Oil and Stocks Have Bottomed, But Their Paths Forward Vary

Oil and stocks seem to have bottomed as I suggested last month. Since that March 16th post, stocks are up another 8%, a scorchingly hot run on an annualized basis. Since March 6th the S&P is up over 21%. Meanwhile the price of oil has risen almost 35% since February 18th, not quite two months ago.

More Gains to Come

I continue to expect further gains for both stocks and oil - and eventually for natural gas - but each is a different case. I see stock market gains as a bounce back from an oversold condition caused by the great banking collapse and subsequent recession. More stock price recovery will come before the market is fairly priced for a mildly resurgent economy that most economists now predict for 2010. Businesses are writing off 2009, throwing all their problems into this year’s P&L. Earnings will be awful. But that sets up 2010 for pleasant surprises.

In the short term there may be - should be - almost surely will be - market pullbacks. For that reason I am keeping a substantial amount of powder dry - about 35%. But Thursday’s Wells Fargo (WFC) earnings announcement was a wake-up call to the market that the banking sector has pulled out of its free fall. Goldman’s (GS) coming equity sale and subsequent repayment of their TARP funds should build more optimism for the whole market. So I’d guess any market declines will be limited and not a serious test of the lows of last November.

Of course we will get more bad economic news. GM and Chrysler have to complete their dance of death and banks face huge loan losses going forward, especially in commercial real estate. But it seems increasingly clear that the old rule of thumb, “don’t fight the Fed” is still operational. The fact that credit is currently still very tight is actually positive because you know that it has to become looser over time. The Fed will win. That will be good for the economy and for stocks. Even the downsizing, de-leveraging, and cost-containment of the U.S. auto industry is a longer-term positive for auto profitability and therefore for the economy.

The level of GDP that can be achieved in the recovery will not compare with the fluffy economy of 2007-2008 that depended on vast financial engineering and consumers borrowing to spend instead of saving. I doubt that world is coming back. Nonetheless, in two or three years we might see more robust growth. When that happens the velocity of money will start to expand and the Fed will need to stop easing. Interest rates will start rising and at that point stocks could be in for a rough correction or even worse if inflation worries begin to gain traction. Oil prices may also be rising rapidly at that point, as discussed below. None of that would be great for the stock market. So even if we have a fairly benign stock market for the next 12 - 18 months I doubt stocks will travel back to their previously high levels. In fact stock prices may not reach fall-2007 levels for quite a long time, but that is another discussion.

Right now the economy is a long time away from growing robustly. That scenario seems like a 2011 problem, not one for 2010 - and certainly not a problem in 2009. So on balance there should be more stock market gains I’d guess (and let’s remember all of this is only one man’s best guess) lasting for perhaps as long as the next eighteen months. A rising stock market would also help the economy’s recovery. Eee gads! Not a positive feedback loop!

Oil and Gas

In terms of oil, I see a mild near-term price recovery. In fact, in the very near term oil prices could well turn down and even test recent lows because there is still a huge amount of global spare capacity for oil production no matter how much temporary tightening might come to above-ground inventories. But whether or not a serious a re-test of recent low oil prices happens, I’d be surprised if oil is not above $75 in a year as stronger demand and lower non-OPEC supplies work off the current spare capacity glut. I suspect 2010 may well see an “equilibrium” oil price around $70 - $90. In that price range drilling will be profitable again but OECD consumers will not feel they are being raped. In 2011 and beyond, as discussed below, I believe oil prices will continue on to new highs.

Natural gas is too low at $4 to be sustainable. Inventories are now high and new LNG capacity is threatening to bring in cheap Qatari supplies. But gas wells deplete very rapidly and many drilling rigs have been mothballed until prices are higher. So at some point in the not too distant future I suspect we’ll see the truth of the old trader’s adage, “the cure for low prices is low prices.” In other words, after a long enough period of low natural gas prices supply will diminish enough to bring prices higher. And even demand may respond to low prices to some extent.

The Car/Oil Cycle

I’ve long believed that there is an oil-related basis for the global car-sales cycle we are seeing. Of course the obvious reason U.S. car sales are down over 40% from 16 million to 9 million is the recession . But I would argue that car sales began turning down well before the financial crisis hit and that weak car sales has been an important cause of our economic pain - not just a result of it.

