of sales.

The Arctic: Russia is investing heavily in infrastructure to develop its 24,000-kilometre Arctic coast, which it expects global warming to open up as a shorter sea route between Asia and Europe. In November it christened a nuclear-powered icebreaker that can crash through ice three meters thick. It’s a 33,000 tonner – the size of a world war two aircraft carrier. Three even larger ones – 70,000 tonners – are planned.

Equities: One metric that shows how clearly American shares are currently overvalued is that although the S&P500 index is now 170 per cent higher than it was at the end of 2012, there has been almost no growth in corporate profits. They have risen at an average annual rate of just 0.2 per cent since the start of 2013.


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