Haymaker - Friday Edition
In The Ring - June 23rd, 2023
“It has become cheaper to look for oil on the floor of the New York Stock Exchange than in the ground.” -T. Boone Pickens (A quip from him many years ago but just as true today… possibly even more so.)
"My formula for success? Rise early, work late, strike oil." -Jean Paul Getty
Charts of the Week
Despite generally weakening economic data — including a deepening manufacturing recession in Europe and the likelihood of an industrial downturn in America, as well — central banks are being forced to tighten due to sticky-high inflation. The Bank of England hiked by ½% (50 basis points) yesterday, shocking markets. The European Central Bank also recently raised by ½%. Per the below chart, the 10-year government bond rate in the U.K. is threatening to take out the peak it hit during last fall’s chaos in that market. Longer-term Treasury rates in the U.S. are also moving higher. Should this trend continue, it could trigger a sharp correction in the U.S. equity market, which has been exceedingly complacent. Over the last week or so, however, signs pointed to a fading of that no-worries mindset.
(Click chart to expand)
In my 44 years in the financial industry, I’m not sure I’ve ever seen such an odd divergence as the below chart showing the divergence between the stock price of the main homebuilder ETF (green line) and lumber prices (orange line). Clearly, something is out of whack. Presently, a limited supply of new homes is boosting the builders. This is likely why housing starts recently surprised to the upside. However, I question how long this can continue when affordability continues to be atrocious. If long-term government bond yields do breakout to a higher level, that might narrow the gap shown below.
(Click chart to expand)
Opportunity Pounding
Quick… what was the best performing S&P sector of 2021 and 2022? If you guessed tech, you’d have a lot of company. Unfortunately, though, you’d be wrong. The most adored segment of the S&P 500 has returned 35%, including dividends, since 12/31/2020, while the long neglected, even detested, energy component generated a total return of 130%. That’s quite a difference, don’t you think?
This year, of course, it’s been the inverse. Tech has been utterly en fuego, soaring 38% while energy has corrected 6%. As usual, sentiment and money flows are reflecting this recent performance gap. The feverish animal spirits toward tech right now have caused inflows into related funds to soar of late. One recent week saw the strongest tech inflows on record. Along these lines, on Tuesday The Wall Street Journal ran the following chart:
Figure 1
As strong as the flows into the tech sector, the number for TSLA is a stunner, greater than the other four growth superstars combined. The $1.37 trillion exceeds its market capitalization and I don’t quite get how that can happen since it indicates net purchases, presumably after adjusting for sales. Regardless, this does reflect the rabid enthusiasm presently for the sexiest growth names (more on this in the Down For The Count section).
When it comes to energy, conditions couldn’t be more different. Over the weekend, I listened to a podcast with a man who runs one of the largest energy funds in Canada. He stated that sentiment is as negative as it was in the spring of 2020 when the futures contract price for oil went negative. Another expert on CNBC on Monday made essentially the same point.
The below speculative positioning chart for the U.S. West Texas Intermediate (WTI) contract validates their views. The white line is the net of the long and short positions. (A low reading means that shorts are high relative to longs; the orange line is the price of oil.) As you can see, it is below where it was at any time in 2020 indicating extreme bearishness, the stuff of which powerful snap-back rallies are made.
Figure 2
A prime reason for that negativity is the punk price action by oil for almost a year. It’s tumbled from a peak of around $120 last summer to $70 this week, with a few forays even below that level. This type of plunge typically only occurs when inventories are bulging as they were in the spring of 2020 as the world was locking down. Yet, today, it’s the polar opposite with inventories at shockingly low levels, at least adjusting for releases from the Strategic Petroleum Reserve or SPR (the blue line below). As you can see, oil stocks are the lowest in 30 years. Moreover, demand is much higher than it was in the early 1990s.
Figure 3
(Click chart to expand)
That last part is critical because it’s apparent that most investors, using that term loosely, are focusing on the unadjusted inventory data. Frankly, the reality is that the oil market is heavily influenced by hedge funds and other hyperactive speculators. It’s their positioning that is largely reflected in Figure 2 above. The derivative (or paper) market for crude is at least 30x greater than the physical market. With most key commodities, the ratio is more like three to five times larger. As I’ve relayed in prior notes, these fast money players have been selling immense amounts of futures contracts of late, like over 50 million barrels. Hence, this has resulted in the large short position displayed in Figure 2. In the not-too-distant future, it will need to be covered. Assuming the SPR gets refilled at some point, that’s more de facto short covering that is likely to occur. This is a key reason why I feel an explosive oil rally is highly probable.
