December 14, 2018

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December 14, 2018
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November 7, 2018

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November 7, 2018
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October 17, 2018

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October 17, 2018
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May 25, 2018

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May 25, 2018
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May 10, 2018

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May 10, 2018
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April 13, 2018

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April 13, 2018
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Why I Love/Hate the Oil Companies

The first thing I do when I get up every morning is to curse the oil companies as blood sucking scourges of modern civilization.

I then fall down on my knees and thank God that we have the oil companies.

This is why petroleum engineers are getting $100,000 straight out of college, while English and political science major are going straight on to food stamps.

I recommend (XOM) and other oil majors as part of any long-term portfolio. In my lifetime, the price of oil has gone up from $3 a barrel up to $149.

The reasons for the ascent keep growing, from the entry of China into the global trading system, to the rapid growth of the middle class in emerging nations.? They?re just not making the stuff anymore, and we can?t wait around for more dinosaurs to get squashed.

Big oil companies aren?t in the oil speculation business. As soon as a new supply comes on stream, they hedge off their risk through the futures markets or through long-term supply contracts. You can find the prices they hedge at in the back of any annual report.

This is why the oil crash barely caused the shares of oil majors to move. Exxon Mobil (XOM) shares are now down only 15%, while its principal product is off by an astounding 80% from its 2011 top.

When oil made its big run to $149 a few years ago, I discovered to my amazement that (XOM) had already sold most of their supplies in the $20 range. However, oil companies do make huge killings on what is already in the pipeline.

Working in the oil patch 15 years ago pioneering the ?fracking? process for natural gas, I got to know many people in the industry. I found them to be insular, God fearing people not afraid of hard work.

Perhaps this is because the black gold they are pursuing can blow up and kill them at any time. They are also great with numbers, which is why the oil majors are the best-managed companies in the world.

They are also huge gamblers. I swallow hard when I see the way these guys throw around billions in capital, keeping in mind past disasters, like Dome Petroleum, the Alaskan Pipeline oil spill, Piper Alpha, and more recently, the ill-fated Macondo well in the Gulf of Mexico.

But one failure does not slow them down an iota. The ?wildcatting? origins made this a faith-based industry from day one, when praying and dousing wands were the principal determinants of where wells were sunk.

Unfortunately, the oil companies are too good at their job of supplying us with a steady and reliable source of energy. They have one of the oldest and most powerful lobbies in Washington, and as a result, the tax code is riddled with favorite treatment of the oil industry.

While Social Security and Medicare are on the chopping block, the industry basks in the glow of $53 billion a year in tax subsidies.

When I first got into the oil business and sat down with a Houston CPA, the tax breaks were so legion that I couldn?t understand why anyone was not in the oil racket.

Ever wonder why we have had three presidents from Texas over the last 50 years, and are possibly looking at a fourth (Jeb Bush, Rick Perry)?

Three words explain it all: the oil depletion allowance, whereby investors can write off the entire cost of a new well in the first year, while the income is spread over the life of the well.

This also explains why deep-water exploration in the Gulf is far less regulated than California hairdressers.

No surprise then that the industry has emerged in the cross hairs of several presidential candidates, under the ?loopholes? category. Not only do the country?s most profitable companies pay almost nothing in taxes, they are one of the largest users of private jets.

It is an old Washington nostrum that when things start heading south on the domestic front, you beat up the oil companies. It?s the industry that everyone loves to hate.

Cut off the gasoline supply to an environmentalist, and he will be the one who screams the loudest. This has generated recurring cycles of accusatory congressional investigations, windfall profits taxes, and punitive regulations, the most recent flavor we are now seeing.

But imagine what the world would look like if Exxon and its cohorts were German, Saudi, or heaven forbid, Chinese. I bet we wouldn?t have as much oil as we do today, and it wouldn?t be as cheap.

Hate them if you will, but at least these are our oil companies. Try jamming a lump of coal into the gas tank of your Prius and tell me how far you go.

Well, that?s enough ranting for today.

$WTIC 4-15-15

oilLove Them, Hate Them or Both?

More Pain to Come in Oil

There are very few people I will drop everything to listen to.

One of the handful is Daniel Yergin, the bookish founder and CEO of Cambridge Energy Research Associates, the must-go-to source for all things energy.

Daniel received a Pulitzer Prize for The Prize: The Epic Quest for Oil, Money, and Power, a rare feat for a non-fiction book (I?ve never been able to get one).