What started the car sales cycle heading down, I believe, was a new and important motivation for people not to buy cars - the fact that car technology is in a significant and rapid transition phase that is related to the growing shortage of oil. Consumers are well aware that a “next generation” car is in the process of coming to market. They’ve known that since oil began selling for over $100 a barrel. They may not have known if the next generation car would be an electric vehicle or a hybrid or a plug-in hybrid. But they damn well knew that in a few years it’s likely that whatever car they buy might now will be fairly obsolete. That knowledge has to be a significant damper to car sales.

Well, now we can pretty much see how the cycle of new car technology is going to play out. The winning technology will clearly be the plug-in hybrid electric vehicle (PHEV). It will probably have some sort of lithium battery although other and newer battery technologies could well become dominant before too long. But consumers are not hung up so much on just what battery will be in the car (though they should care more). Consumers are more focused on the simple fact that the next generation car will be much more dependent on electrons for propulsion and less dependent on oil than any car they can buy today. That is a sea change. As long as they perceive that the “real deal” next generation car is not yet for sale, they will hold off buying cars in great volume.

Now it’s becoming clear that a serious number of PHEV’s will make their entry in 2010 - 2011 and that by 2012 there will very likely be a wide enough selection of PHEV’s that consumers can be fairly confident that “the future is now”. Not every car they buy in 2012 will be a PHEV, nor will sufficient PHEV production volume will be available in showrooms in 2012 to satisfy potential consumer demand. In fact, the car industry will have trouble ramping up its PHEV capacity sufficiently to keep up with consumer demand if I’m right about oil prices becoming much higher in 2011. And if oil prices keep rising, as I suspect they will, no matter how hard the industry tries, it will fail to produce enough PHEV’s in 2012 - 2015 to satisfy demand.

There are several reasons why consumer demand for next-generation PHEV’s will become overwhelming in two to three years. One is that the recession will be over and with economic growth will come a lot of catch-up demand for new cars. Secondly, the technology will be dazzling. It will feature great performance characteristics and mind-blowing gas mileage - in the 100 mpg+ range depending of daily driving distance.

But the final reason why PHEV demand will explode is that by 2011, oil prices will again be over $100 and heading north. It just so happens that, as I wrote last month, the recent rapid increase in spare oil capacity will have worked itself down to a shortage position by some point in the 2011 - 2013 time frame. (My analysis of the oil supply/demand flows that back up that statement is here.) That time frame coincides exactly with the other two factors that will drive PHEV sales - the economic cycle and the availability of product.

An Oil-Price-Driven Second Recession?

My recent writings referenced above - last month’s newsletter and my oil spare capacity analysis - included discussions of the possibility that the next oil supply crunch could cause OECD economies in particular to fall back into recession. I won’t repeat the thought process here but I will add two follow-on ideas. First, as mentioned above, the oil price could well stay in some equilibrium price in the range (say, $70 - $90) for some fairly extended period - maybe a year or so. I call it an “equilibrium price” because it would be high enough to motivate new drilling activities and for consumers to buy into the new PHEV technologies but not be so high as to cause OECD economies to be pushed back into recession.

My second thought on future oil prices stems from my supply/demand analysis referenced above. If extreme supply shortfalls in the period of 2013 - 2016 elevate oil prices there will be substantial efforts by automobile consumers and producers and by government to push next generation high-mpg cars into the fleet. But the number of such cars that could be manufactured for U.S. consumption will be limited due to battery shortages to perhaps 1 - 3 million per year - not enough to make a significant dent in America’s 250-million car fleet. That’s one reason Hirsch’s 2005 analysis forecasted a 20-year time requirement for the world to mitigate peak oil.

There may also be enlightened efforts to transition some truck fleets to natural gas. But again, it would require well over a decade for natural gas powered trucks to make a major impact on truck fleet fuel economy. No foreseeable natural gas program would have a major impact by 2015.

So for those reasons I tend to think there could be a great deal of global economic angst generated in a few years by another oil shortage. It will start to be seen in 2011 and will be in full flower by 2013. At the same time, those are the years when the U.S. national debt level could become alarmingly large, perhaps igniting inflationary fears and possibly even a flight away from the dollar. On both of those accounts, it would seem like owning oil - the physical commodity -might be a wise investment choice. (One way is to buy the ETF “USO”.) Whether oil-related equities will fare as well as the commodity is a much harder - probably impossible - question to fathom from this perspective in time.