OPEC is making it clear that it is not a fan of the SPR releases. It’s further miffed that the predicted replenishment has not yet begun; in fact, additional drawdowns have occurred. In early June, I opined that I doubted OPEC would cut its output yet again in retaliation. As an organization it didn’t, but Saudi Arabia announced that it would do so unilaterally. That takes another million barrels/day out of an inventory balance that is as tight as the face of an aging movie star who’s had too much plastic surgery.
Meanwhile, the world’s leading quasi-governmental authority on the oil market, the International Energy Agency (IEA), continues to be in deep denial about the grave shortage. This is a situation that has been going on for over 20 years with the IEA periodically — and surreptitiously — revising supply down and demand up. In February of last year, it made a stealth 2.9-billion-barrel upward revision to global consumption. That’s about five times the normal level of the SPR and over eight times its current depleted status. The Eighth Wonder of the World is how the IEA has any credibility after so many years of misleading those who rely on its data. This is mainly due to its inexcusable blind spot about the rapid growth of energy usage in developing countries.
The positive side of this is that it has once again created a stellar opportunity for independent-minded investors — those who truly think long-term — to capitalize on this persistent misinformation campaign. Oil futures contracts continue to trade at a discount to the current or spot market, a most unusual condition. As a result, ETFs that invest in a series of contracts that expire over the next two years continue to offer appeal for those who don’t want to participate in the futures market (as I do personally).
For most Haymaker readers, however, buying oil and gas producers is a more conventional way to take advantage of the current apathy — even antipathy — toward this sector. Those heavily oriented toward America’s most prolific oil-producing basin, the Permian, may be particularly attractive. One of the best companies located there is down 25% from its recent high. It trades at a single-digit P/E and with an estimated free cash flow yield in low double digits. There are rumblings that Super Majors like Exxon are preparing to make an acquisition of a leading competitor. If so, that should have a positive impact on the prices of all the top-tier Permian producers.
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Should oil take off again and fly well over $100, as I anticipate, that would be a very powerful catalyst for this company and its peers. A relatively new development that could trigger such a price spike is a recent pronounced dropoff in the drilling rig count. This should aggravate the situation I mentioned in our June 2nd edition, courtesy of Raymond James, the fact that oil and gas discoveries are down 90% from their 2006 peak.
It’s ironic that the stock market is embracing the no-recession narrative, yet oil prices, and stocks, get beat up on almost a daily basis due to fears of an economic downturn. This is despite the likelihood that China’s reopening — its halting nature aside — will increase oil demand more than a recession would reduce it. And that’s before factoring in OPEC’s cuts and Europe’s ongoing need for additional oil to replace the energy supplies it’s lost from Russia.
To close out this Champions section, please look back at Figure 2 above. If you had bought energy stocks every time the white line got down this low since 2011, or even somewhat higher, you would be a very happy investor. If I was doing a podcast, I’d be pounding the table about now. In this case, you’ll just have to imagine that sound, but you certainly don’t have to ignore the message.
Champions
Oil and gas producer equities (both domestic and international)
Japanese yen
Gold & gold mining stocks
Farm machinery stocks
Select financial stocks
U.S. Oil Field Services companies
S. Korean stock market
Copper-producing stocks
For income:
Certain fixed-to-floating rate preferred stocks
Select LNG shipping companies
Emerging Market debt closed-end funds
Mortgage REITs
ETFs of government guaranteed mortgage-backed securities
BB-rated energy producer bonds due in five to ten years
Select energy mineral rights trusts
BB-rated intermediate term bonds from companies on positive credit watch
Contenders
Despite the glowing future I see for nuclear energy, the recent run-up in uranium in general, and an ETF that holds it, in specific, is causing me to be a bit more cautious on U2 for now. Part of this is due to the weakness it exhibited from my initial positive uranium write-up last October. For a time, it was one of the worst performers of the securities I’ve highlighted. Now, though, it is up from each of the points when I wrote it up favorably. While I’m not suggesting you consider profit-taking, unless you are very heavy in this weighty element, it might make sense to suspend any purchases until it works off its current overbought condition. Long-term, though, I suspect buying it around this level will likely produce substantial gains. Of course, there are considerable risks with any nuclear-related investments should there be another Fukushima-type event.
