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

 |  Includes: DBC, DJP, GSG, OIL, UDN, USO, UUP, XLE
by: The Sovereign Society

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.