Instead of worrying about the 2013 - 2015 outlook for oil stocks, at this point I would simply focus on the more near term “sweet spot” of nascent economic recovery and equilibrium oil pricing in the $70 - $90 range that seems likely through 2010. Those gentle winds should propel both oil and stocks - especially oil stocks - a good deal higher than they are now. Slow and gentle uptrends for oil and other commodities will not be alarming. Let’s hold on to that thought and - if I’m right - enjoy the ride.

Politics

Here’s a cartoon from 1933, a wonderful reminder from Barry Ritholtz of how history sometimes does more than rhyme - it actually repeats itself:

I heard these same fears of a U.S. spending program gone amuck at Passover from a relative who is a big Republican at the national level. He actually repeated the old Republican shibboleth that “only WWII got us out of the depression.” Of course the facts are a bit different. FDR’s spending programs succeeded in reducing unemployment from 25% in 1933 to near single digits in 1937 - that is, until FDR reversed course in 1937, increased taxes and reduced spending to bring down the budget deficit - and the economy turned back down. (For details see Krugman’s The Return of Depression Economics and the Crisis of 2008.) So a Keynsian solution to depression was demonstrated to work - it’s just that FDR pulled out of it too soon.

It is astounding to me the number of big issues on which Republican philosophy has been dead wrong in recent history: against Keynsian solutions to economic depression (1930’s and repeating the mistake in 2008-9), against Social Security; against Medicare; against the U.S. entering WWII, against the 1960s civil rights protections for African-Americans, against tobacco reform and class-action lawsuits that were the only way to stop big-tobacco from rapidly killing Americans, against equal rights in the workplace for women. And now against reforming our medical care system that has clearly been proven to be inefficient (in terms of life expectancy where the U.S. ranks 32nd in the world) and wildly too expensive.

What have Republicans been for? Any sort of military spending, invading Iraq, ending the separation of banking from casino-style risk-taking (Glass-Steagal) in 1999 (Phil Gramm’s brainchild) which put us on the road to the current economic shock, letting the SEC go on vacation from 2001 - 2008, government incompetence at nearly all levels under Bush 43, divorcing science from government decision making including taking no action on climate change or oil dependency, making the tax code so unfair that only the wealthy were able to increase their per capita inflation adjusted income during the most recent years of economic expansion, a “war on drugs” that has only made drugs cheaper and more abundant and criminal gangs vastly wealthy, and finally - insuring the freedom of any gun dealer to sell military-quality assault rifles to nearly anyone.

Not to say that the Dems are always brilliant or right-minded. Plenty of Dems oppose good things for bad reasons, like Harry Reid being against mining reform because the Nevada mining companies own him or Chuck Schumer being against tax reform for LBO firms (they get their incentive comp. taxed at 15% while their secretaries pay 25% on their salaries) because Wall Street owns him. But at least on the really big issues the Dems generally seem to have a sense of fairness and common sense. Frankly, I was not a partisan until recent years, generally voting for the “best woman”. But now? I’ve come to think today’s Republican party is the enemy our country’s best interests. I wish it were not so.

Next

I’m headed to the hospital next week to get a new right hip. I can’t express how much I am looking forward to coming out of re-hab with my new hip functioning and getting back to old pleasures like taking a walk and playing tennis. I hope this letter finds you in good health.

Comments

[Mad Hedge F...:]

For sure. Think stocks down, oil down. Daniel Yergin of Cambridge Energy Partners says that crude prices will stay in a $40 to $60 range for the foreseeable future. The author of the Pulitzer Prize winning “The Prize”, the best business book I have ever read, believes the recent 26% rally in the stock market is what dragged crude up from $35 to $54. Another downdraft in stocks, or a realization that the recession will be longer than expected, could take crude back to $40 in a heartbeat. Inventories are at a 16 year high, with possibly 80 million barrels at sea, as demand has shrunk from 86 to 83.5 million barrels a day over the last two years. Spare capacity is now huge. Don’t expect to break out of this range until a recovering economy eats into these supplies, and inflation makes its inevitable return. Then all commodities will roar, not just crude.