Suffice it to say that every professional in the oil industry, and not a few hedge fund traders, have devoured this riveting book and based their investment decisions upon it.

Yergin thinks that the fracking and horizontal drilling revolutions have made the United States the new swing producer of oil. There is so much money in the investment pipeline that American oil production will continue to increase for the next six months, by some 500,000 barrels a day.

Much of this oil is coming from heavily leveraged, thinly capitalized producers whose bankers won?t let them cut back a drop on production so they can maintain interest payments on their debt.

This new supply will run head on into the seasonal drop in demand for energy, when spring ritually reduces heating bills, but the need for air-conditioning has not yet kicked in.

The net net could be a further drop in the price for Texas tea from the present $31 a barrel, possibly a dramatic one into the teens.

Yergin isn?t predicting any specific oil price as a potential floor, as it is an impossible task. While OPEC was a monolithic cartel, the US fracking industry is made up of thousands of mom and pop operators, and no one knows what anyone else is doing.

However, he is willing to bet that the price of oil will be higher in a year.

Currently, the 96 million barrel global market for oil is oversupplied with 2 million barrels a day.

If the International Monetary Fund is right, and the world adds 3.0% in economic growth this year, we will soak up 1 million b/d of that with new demand.

In the end, the oil price collapse is a self-solving problem. The new economic growth engendered by ultra low fuel prices eventually drives prices higher.

Where we reach the tipping point, and the oil market comes back into balance, is anyone?s guess. But when it does, prices will go substantially higher. The cure for low prices is low prices.

This is why I listed energy as the top performing asset class this year (click here for my ?2016 Annual Asset Class Review? by clicking here.

The bottom line is that there will be a great time to buy oil companies, but it is not yet.

What we are witnessing now is the worst energy crash since the 1980?s, when new supplies from the North Sea, Mexico and Alaska all hit at the same time.

I remember the last time oil plunged to $8 a barrel, because Morgan Stanley then set up a private partnership that bought commercial real estate in Houston for ten cents on the dollar. The eventual return on this fund was over 1,000%.

This time it is more complicated. Prices lived over $100 for so long that it sucked in an unprecedented amount of capital into new drilling, some $100 billion worth.

As a result, sources were brought online from parts of the world as diverse as Russia, the Arctic, Central Asia, Africa, the Canadian tar sands and remote and very expensive offshore platforms.

Yergin believes that Saudi Arabia can survive for three years with prices at current levels. After that, it will burn through its $150 billion of foreign exchange reserves, and could face a crisis.

Clearly, the Kingdom is betting that prices will recover with its market share based strategy before then. They are playing for the long haul.

The transition of power to the new King Salman was engineered by a committee of senior family members, and has been very orderly.

However, King Salman, a Sunni, will have his hands full. The current takeover of Yemen by a hostile Shiite minority, the Houthis, is a major concern. Yemen shares a 1,100 mile border with Saudi Arabia.

Daniel says that a year ago, there was a lot of geopolitical risk priced into oil, with multiple crises in the Ukraine, Syria, Libya and Iraq frightening consumers, so trading levitated over $100 for years. Delta Airlines, Inc. (DAL) even went to the length of buying its own refiner to keep fuel prices from rising further.

US oil producers have a unique advantage over competitors in that they can cut costs faster than any other competitors in the world. On the other hand, they are eventually going head to head against the Saudis, whose average cost of production is a mere $5/barrel.

A native of my own hometown of Los Angeles, Yergin started his professional career as a lecturer at Harvard University. He founded Cambridge Energy in 1982 with a $7.00 investment in a file cabinet at the Good Will. He later sold Cambridge Energy to the consulting group IHS Inc. for a small fortune.

To buy The Prize at discount Amazon pricing, please click here.

The Prize

world liquid

Here Comes the Final Bottom in Oil

I had a fascinating dinner last week at Morton?s, San Francisco?s best steak restaurant, with one of John Hamm?s original investors.

You remember John, the legendary Texas oilman who saw fracking coming a mile off and made billions?

Since some of what my friend had to say came true in a matter of days, I thought I?d pass on the essence of our conversation.

The oil storage facility at Cushing, Oklahoma is full, at 480 million barrels. The US Strategic Petroleum Reserve has been full for a long time, with 713 million barrels (36 days of US consumption).

Contangos are exploding. It might as well be the end of the world for the oil industry.

The oil Armageddon is here, and the final flush is upon us.

