Shiv139

Oil Up $6 to $104

What are the cyclical opportunities for out-performance? When will the out-performance from secular growth sectors re-commence?

This article looks at out-performance opportunities at a sector level. The aim is to identify where we are in the economic cycle and use history as a guide to seek out the coming sectors of out performance, within the present economic cycle.

The article also applies the sector rotation rationale applicable to an economic cycle to a multi-economic-cycle level; the aim being to identify the secular (16 year; roughly 3 economic cycles) trends. The intent is to identify sectors which are in secular bull formations and which will lead during the next cyclical bull.

Sam Stovall's vision on sectors is used in identifying the typical flow through sectors during the course of an economic cycle.

The conclusions are - out-performance opportunities are in financials & IT. Secular sector to lead the next cyclical bull will continue being Energy after a cyclical correction.

Peak Oil - Are We There Yet?

Very well put together article.

The problem with predicting peak oil is that proven, probable & possible reserves are used. The swing factor which can defer peak oil for many, many years is the unknown. To date just about 1/4 of the earth surface has been explored. With technology now available, shallow water and mid water has been explored for some years. We are now well into the age deep and ultra deep-water exploration. It has never been done before because the price of oil never did justify the investment. Driven by demand for oil from emerging markets in India and China, oil prices have now risen well over the marginal cost of ultra deep-water. As a result, there has been huge investment in ultra deep-water. Coming from this economic viability, we will have increased exploration. This combined with technical feasibility & equipment availability, will ultimately bring new reserves. So yes, we will continue to rush towards peak oil; but we are likely several years away.

In the mean time we are in a demand led secular bull market for oil. Increasing demand with supply side concerns have pushed oil prices ahead of fundamentals. Within this bull we have recently entered a cyclical bear. During this period of the cyclical bear (approximately 1.5 to 2 years), I expect oil prices to revert to economic equilibrium (where marginal cost equals marginal revenue - somewhere between $50 and $70 per barrel); at these price levels investment in ultra deepwater is viable.

Then the next cyclical bull within a secular bull will emerge. Over the course of the secular bull (roughly 2003 to 2019), you will see some things happen:

1. Structurally, the world is less energy intense (a $ of GDP has a smaller energy dependency compared to the past) compared with the seventies. The energy intensity of emerging markets will reduce considerably. This will reduce the impact of oil prices on the real economy; this is a net positive because investment can continue at higher price levels because the real economy is able to absorb the higher price with lesser demand destruction.
2. Since oil is a finite resource, there will be many new conservation technologies which will result in demand reduction.
3. For the same reason, there will be new alternative energy technologies which will reduce dependence on oil.

Today, the oil demand curve is generally inelastic; however, we have now reached that part of the demand curve where the price elasticity is high. At these elevated prices, two things will happen in the long term - (a) the demand curve will change from very inelastic to less inelastic as energy alternatives are adopted & (b) the entire demand curve shall shift inwards as a result of shifts to energy alternatives and more importantly, because technologies to improve oil energy utilization will evolve.

From an investor perspective, oilfield services and drillers are very appealing. Integrated Oil Majors, E&P & refiners too, but to a much lesser extent - today most opportunities in exploration and production are led by the State. In addition, in the years gone past, the majors commanded respect because they had the intellectual property & equipment required by the business; this drove nations to production share agreements with the Majors. Today engineering, IP and equipment can be obtained as a service from fantastic companies such as Schlumberger and Transocean. Yet, at this point in time, because of our entry into the cyclical bear, I would wait for valuations to get better before committing to the sector. Trading position (few weeks - risks are low oil is oversold); short term position (few months) risks are high; long term position (a year) risks are high; secular position (12 years) risks are insignificant. Expect a contraction in valuations in oilfield services; but do not expect it to be very harsh; I would say 50% to 65% from peak value is what can be looked for. For drillers, the backlogs created provide a high degree of stability but leverage could end up being a significant risk if new build contracts are terminated (delivery delays & performance are fairly common reasons for termination).

Wall Street Breakfast: Must-Know News

Like the UK FSA, early Friday morning the SEC too has banned short selling for financial services. While stocks can still be shorted; naked short selling is history for now. You can see the full text of the SEC orders at www.sec.gov/news/press....

A significant rally is likely to develop in companies where naked shorts have been high. These would include GS, MS, C to name a few. The financial services sector has a positive catalyst in terms of the additional liquidity provided to the market and initial steps taken to address the solvency issues causing great concern on capital markets. It would take significant foolish guts to short the sector. So for this sector expect a strong rally on account of short covering.

Outside financial services, we can expect to see Energy and Metals recover too; though the exuberance might be muted compared with financial services. Technology is another area where naked shorts have built up since Dell cited concerns on growth. NOTE THAT THE BAN IS ONLY ON FINANCIAL SERVICES, BUT I EXPECT SYMPATHY TRADING IN OTHER SECTORS.

Since the short covering adjustment will be a one time event, it will make sense to adopt a trading position - i.e. use the rally to exit in a few weeks. For financial services, the risks to short term positions, long term positions and secular positions, while considerably reduced, remain elevated. The healing process has begun and much will happen between now and the end game; this will allow building value positions with lower levels of risk (because of better visibility).