Apr 12 06:24 PM

[sether:]

Yes both parties bear responsibility for the current crisis, but the rot and cancer at the core of our politics for the last 30 years has been conservatism. Conservatives have derived their political power over the last 30 years by appealing to people's basest instincts; greed, fear, and hate. Vote for me, I'll cut your taxes. Vote for me, or you will be killed by communists / terrorists / socialists. Vote for me unless you want blacks and homos raping your women and children. It was a bag of cheap tricks, and very effective. Appealing to people's basest instincts is the opposite of leadership, but it will always work with a certain segment of the population. That segment is at long last in the minority, because I think enough people are finally disgusted with that, and the honest ones are disgusted with themselves for buying it. The dishonest ones will continue to claim that Liberalism is just the other side of the same coin. In a country guided by liberal humanist principals, you wouldn't have both parties owned by Wall Street. You wouldn't have 1% of the people owning 98% of the wealth. You wouldn't have a shell of an economy, disemboweled by Globalist freemarketeering and financial deregulation and speculation.
GOD DAMN ALL OF YOUR BLACK HEARTS.


On Apr 12 03:54 PM Nathaniel C wrote:

> Jim-- Regarding your discussion on politics I see that you are caught
> in the phony left/right paradigm. That is too bad because it blinds
> you from the truth that both parties are working together to ruin
> the US. They both stole trillions from the taxpayer (and borrowed
> trillions more) and gave it to the offshore banks that brought down
> the US economy. The single largest contributors to Obama's campaign
> were Goldman Sachs and JP Morgan. The banks own both parties. That
> is why Hank Paulson (GS ceo) was Treasury chief under Bush and Geithner
> (NY Fed president also known as the bankers agent) was choosen by
> Obama. The banks always win.
>
> Both parties support perpetual wars: that is why Obama is increasing
> the number of troops in Afghanistan and the Dems and Republicans
> appropriate trillions to fund the war.
>
> Regarding social security and medicare: they are illegal under the
> US constitution but are coincidentally in the communist manifesto.
> I realize that Communists like yourself dont care for the US constitution
> but it is still the supreme law of the land. Even though politicians
> choose not to follow it anymore.
>
> I am surprised that you would support social security considering
> it is a ponzi scheme larger than Madoff's scheme (steal money from
> the youth to pay for the elderly). Social Security is not a benefit--check
> with the IRS about that. If you do not pay social security and medicare
> TAXES you will be sent to jail. Social security is a confiscation
> of wealth. The yearly inflation adjustments do not keep pace with
> inflation. Numerous studies have shown that if people could keep
> their own money (I know it is a radical concept) and invest it in
> bonds they would have monthly payments 3 times higher than what they
> get through social security. Instead retirees are kept in poverty
> and forced to eat dog food on their $1200 a month check. The government
> knows that will keep them loyal and obedient slaves.
>
>

Apr 12 08:50 PM

[longoil:]

There is equal blame to go around for both parties.

1) Bush 43 wasted one trillion dollars and sacrified over 4000 young lives for access to the oil fields of Iraq.

2) Clinton torpedoed the CAFE standards by implementing the light truck exemption, in order to buy UAW votes, during the 1990's. The CAFE standard had risen steadily from the Carter era through the Reagan's and Bush 41 terms from 15 mpg to 27 mpg.

I think Obama will be another Clinton in this regard, thinking more about the next election rather than implementing change we need.

Apr 12 10:00 PM

[Obi-Wan:]

Is this a market opinion or a political soapbox?
I agree on only one comment....there is enough blame to go around. But if you want to lay blame, don't forget the consumer in all this. We like when we have plenty of everything, instant gratification and live for the moment, not worrying about tomorrow.
Yes, it's time indeed for the reset button....past time.
Now if only Congress had people of vision and foresight who thought beyond padding their own pockets.....and actually served the public.
There, I did it, I actually succumbed to my own political diatribe...see what you all made me do??
*shakes head*

Apr 13 08:50 AM

[anarchist:]

Sether, great comment. Jim didn't just blame Conservatives he also blamed Democrats so get a grip you knee-jerk Bush conservatives.

Apr 13 09:59 AM

[anarchist:]

obi wan, there is no way to separate politics and the market, they are intertwined-especially in times of financial crises like now. If one ignores the influence of politics on the market they, in their ignorance loose a hell of a lot of money.