There is a 50% chance we will bottom at $32/barrel, and another 50% chance that we go all the way down to $20. If we go down to $20, the last three ticks of the move will be $22?.$20?.$22. Then a saw tooth bottom will unfold between $24 and $32 which will last for several months.

There will be many chances to buy this bottom. There isn?t going to be a ?V? shaped bottom in oil this time, like we saw in past energy crashes.

The margin clerks and risk control managers are in control now, so we may see the final low sooner than you think. But it could be some time before we break $40 again to the upside and hold it.

The industry was really drinking the Kool-Aid with both hands to get it this wrong. Ultra low interest rates drove in billions in capital from first time oil investors looking to beat zero interest rates. They also saw China continuing an endless economic boom forever, and the energy demand that went with it.

In the end, they got both the supply and demand sides of the equation completely wrong on a global scale, always a recipe for disaster.

Many of the fields drilled in places like North Dakota would never have been touched during normal times. Then Saudi Arabia came out of left field with a grab for global market share that has yet to play out.

The seeds of this recovery are already evident. Chinese auto sales are up 19% YOY. China is buying all the cheap oil it can to fill up its own strategic oil reserve. Miles driven in the US are already up 4.6% YOY, which is a huge gain.

All of this will contribute to a higher US GDP in 2016.

Once we put in a final bottom in oil, don?t expect $100 a barrel any time soon. The ma and pa investor in the oil patch will not be back in this generation.

Marginal sources, like high cost Canadian tar sands, deep offshore, and some in North Dakota aren?t coming back either. These supplies needed $100/barrel just to break even.

Personally, my friend does not see oil topping $80/barrel this decade. He see?s a $62-$80 trading range persisting for a long time.

As the US has become more energy independent, the geopolitical factors have mattered less and less. That is why oil moved only $1 on an ISIS victory, the Paris attacks, or some other disaster.

To call the bottom in oil, watch the shares of ExxonMobil (XOM), Conoco Phillips (COP), and Occidental Petroleum (OXY). When they revisit their August lows, down 5%-10% down from here, that will be a great time to jump back into the oil space.

None of these companies are going under, and the dividend payouts are now enormous, (XOM) at (3.7%), (COP) at (5.8%), and (OXY) at (4.2%).

Distressed debt is where the smart money is focusing now, where double-digit returns have become common. If the issuer goes bankrupt the equity owners get wiped out while the bondholders get the company for pennies on the dollar.

Energy companies and master limited partnerships (MLP?s) have far and away been the biggest borrowers in the high yield market in recent years.

There is a junk maturity cliff looming, with $145 billion in bonds due for refinancing from 2017-2021. Expect the default ratio to rocket from this year?s 2.8% to 25%. A 12% default rate is a normal peak in a recession.

Individual company research now has a bigger payoff than in any time in history, even the 2008-09 crash.

Small leveraged companies with exposure to the price of oil are toast.

The play is for the toll takers, master limited partnerships that profit from the volume of oil pumped, and not the price of oil. Over time, volumes will increase, and so will the profits at these MLP?s.

In the meantime, everything is getting thrown out with the bathwater, regardless of fundamentals. People just don?t want to be near the space, especially going into yearend book closing.

Nobody wants to be seen as the idiot who owned oil in 2015.

Linn Energy (LINE) is a perfect example of this. It suspended its dividend so it could buy more assets on the cheap. It has plenty of cash, and will be backstopped by Blackrock with additional credit lines, if necessary.

While this raises volatility for the short term, it increases returns over the long term. It?s definitely your ?E? ticket ride.

I pointed out that President Obama did the oil industry the biggest favor in history by dragging his feet on the Keystone Pipeline, and then ultimately killing it. It prevented US consumers from loading the boat with $100/barrel tar sands crude at the top of the market.

My friend conceded that it is unlikely the pipeline would ever be built. The market has moved away.

I have accumulated a variety of odd tastes in my half-century of traveling around the world.

So when I heard we were eating at Morton?s, I brought my own jar of Coleman?s hot English mustard. It makes a medium rare cooked filet mignon taste perfect, but my action always puzzles the waiters. They never have it.

John Hamm gained public notoriety last year when he wrote a $974 million divorce settlement check to is ex wife and she refused to cash the check. I asked if the check ever got cashed?

?She cashed the check,? he said.

Needless to say, my friend picked up the check for the dinner as well. I let him drive my Tesla Model S-1 back to his hotel.

