Latest from Coxe...
[Note: special thanks to Dara, who transcribed the main portion of the call.]
Nesbitt Burns Institutional Client Conference Call for January 20, 2006
Don Coxe
Chicago
“Iran and Nigeria Trump a Warm Winter for Oil Prices”
Chart: Crude oil
stockcharts.com[w,a]daclyyay[pc50!c100][vc60][iUb14!La12,26,9]&pref=G
Thank you for tuning into the call which comes to you from Chicago. The chart that we faxed out - the revised chart and call because we had to re-set the time is crude oil and our comment is Iran and Nigeria trump a warm winter for oil prices. I thought that in revision that we should bring Nigeria into this because the situation in Nigeria has deteriorated almost as fast as the situation in Iran.
So we've got lots else to talk about but I want to lead off with the oil story because the developments here have been really dramatic. We're not talking about something that's as relatively trivial as Katrina for oil. Trivial in the sense that at all times there was lots of strategic petroleum in reserve available to make up for what was lost and although it was going to be a big blow and it was going to be a knock to consumers and there was going to be a lot of human misery in it but in terms of the price structure for oil this was not a big a development as potential problems that we have unfolding in Nigeria and Iran. We have to take them seriously.
I think this was brought home to us yesterday from a very unlikely source namely Jacques Chirac who in speaking to the naval base where they have the French nuclear submarine he came out and said warning rogue states that if a rogue state were to make nuclear material or weapons of mass destruction available to terrorists, France would use its force de frappe namely its nuclear weaponry to respond.
Now this is the first time that I can think of in years where any NATO, I'm not sure of France's relationship to NATO it's always been a nuanced one, has specifically come out and threatened publicly to use nuclear weapons and since the rogue state that he is talking about, there are two of them out there, Iran and North Korea, but everybody said that he is really referring to Iran.
What it indicates is that Europe, the negotiators who thought they could use what they called constructive engagement to resolve this situation with Iran, that they've lost patience here. As usual with these things what you discover is developments come out that you hadn't really thought and they come in together and they can produce an outcome that is worse than anybody thought.
As we came into year-end although we knew that Ariel Sharon had had a mild stroke, he was so vigorous it didn't seem that anything else untoward was going to happen there and he was headed for an election victory with his new party that he had set up which was to be a more moderate party particularly moderate in the sense of dealing with the Palestinians than the Likud which is now headed by Bibi Netanyahu has always been seen whether accurately or not to be a party that was not going to yield at all in negotiations with the Palestinians and therefore the situation in that part of the world would not improve.
Well with this tragic situation Premier Sharon being incapacitated and an election coming up in a couple of months what this suggests is that the Israeli side of things could be in hardened hands and meanwhile the Palestinian election which looked a year ago to be progressive, it now looks as though Hamas is a real threat to depose the more moderate leadership of Abbas and now we have Iran really stepping front and center with Mahmoud Ahmadinejad saying a series of truly bizarre things. And yet as in Hamlet "if this be madness yet there is method in it", in a matter of a few weeks he has organized a conference in Iran - A World Without Zionism.
He made a statement that he would like to wipe out Israel off the map. He's suggested that it could be moved to Alaska or Europe, denies the holocaust and now what he's done, he's made it clear that the deals that are out there which seemed to be a situation of constraining the development of nuclear weaponry in Iran specifically the Russian proposal that they would enrich uranium and deliver it which would mean he could go ahead with building nuclear reactors but not nuclear bombs. He's now pulled out of all of these things. He's said he's not going to allow inspectors to come in and he said that if they take this to the Security Council and if there's any kind of sanctions imposed on Iran that he would cut back oil exports.
Now this really ratchets up the game because Iran is the second biggest OPEC oil exporter behind the Saudis and at 4 million barrels a day although they aren't using their full quota because they aren't putting the kind of money back into the ground that they should that's not what these kind of radical states do. Still there's something like 4 million barrels a day potential that could be pulled off the market in a worst case scenario. Now back in the days - now this was only 5 years ago - 4 million barrels a day might have meant 5 or 10 bucks it wouldn't have meant a global crisis. Now it means a global crisis.
Now that is a huge change in the fundamentals and Iran seems to be and this is where the method in it taking the view perhaps if you take a best case scenario with all these new oil fields that could be brought on stream in the next five years and all existing oil wells don't go into strong declines, that we could have a surplus of oil some time in the late parts of this decade which has been the view most conspicuously of Daniel Yergin that there was going to be lots and lots of oil and prices were going to fall back into the 40's or 30's.
Well you've heard me wailing on these calls for the last two years about what was the bad research on oil and that this has led to bad decision making, particularly of companies selling too much oil or gas forward. But in this case it could have another malign effect. It may be encouraging this guy who Maclean's magazine of Canada calls this week the most dangerous man in the world. It may be encouraging him to think that he's got to move now if he's going to use his maximum leverage.