On Apr 13 08:50 AM Obi-Wan wrote:

> Is this a market opinion or a political soapbox?
> I agree on only one comment....there is enough blame to go around.
> But if you want to lay blame, don't forget the consumer in all this.
> We like when we have plenty of everything, instant gratification
> and live for the moment, not worrying about tomorrow.
> Yes, it's time indeed for the reset button....past time.
> Now if only Congress had people of vision and foresight who thought
> beyond padding their own pockets.....and actually served the public.
>
> There, I did it, I actually succumbed to my own political diatribe...see
> what you all made me do??
> *shakes head*

Apr 13 10:06 AM

[sdcougar:]

Despite the truth in some of his assertions about Republican 'wisdom,' here is one example of where he is way off base: "divorcing science from government decision making including taking no action on climate change."

Unfortunately, too many republicans have caved on the issue because the mass brainwashing that has been done with our tax dollars.

He wants our debt ridden government [read that our grandchildren] to funnel more billions of dollars down the rat hole of attacking a fraud-based claim, i.e. "man-made global warming."

We better spend our children's money on REAL problems.

see this video [an hour] which includes scientists that WERE on the IPCC.
video.google.fr/videop...

And the actual Global Warming? Temps are going down in latest readings.
'
Warming fears are the “worst scientific scandal in the history…When people come to know what the truth is, they will feel deceived by science and scientists.” - UN IPCC Japanese Scientist Dr. Kiminori Itoh, an award-winning PhD environmental physical chemist.'

Here is how scientists keep their federal research grants:
"“James Hansen and his underlings at GISS will always find a way to make the temperature data fit his global warming advocacy,” said Robert Ferguson, president of the Science and Public Policy Institute.

“Hansen’s track record for presenting false data is undeniable, and yet neither the press nor the government holds him accountable for his self-serving errors and lack of objectivity,” Ferguson added. “You couldn’t make this stuff up if you tried—you would be laughed out of the room if you presented this as a plausible story line in a fiction novel.”

And its effect?
Here is what is happening in the White House:

WASHINGTON – Tinkering with Earth's climate to chill runaway global warming — a radical idea once dismissed out of hand — is being discussed by the White House as a potential emergency option, the president's new science adviser said Wednesday.

That's because global warming is happening so rapidly, John Holdren told The Associated Press in his first interview since being confirmed last month.
news.yahoo.com/s/ap/20...

Apr 13 10:41 AM

[Jimbo:]

I support the views of suncatcher and prudent man. The conversation has morphed into the "climate change" mode. I took a grandchild on an Elderhostel program at Northern Arizona University in 2002. Astronomers at the Lowell Observatory told me they believed that the Earth's orbit around the sun, plus several poorly understood cycles of solar activity were the main drivers of climate on Earth. A city in South Africa reported the lowest ever reading for a September night last year and a mountain on the South Island in New Zealand had a record snowpack last year.Investor's Business Daily printed an editorial claiming the interior of Anarctica has actually cooled recently. They a;lso claim the recent ice melts on the periphery of the continent are being caused by a subterranean volcano. A similar undersea volcano is erupting in the southwestern Pacific, east of Australia. I fear that the climate issue has taken on a theological, rather than a scientific, tone.

Apr 13 11:44 AM

[ArtfulDodger:]

Hey Jim Kingsdale:

Thank you for this article and for all your work.

I hope your operation goes well.

The best to you, The ArtfulDodger

Apr 13 02:22 PM

[Tony Petroski:]

I love how an oil article morphs into a political screed.
Progressives of the World: How long will you refight the efforts made during the 1930's? This is the Age of Obama. Come up with a new debate.

Apr 13 05:28 PM

[football frank:]

Politics aside, the price of oil will rise over time because easy
access to oil supplies is getting harder to find. The good old
supply and demand theory will play out. By most accounts the
mature oil fields are in decline, and the new oil is more costly.
The recession has slowed investment in the tar sands, and off
shore projects. Once the economy turns, it will take awhile to
get production up to where we are accually keeping up with demand.
Projections by some show we are fighting a losing battle just
to keep pace, and the recession has made things worse.

