Just a Commodities Correction - Not the End of the Bull (Part 2)

By Eric Roseman

As I said yesterday, the commodity bull market isn't over...not by a long shot. Even with the higher dollar and the temporary correction in oil prices, it's still a mistake to think we're on the cusp of a commodity bear market. 

This simply isn't the same oil bull market we saw in the 1970s. For starters, the energy sector is not as reliant on U.S. domestic consumption compared to 10 or 20 years ago.

Compared to the last oil shock in the 1970s, China was barely a factor in global consumption. Today China is the primary reason why most commodities are in a secular bull market. That's also the case regarding oil. It's a primary demand-driven trend that won't end anytime soon.

The Chinese are becoming big global consumers. Total domestic retail sales in China grew a formidable 23% year-over-year through July compared to just 0.1% in the United States. The Chinese are avid consumers and of course, major exporters. The economy will continue to grow and that means the consumption of raw materials, including oil.

Compared to the 1970s when China was barely a dot on the consumption map, today they   devour excess supplies of most commodities - especially on corrections or when prices dip lower. The Chinese hoard commodities during big corrections.

Barely Any Demand Destruction in China

What some investors fail to understand is the primary source of new oil demand comes from the emerging markets, not the United States or Europe.

According to Merrill Lynch, oil demand growth in the emerging markets has never contracted year-over-year in the modern era. Although demand destruction has started in the emerging markets, the overall trend for consumption remains long-term bullish.

Total oil supplies remain in deficit to the tune of roughly 2 million barrels per day or 87 million barrels of demand compared to 85 million barrels of supply. That discrepancy in supply and demand has been consistent for over a year and remains threatened by supply bottlenecks in many oil-producing markets and threats of regional conflicts.

Oil Stocks are Cheap

A stable dollar is a plus for world growth because a lower dollar will help moderate inflation for many emerging market currencies. This should stimulate economic growth and demand for oil and other distillate fuels at a time when the global economy is slowing.       

Provided that U.S. interest rates remain low for the foreseeable future, and they will, global economic growth will continue. Oil prices will find a floor. That makes energy stocks a great buy at these distressed levels.

I've been busy buying oil and energy services companies over the last few weeks following big price declines. Most oil stocks are not priced for US$75 oil let alone oil prices north of US$100 per barrel. And compared to banks, energy stocks have real assets and real earnings!

Cash-flows for the majors in the United States, Canada, and Europe are bulging and dividend payments are still increasing. These stocks now trade at 52-week lows and should form a bottom over the next several few weeks or sooner as oil prices finally trough.

Thank God for the Chinese!

To recap, the global macroeconomic picture is nothing like it was in the 1970s. This is perhaps the most significant bullish point I can make about this big correction for raw materials. We don't have skyrocketing interest rates and double-digit inflation.

China is now a major player with regards to commodity consumption. It was almost insignificant 30 years ago. Thank goodness for the Chinese. If they didn't exist the bear market in U.S. stocks and bonds would be far more severe, the dollar would be near-worthless and commodities would be trading in the basement.

Provided that global interest rates remain historically low and the United States and Europe can eventually stabilize the ongoing credit crisis then global economic growth should reaccelerate later in 2009.

A stable dollar will also mitigate inflationary pressure globally and that's a positive development for new consumption. Also, slowing growth and lower commodities prices now will eventually open the door to central bank rate cuts in 2009 - a boon for commodities.  

The time to buy or accumulate new positions in the energy sector is now. The oil majors and the oil drillers have been smashed hard over the last six weeks and offer great value in an otherwise sluggish earnings landscape. Earnings for the oil majors and the drillers will continue to flourish even at US$75 oil, which I don't expect unless the Chinese economy collapses. And that won't happen anytime soon.   

Comments

[maximax:]

"We don't have skyrocketing interest rates and double-digit inflation." - we do not have double digit inflation due to changes in the measurement thereof, using the old methodology, inflation would be double digit. Google Shadow Stats for more info.

"According to Merrill Lynch, oil demand growth in the emerging markets has never contracted year-over-year in the modern era." - comments like these kill it for me. So you are writing about oil but do not even seem to have access to consumption stats, you seem to be merely quoting the conclusion of others. That won't go far in the shady sector of oil... and you get it wrong in saying that consumption increases have all been from the developing world. the big consumption jump of 2004 was led by China, but the US came to a rather close 2nd. But the main theme of the article, commodities are just pulling back and will resume, sounds reasonable to me, for oil that is. However that oil pullback could now last a bit longer than the 3-6 months I personally had expected, unless political events necessitate a strong rebound.

2008 Aug 20 06:38 AM

[CLH:]

Little you say I can agree with. The US is cutting back as is most of the developed world. However, the developing world will cut back much faster as subsidies are removed. How much gas can a man making $1 a day buy? The only countries not cutting back are the producers. How much oil can they eat?

Oil has a long way down to go.

2008 Aug 20 07:35 AM

[Ishortyou:]

oil have bought a lot of special interest in Washington, but now too bad for the politicians with special interest in oil, the situation is becoming a major headache, specially in the middle east and Russia adjacent regions, the public is getting upset as well, so now things are looking different, aiming at developing new technologies that will free us from oil or fossil fuel for good.

2008 Aug 20 07:36 AM

[mangolfer:]

Good post CLH. Very true... I'm puzzled why people are long oil right now, probably bought in earlier and will lose a lot. They will lose more if they don't get out now, unless they want to hold on for many years to see if it ever comes up to the bubble level again. Everybody everywhere is reducing consumption. I believe, once we break $100, it's bottomless. $80 oil here we come.

2008 Aug 20 07:48 AM

[hoolio:]

'you seem to be merely quoting the conclusion of others'

Presumably the only way he can avoid quoting other people's conclusions here is by personally counting all the barrels of oil?

2008 Aug 20 08:33 AM

[David Martin:]

Since oil production has remained broadly stable for the last 3 years and new discoveries have been far less than consumption since around the 70's, your thesis that oil will resume it's rise shortly should be correct.
It is so right, furthermore, that it will destroy the second part of your thesis, that falling prices will re-stimulate growth.
As growth takes off again rising oil prices will soon throttle it.

2008 Aug 20 09:41 AM

[Alphameister:]

Excellent article, and your decision to buy oil service stocks now should be successful regardless of the direction of oil prices for the foreseeable future. China is likely to be very cautious about reducing subsidies for gasoline considering that its primary focus is now promoting growth.

2008 Aug 20 10:29 AM

[bowman711:]

Does CLH stand for 'Curmudgeon & Lunatic Here'?

2008 Aug 20 10:28 PM