Now whether he's guided by such things as supply and demand analysis, who knows? But one should not underestimate Iranians. This is a well educated society. A society that had until recently, a pretty interesting looking democracy although they didn't have final decision making power. They had a structure rather like the estates generale of France before Robespierre and the Jacobeans took over in their pursuit of the general will and therefore one could have some optimism that things were going to get better for Iran.
Well now what we have is this is the state that sponsored Hezbollah, which is one of the terrorism organizations in the area around Israel, specifically Lebanon. And given his desire to wipe Israel off the map, if he goes forward and develops nuclear weapons then we already know that Israel has advised the US that it's already made its plans if necessary if the US doesn't do anything about it or if Europe doesn't that they will try to take out the Iranian capacity the way they did with Saddam. They were denounced at the time for what they did to Saddam's reactor and that was a couple of decades ago.
The world should be grateful that Israel did that, but given the amounts of tension there are in the world right now, if Israel actually did go in first of all we don't know how effective they would be at being able to bomb him because the Iranians apparently have thought about that in terms of designing deep underground materials and so forth but it would make a bad situation in the Middle East much worse. So all of this is the stuff of fear about oil and what this has done, as we've said, is trumped the warm winter.
Now, it's true that it's very cold in Russia and Eastern Europe but the part of the world where it's really cold right now the total population isn't that heavy. It goes as far as what use to be roughly the Berlin Wall area, but Western Europe is pretty normal temperatures and certainly I've just returned from the Virgin Islands coming back to Chicago it was 54 degrees at 6:30 last night in Chicago. Now that is an April temperature for Chicago.
So what we should have at this point is miniscule prices for oil and natural gas and we're not getting them and meanwhile we're heading into the season where the oil refiners are going to have to be doing a lot of maintenance work which they kept on postponing because of the Katrina crisis situation. And as we found out from the disaster at the Galveston operations at BP, the industry hasn't been as good as it might have been because prices were so high and is was something that you could put off and that can lead to further troubles.
So what we have is a changed situation in the hydrocarbon outlook, much more negative. And if we needed any confirmation on that, I was watching CNBC and Daniel Yergin himself appeared on it. I've not seen him before, but he is the most articulate expert out there about the idea that oil prices should never have gone above $50, that it's all idle speculation. There's lots and lots of oil and prices are going to fall back into the 30's and he's able to charge thousands and thousands of dollars for his reports that demonstrate this.
Now you've heard me talk of him before with respect but in disagreeing with him because what he does is, I would say is, he takes the best case scenario. He takes all the OPEC countries forecasts for how much they're going to produce and he assumes that there will be no real decline rate of any great magnitude in the rest of the world and takes a rather cautious view of the increase in demand from China and India and so as a result of that what he has is a situation of great oversupply of oil starting late this year and continuing for several years.
As a matter of fact, he's got a lot of client work with OPEC and when you see the kinds of arguments that come out publicly among OPEC members about the need maybe to cut back on production, it always seems to come out after a Daniel Yergin report which indicated that there's lots of this stuff out there. Anyway, he was being interviewed and he talked about Nigeria and Iran and in response to a question, "Well, does that mean that oil prices can go back up above $70," and he says, "Well, if the situation continues, certainly."
Now this has been a man who's been, I think, for some time needing to have a way to get off from an extremely bad call. Traders know that if you're long and wrong you have to get off the position fast. And forecasters - and of course I'm one of them - it's very difficult to get off a bad call. And what you seek is some sort of deus ex machine, an event which people hadn't forecast but you can say, "Ah, well, nobody could have predicted that and so therefore I would have been right if that hadn't happened and therefore I change my call." And you hope that you can run that by an incautious audience and not look too badly about the fact that you've done a 180 degree turn on a bad call. So without ascribing to the distinguished Daniel any false motivation here, it's quite clear the situation has changed for the worst.
In Nigeria, it's really gotten bad because the Nigerian people now seem to have Islamist activity in there. And Islamists here I'm using in the sense of those who are really trying to promote an Islamic government in Nigeria. And this has been a problem that's bedeviled Nigeria basically since independence. And the battles between them one of the early premiers was Sir Abubakar Balewa and in a coup he was killed and thrown into a ditch and the winning side were ranked as Christians and Animists. It seems inappropriate to be ascribing religious qualities to the people who do these kinds of things but that's the way you categorize them.
So, up until now the problems with Shell in the Niger delta, have been a complaint between the Iger people who live down there and they live in squalor and the fact that the money that Shell pays out in royalties and other things goes upstream to the government and that money never comes back down to make life better for the people who are claiming it. And the government says, "It's not yours. It's ours. It belongs to the people of Nigeria."
And that argument went on and off and over the years there was all sorts of consequences of it, like Shell being forced to overstate its reserves in order to increase the OPEC quota. But now what we have is a new ugliness in this because you're actually getting hostage taking. You’ve had some killings. Shell is being forced to pull people out.