Apr 13 05:54 PM

[Repsonsible...:]

This is the Interview that got Dylan Radagin FIRED from CNBC 3 weeks ago , He Tells the REAL TRUTH ABOUT THE TRUTH ABOUT THE BANK CORRUPTION GOING ON NOW , He was about to start Investigating the Bailout Money Transfer rom AIG of $180 Billion to Goldman Sacs but he was fired the day before and I fear he's in REAL Danger from the POWER Players on Wall Street and Washington .
heres the link www.fedupusa.info/Dyla......
pass it on !

Apr 13 10:35 PM

[clomark:]

...I was not a partisan until recent years, generally voting for the “best woman”...

I you are unable to recognize partisanship from this, then may be it's time someone explain it to you:

Partisanship: Adherent or supporter of a person, group, party, or cause, esp. a person who shows a biased, emotional allegiance.

As for your hip operation, I hope for you you didn't settle for the 'best woman doctor out there'. But again, what do I know, I'm only a man...

Apr 14 03:19 AM

[Soldalma:]

Mr. Kingsdale repeats the old story that the recession in 1937 was due to FDR cutting expenditures. He does not mention that wages went up 13.7% due to the National Labor Relations Act. That would be enough to sink any economy. Unless you are a Keynesian (which Mr. Kingsdale is) in which case you should think it was a huge stimulus. But neither of the two views fits his Keynesian dream, so he chooses to conveniently ignore reality.

Just like the Soviet Union was a major economic experiment that exposed the inefficiency of central planning, the New Deal showed that government spending cannot pull a country out of a recession. The recent academic literature on the subject, which I am sure Mr. Kingsdale also conveniently chooses to ignore, has been clear about the failure of the New Deal.

And we have another wonderful experiment showing the same thing: Japan since 1990. Never has a government spent so much and printed so much money for so long as Japan did since that fateful year, with absolutely dismal results.

So why do people keep repeating the same inanities as Mr. Kingsdale? Because they want socialism no matter how much misery it will bring to people: it is all envy driven.

Apr 14 12:05 PM

[john s. gordon:]

longo -
bush 43 wasted 1 trill $ and 4000 american lives + lots more maimed for life (physically & mentally) because 'they were the people who tried to kill my father' (he said it on tv, remember). this a private personal vendetta/
darth cheney's objective was to control all the oil in iraq (wolfowitz et al said the war would be self-financing using oil revenues, remember? he had no hesitation in steering all those no-bid contracts to halliburton - conflict of interest here.
> jack

Apr 15 06:32 AM

[john s. gordon:]

longo -
bush 43 wasted 1 trill $ and 4000 american lives + lots more maimed for life (physically & mentally) because 'they were the people who tried to kill my father' (he said it on tv, remember). this a private personal vendetta/
darth cheney's objective was to control all the oil in iraq (wolfowitz et al said the war would be self-financing using oil revenues, remember? he had no hesitation in steering all those no-bid contracts to halliburton - conflict of interest here.
> jack

Apr 15 06:33 AM

[john s. gordon:]

longo -
bush 43 wasted 1 trill $ and 4000 american lives + lots more maimed for life (physically & mentally) because 'they were the people who tried to kill my father' (he said it on tv, remember). this a private personal vendetta/
darth cheney's objective was to control all the oil in iraq (wolfowitz et al said the war would be self-financing using oil revenues, remember? he had no hesitation in steering all those no-bid contracts to halliburton - conflict of interest here.
> jack

Apr 15 03:08 PM

[john s. gordon:]

longo -
bush 43 wasted 1 trill $ and 4000 american lives + lots more maimed for life (physically & mentally) because 'they were the people who tried to kill my father' (he said it on tv, remember). this a private personal vendetta/
darth cheney's objective was to control all the oil in iraq (wolfowitz et al said the war would be self-financing using oil revenues, remember? he had no hesitation in steering all those no-bid contracts to halliburton - conflict of interest here.
> jack

Apr 15 03:08 PM

[john s. gordon:]

longoil -

cheney's objective was to control all the oil in iraq.
bush 43 had a private personal vendetta against the dictator, oil was incidental.
the irony is, the chinese will come in & control the oil & we really did waste the $ and the lives, not to mention the veterans medical care costs for the rest of their lives.
> jack

May 08 10:10 AM

[Freya:]

Its always been a political soapbox, why "change" now?

Stick with the first part, ignore the last.

Apr 13 09:12 AM