WTIC 12-7-15

XOM 12-7-15

COP 12-8-15

OXY 12-8-15

LINE 12-8-15

Hamm Check


Ten Reasons Why Stocks Are Still Going Up

While driving back from Lake Tahoe last weekend, I received a call from a dear friend who was in a very foul mood. He had bailed on all his equity holdings at the end of last year, fully expecting a market crash in the New Year.

Despite market volatility doubling, multinationals getting crushed by the weak euro and the Federal Reserve now signaling its first interest rate rise in a decade, here we are with the major stock indexes sitting at all time highs.

Why the hell are stocks still going up?

I paused for a moment as a kid driving a souped up Honda weaved into my lane of Interstate 80, cutting me off. Then I gave him my response, which I summarize below:

1) There is nothing else to buy. Complain all you want, but US equities are now one of the world?s highest yielding securities, with a lofty 2% dividend. That compares to one third of European debt offering negative rates and US Treasuries at 1.90%.

2) Oil prices have yet to bottom and the windfall cost savings are only just being felt around the world.

3) While the weak euro is definitely eating into large multinational earnings, we are probably approaching the end of the move. The cure for a weak euro is a weak euro. The worst may be behind for US exporters.

4) What follows a collapse in European economic growth? A European recovery, powered by a weak currency. This is why China has been on fire, which exports more to Europe than anywhere else.

5) What follows a Japanese economic collapse? A recovery there too, as hyper accelerating QE feeds into the main economy. Japanese stocks are now among the worlds cheapest. This is why the Nikkei Average hit a new 15-year high over the weekend, giving me yet another winning Trade Alert.

6) While the next move in interest rates will certainly be up, it is not going to move the needle on corporate P&L?s for a long time. We might see a ?% hike and then done, and that probably won?t happen until 2016. In a deflationary world, there is no room for more. At least, that?s what Janet tells me.

This will make absolutely no difference to the large number of corporates, like Apple (AAPL), that don?t borrow at all.

7) Technology everywhere is accelerating at an immeasurable pace, causing profits to do likewise. You see this in biotech, where blockbuster new drugs are being announced almost weekly.

See the new Alzheimer?s cure announced last week? It involves extracting the cells from the brains of alert 95 year olds, cloning them and then injecting them into early stage Alzheimer?s patients. The success rate has been 70%. That one alone could be worth $5 billion.

8) US companies are still massive buyers of their own stock, over $170 billion worth in 2014. This has created a free put option for investors for the most aggressive companies, like Apple (AAPL), IBM (IBM), Exxon (XOM), Wells Fargo (WFC), and Intel (INTC), the top five repurchasers. They have nothing else to buy either.

They are jacking up dividend payouts at a frenetic pace as well and are expected to return more than $430 billion in payouts this year (see chart below).

9) Oil will bottom in the coming quarter, if it hasn?t done so already. This will make the entire energy sector the ?BUY? of the century, dragging the indexes up as well. Have you noticed that Conoco Phillips (COP), Warren Buffets favorite oil company, now sports a stunning 4.70% dividend?

10) Ditto for the banks, which were dragged down by falling interest for most of 2015. Reverse that trade this year, and you have another major impetus to drive stock indexes higher.

My friend was somewhat set back, dazzled, and non-plussed by my long-term overt bullishness. He asked me if I could think on anything that might trigger a new bear market, or at least a major correction.

I told him to forget anything international. There is no foreign development that could damage the US economy in any meaningful way. No one cares.

On he other hand, I could think of a lot of possible scenarios that could be hugely beneficial for US stocks, like a peace deal with Iran, which would chop oil prices by another half.

The traditional causes of recessions, oil price and interest rate spikes, are nowhere on the horizon. In fact, the prices for these two commodities, energy and money, are headed lower and not higher, another deflationary symptom.

Then something occurred to me. Share prices have been going up for too long and need some kind of rest, weeks or possibly months. At a 17 multiple American stocks are not the bargain they were 6 years ago when they sold for 10X earnings. Those were the only thing I could think of.

But then those are the arguments for shifting money out of the US and into Europe, Japan, and China, which is what the entire world seems to be doing right now.

I have joined them as well, which is why my Trade Alert followers are long the Wisdom Tree Japan Hedged Equity ETF (DXJ) (click here for ?The Bull Case for Japanese Stocks?).

With that, I told my friend I had to hang up, as another kid driving a souped up Shelby Cobra GT 500, obviously stolen, was weaving back an forth in front of me requiring my attention.

Whatever happened to driver?s ed?

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DXJ 3-23-15