Stagflation and Peak Oil: How Related Are They? (Part II) 23 comments
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(See part I here.)
Investing in a Stagflation environment reminds me of a game that we used to play when we were kids. You would think of two disgusting scenarios, and have to pick the lesser of two evils. Stagflation reminds me of that. Quick, choose between slow growth and high inflation. Unlike when we were kids, however, you get to be stuck with both.
So, what does well during a period of Stagflation? Not much - but, you can at least protect (and gain somewhat) by changing your portfolio to reflect the times. Earnings will rise dramatically, so at first glance, things don't look that bad. However, when you strip out the rise in earnings that is directed attributed to inflation, the generic growth of companies slows to a halt, which does a nice job on P/E ratios. Consumer discretionary stocks normally take a beating, as people can barely afford to eat, heat their homes and put gas in the tank...
So, what might work? No one knows for sure, but here are some ideas:
Invest in what is going up
This one makes sense, but it is often overlooked. What does well during a time of Stagflation:
- Interest rates. In order to combat the inflation spike, rates go up accordingly. One play on this is Treasury Inflation Protected Securities [TIPS]. These are tied to inflation, and provide a little bit more return than the inflation rate. You won't get rich, but you'll keep up your buying power. One way to play them is through Lehman's ETF (TIP).
- Gold. In past bouts of hyper-inflation, Gold has been a great hedge. No one knows for sure if this will still be the case, but the odds are good. Two ways to play this are the commodity itself and its producers. The commodity takes out the risk of exploration and high costs of production, but also takes out any extra leverage. If you like to sleep at night, look at an ETF such as streetTracks Gold (GLD), which gives you a straight relationship to the price of bullion, minus a small management fee. If you like the extra leverage of a gold producer, now is not the time to look for a small fry - think big. Two great plays at Barrick (ABX) and Newmont (NEM). A third player (still large, but with a bit more of a growth pattern) is GoldCorp (GG).
- Real Estate. Most homeowners will see a rise in home prices inline with inflation. So, if you own a home, you might be able to skip this part. If you don't, I'd look for a REIT ETF. Unless you follow the actual REITs themselves, this is an easier way to play it.
- Oil Producers. The inflation is likely going to be directly related to the higher price of Crude. One way to play this is to own those who own the Oil. There are two types of companies that you can look at. Either way, think big cap here too. First, some of the State owned companies are listed on the various markets, and they tend to have a more consistent reserve base. Two to look at are Statoil (STO) and PetroBras (BZE). A third one, if it continues to come back to a more reasonable evaluation, is PetroChina (PTR). The second type of companies are the Publicly traded ones. Again, think big, but also think those who have a decent reserve life. I personally like Devon Energy (DVN) and Conoco-Philips (COP). Devon has a great growth profile, and just seem to know how to effectively and cheaply raise their reserves. COP is relatively average in performance, but always trades at rock bottom prices.
- Oil Service companies. A more leveraged way to play the price of the crude. These stocks tend to swing at a much more leveraged rate to the price of Oil than Producers. There are three that stand-out in my mind. First, Schlumberger (SLB) has a dominant stance in this field. It is an expensive stock, so wait for a pull back. My value play is Baker Hughes (BHI), who does tend to disappoint investors once in a while, so be forewarned. Finally, my third play is to provide leverage to the increasing drilling happening off shore, and that is Transocean (RIG).
- Companies that can easily raise prices. Here, you want to look for companies that have little trouble passing on costs. I tend to like companies with very strong presence/brands and those with an international scope (to better play the shrinking Greenback). Two that I like are Coca-Cola (KO) and Intel (INTC). Even if the cost of Coke were to double, it is unlikely that people would change their habits too much. Their strong distribution network also protects them from lower cost alternatives. As for Intel, their dominance in the growing Processor market is one that isn't likely to end soon. There is a large movement to push all of the world to a Digital Age, and Intel is a great way to play this. They will also benefit from a shrinking greenback.
- Companies with a low P/E now. These companies, especially ones that are well financed, can often weather the storm well. One that comes to mind is Pfizer (PFE).
- Areas that will benefit from what is causing the inflation. In this case, those who can help us kick the reliance on Oil. One easy play is General Electric (GE), with their strong stance in the Green space. The next two may shock you at first: Honda (HMC) and Toyota (TM). I mean, aren't they part of the problem? Yes, but people will still need to get around, even in booming oil times. These two companies are the leaders in low-energy cars, and this isn't likely to change (Sorry, Rick Wagoner!).
Areas to avoid (in no particular order):
- Auto (except Toyota and Honda)
- Airlines
- Transportation
- Travel
- Durable Goods / Consumer Discretionary
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This article has 23 comments:
Then there's the supply problem. The deficit is already enormous and is growing as more bailouts and "stimulus packages" force the Treasury to borrow ever more. For now demand appears to be keeping pace, but there are limits. When (not if, when) foreign central banks decide they've had enough, this game will come to an end and interest rates will rise abruptly. TIPS all have intermediate to long duration (no 1-year TIPS, sadly) and will be crushed when 10-year rates inevitably hit 10% while the CPI continues to be reported at benign levels like 4-5%.
Fred -- You're absolutely correct. I mean PBR....
209003 / drooyich:
- There no absolute guarantees when it comes to how to invest...all you can do is to guess what might go up.