Uranium
Short-intermediate Treasurys (i.e., three-to-five year maturities)
Japanese stock market
Top-tier midstream companies (energy infrastructure such as pipelines)
European banks
U.S. GARP (Growth At A Reasonable Price) stocks
Telecommunications equipment stocks
Swiss francs
Singaporean stock market
Intermediate Treasury bonds
Small cap value
Mid cap value
Select large gap growth stocks
Utility stocks
Down For The Count
It’s my suspicion that out of 15,000 subscribers, and 17,000-plus weekly readers, there are quite a few of you who own Tesla. If you’re one of them, congratulations! It’s been a spectacular run from the early-January nadir at around $100. When it was down there, the market capitalization had shriveled to a somewhat modest $330 billion. Today, it is over $800 billion. That’s nearly a half-trillion-dollar increase in its market value. Hey, I’m good with numbers, aren’t I?
Seriously, my point is that almost a $500 billion valuation increase is massive and it should be driven by the kind of knock-your-sox-off earnings eruption such as what Nvidia reported last month. In fact, $300 billion of that enormous increase came in the last month, apparently as a result of other EV makers signing on to its fast-charging network. Enthusiasm for TSLA’s potential to use AI to enable AVs (I know, too many initialisms — Autonomous Vehicles) was another catalyst.
It’s now trading 35% above the average highly bullish analyst price target. As Barron’s noted on Wednesday, that’s not typical. It’s also strange to see such a monster increase in market cap when sales and profits have actually eased quarter-over-quarter. As has been widely publicized, it has been cutting prices, impairing operating margins. It’s also offering free charging for some models, another sign of flagging demand and/or fierce competition.
In my view, TSLA is one of the biggest beneficiaries of the “echo bubble” occurring right now, the successor to Bubble 3.0. As I’ve often written, I am convinced — with copious amounts of supporting evidence, I might add — that it was the biggest bubble in human history. It ranged from negative yielding bonds to worthless cryptos sporting $88 billion market caps. There were also meme stocks, NFTs and SPACs that rose spectacularly before become total sinkholes. As was the case with Bubble 2.0 (housing and subprime mortgages), real estate and the banking system also were caught up in the frenzy, with deleterious results. (To my way of looking at financial history, tech in the late 1990s was Bubble 1.0 and its implosion would eventually lead to the inflation of the next two.)
It’s my belief the flush from Bubble 3.0 is far from complete. This current echo bubble is both a gift and a threat. It’s a gift for those who take advantage of this latest bout of nonsensical pricing. It’s a threat for those “investors” who get sucked into buying at absurdly high prices.
Returning to TSLA, it did get slammed on Wednesday as I was writing this note, undercutting some of the timeliness of my warnings. As a result, it may bounce back a bit, but it has become so extended that there is an outsized risk of a far more serious derating.
By the way, when it hit $102 in early January that was basically a 75% buzzcut for anyone who had bought it during the most intoxicated days of Bubble 3.0. Ergo, even teflon Tesla can badly burn anyone reckless enough to pay through the nose to own a piece of Mr. Musk’s dream machine. With competition in China, its most important market, having become beyond brutal — BYD is selling EVs at $12,000 over there! — more earnings problems are entirely possible, even probable.
(Full disclosure: I am personally short TSLA but I did cover most of my position in late 2021 and early 2022 before re-shorting into the recent upside explosion.)
Electric Vehicle (EV) stocks
Meme stocks (especially those that have soared lately on debatably bullish news)
The semiconductor ETF
Junk Bonds (of the lower-rated variety)
Homebuilders stocks
Financial companies that have escalating bank run risks
The semiconductor ETF
Bonds where the relevant common stock has broken multi-year support.
Long-term Treasury bonds yielding sub-4%
Profitless tech companies (especially if they have risen significantly recently)
Small cap growth
Mid cap growth
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Can anyone give me another hint on the Permian oil producer he is referring to? PXD is the competitor with rumored buyout, I'm assuming. Apache, Coterra, Fang, Diamondback? I am invested in PXD, CTRA, And APA. Thanks!
That is a wild divergence on lumber. Surely has something to do with this what I would say is a structural issue on housing inventory. Weird economic times..