- In terms of some of the stocks that are mentioned, I know most of them well, and they undoubtedly will give you good leverage to the respective commodities. One of the issues is that no one really knows for sure which commodity will be in the most demand. If Nuclear really does take over, then Uranium Participation (U-Toronto) is a great play. Same goes for Coal, with Fording Coal.
- However, if the technology somehow moves us away from these commodities, they will get killed (unlikely, but stranger things have happened).
- For Uranium exposure, I like U.To to play the commodity, and Cameco (CCO-Toronto) to play the producer. No position in either.
Bearfund -- Dont disagree with you on your statement. I guess it is the only Government-protected way to play it, which is why I mentioned it....I'd love to get another way myself...
Cheers
Larry
you are right on track with energy services and energy investments. they, along with precious metals, will be the only investments americans will have available as long as we don't do what is required, which is to enact a comprehensive long-term energy policy to protect our country from the economic reality posed by the "oil problem":
thefitzman.blogspot.co...
failure to enact an energy policy will mean economic chaos long before global warming has time to destroy us. we have about 5 years to make serious in-roads on an energy plan or this country will be completely hosed. you're already seeing the beginning effects on our currency, stock, and financial markets. unlike the 70's when the saudis turned on the "spigot" and fixed the problem for us, there's no spigot any more, and we import much more oil (70%!) now than then. the US gov, media, and citizens are in oil denial. soon enough though, the realities will be so clear even a moron will be able to figure it out. of course, you'd think $145 oil would have done it too....
It seems odd to me that there isn't much discussion of these and the focus is still on playing energy stocks of the fossil fuel era.
Bottom line is that the entire industrial/agricultura... revolution has been built on oil. It will probably take another 100 years (short of some amazing free energy discovering of huge porportions) to simply make the transition. US Geothermal in the right areas could really be good kind of like hydroelectricity. I also like the idea of windmills as a supplement provided they can build them to last forever with very very little maintenance. Seems like a very good idea versus solar which you still have to replace every 20-25 years plus batteries. Oil shale may help with the transition. Oil/Coal/Nuclear are still the cheapest forms of energy and will likely remain so for a while. This country needs to become more energy independent. It will not only reduce the trade deficit but could actually get people back to producing real things in the country.
Finally, there will be no Stagflation. Hyperinflation leading to a depression is more likely.
For alternate energy, I'd try... oh, wait, my wind power stock went to nothing. Never mind. But my geothermal stock... oh wait, it went into bankruptcy and the reorganization cheated the stock holders out of everything.
GMiki -- Nothing wrong with small-caps. My personal preference is large-caps in downtimes. Look at how many small caps become extremely volatile. When it looks like we are going to start to come out of this, small caps will absolutely destroy large caps, no doubt. Until then, might be kind of risky, at least for me.
I'm not one to chase Alternative energy, but this is the way of the future. I think it may be better to play technologies that have a place today. I like Wind, Nuclear and Solar, but there aren't a lot of safer ways to play this. GE is about as safe as you get, and even they have gotten killed (although that is more to do with their Financial exposure).
Keep the comments coming! I have thick skin....=)
One risky, but with good upside, way to play Alternative Energy is Hanwei Energy (HE - Toronto). They have great exposure to both current fuel sources (material/piping used in Pipelines) and future sources (Wind Turbines and others). They also are a safe way to play Asia/Russia, as they do all of their work in those areas, but follow Canadian Accounting practices.
As a disclosure, this is about 12% of my portfolio now. Risky, but I think this one could be a 2-3 bagger in a couple of years from here.
In addition to the two plays for oil, futures and equity ownership, there is a third, to buy your own leases or to invest with honest operators, who may still be in the majority. There are almost as many scams in the oil mining sector (it really is a mining activity) as there are in gold mining. I live in the Illinois basin, and raise 3/1,000,000ths of the daily refinery input nationally. It is a lot of fun when you learn the business; it has taken me 15+ years to get here.
I think that the housing uproar has a long way to go before prices, in real terms, rise. Suburbanization has made major commuters of most of us; in the 1930's, factory hands lived close to their work, and walked it both ways. In my time, I have car-pooled to work, and did not feel the need to be able to come and go as I pleased. When I rode a bus to work, I would wait in the morning and calculate the percentage of cars passing with more than one head showing; scores were one to three people.
Ownership of gold is attractive now, as it was in the 1920's; acquiring bullion is a nice idea, but about 1934, Americans were required to surrender all their gold, while for silver, that went out the same way around 1965. As compensation, we were allowed to own gold and silver as bullion or as coins.
What are the chances of confiscation again?
The thermodynamic comments were of interest. A variation on the three laws, 1) You can't win; 2) you can't break even; and 3) you can't get out of the game. When applied to wind and solar energy, both are ephemeral; solar weakens substantially at sunset, and weakens under dense cloud cover, requiring rechargeable batteries, while wind does not blow steadily. I have priced both sources, and currently cannot justify investing in either for the production of power at currently prevailing prices for electricity.
The other recommends SWN, RRC, NFX, and HK so that opens up a few more opportunities for people looking to follow that route.
Wages and Inflation correlate. Also, wages and home prices correlate. Therefore, your statement about Inflation and Home Prices correlating makes sense at first glance.
However, in the most recent housing bubble, home prices far outgained wages due to much easier obtained credit. And we are in the process of home prices deflating back towards wages.
So the Inflation we've been experiencing, mostly from high commodity increases, has not seen a corresponding increase in wages, and furthermore, there has been a deflationary effect in housing. I question whether it makes sense to put down a highly leveraged 'bet' on real estate or not.