It's not clear that this situation can improve and new stability can return. And we're talking about a major exporter here. And also not just a major exporter, but Nigeria was one of the countries that there were realistic expectations that they could significantly increase their output over the next five years of oil.
So the best thing one can say about this, is that Nigeria is becoming one of those messy African states which were put together by the colonial powers and that the result is that what you have is old tribal divisions and now we overlay that with these religious divisions and in the Islamic area to the north which they've got a degree of independence, they've restored sharia and cutting off of hands and that kind of thing. And what you've got is the kind of situation where it is not easy to see an answer come for some time.
So, all of these are reasons for higher oil prices, despite the fact that heating oil isn't in great demand in North America. And this has contributed also to a recovery in gold - a dramatic recovery - gold and the precious metals. Because the rally that had been led as a result of looking like an undermining of the Bejing-Tokyo alliance and gold pulling back down after it was quite apparent that that had not fallen apart. Now we've got this new reason for money moving into gold. And certainly Mr Chirac's speech yesterday presented a golden opportunity indeed, because here you had the leader of France threatening to drop nuclear bombs on rogue states. Well that’s stuff that’s good for gold's historic role, which we hadn't thought we would be seeing for some time.
So we have the gold stocks back up and we've got all of that when you have oil and gold moving up together means that the 92% of the S&P which isn't oil and gold, has problems.
Now while I was away I did something that I haven't done much of for years, which is, I actually had a chance to watch CNBC during trading hours. So I had a chance to notice how it is that the public gets its information about these things. And oh boy the beating of the drums for the tech stocks was something ferocious. And came the day I believe it was Tuesday that we were going to get Intel and Yahoo! reporting after the close along with Freeport McMoran. And the Nasdaq had been soaring and they had nine strategists that I happened to see when just wandering through. I left everything on mute. I kept a score.
Of the nine strategists they had over the two weeks I was there that they had, eight said that tech stocks were going to be the market leaders this year and only one included energy stocks on the buy list.
So, you can understand with Intel and Yahoo! about to lead off for the techs there was also a little announcement during the day that Freeport McMoran was going to announce after the close. Well, Freeport McMoran announced doubled earnings and Intel and Yahoo! really disappointed. And the way they handled it was quite amusing because they cut back the time for Freeport McMoran's CEO's interview to three minutes and instead of asking him anything about how they managed to make all this money when their earnings up around 100% and Intel and Yahoo! are doing disappointing earnings. Intel, I note parenthetically, their top line revenue growth, year over year, was 6.2%. That's top line. Which is just about right on, with the sort of back of the envelope calculation about global nominal GDP growth last year. Not the stuff you would expect for one of the world's great tech companies.
Anyway, the interview with Freeport McMoran - they couldn't pronounce the name of the company correctly - and instead of asking him how he got all those profits, the interviewer in an agitated state, because he wanted to get back to Intel, said “Why do you think gold prices are going up?” and asked him to comment on the reasons for a demand for gold. Didn't mention copper, and didn't mention ore bodies or those kinds of things.
So what it showed once again, was that The Street is still positioned for things as they were, not things as they are or things as they will be. Nobody seemed to take any notice of the fact that both copper and aluminum prices are trading at multi-decade highs. The sell-off in Phelps Dodge came because Phelps Dodge had managed to follow through on their statements that they were predicting a big drop in copper prices.
In our most recent issue of Basic Points we ended up the comment noting that the Phelps Dodge management had predicted a drop in copper prices and they had sold 27% of their stock - the insiders. Well, they were consistent. They sold great amounts of copper forward but the told us that they had protected the stockholders against a price drop taking copper below 96 cents. So, with copper at 2.08 it's nice to know, stockholders, that you're protected if it should fall below 98 cents.
So it illustrates that those of us who were bullish on the metals, as usual, have to deal with all sorts of opponents including some of them who run the companies. So all of this says that nothing has changed in one respect, that the groups that we liked last year still look like the groups that are going to do well this year.
But there is one potentially huge change coming out there which comes on Monday in Canada with an election. It will be a huge change in the sense that if the Liberal party who are the natural ruling party of Canada, manage to lose this election with the Canadian economy in such strong shape - unemployment low, inflation low, economic growth very strong. If they manage to lose this election, it will be a real shock. And the political commentators will be talking about this election for decades to come.
I'll be watching that with interest. I'll be going up to Canada on Monday. The Canadian Dollar has been quite strong but not greatly strong in this but certainly any outcome that would put the Tories in power would be greeted I think favourably by the financial markets. Because the Conservatives would probably continue so much of what were good about the Liberal policies which were brought in by Paul Martin who arguably had the best CV of any prime minister coming into office based on his background.
The Liberals do seem to have bad luck with great finance ministers becoming prime ministers because John Turner who has been widely regarded as one of the great finance ministers, one of the greatest since Doug Abbotts' day, had difficulties as prime minister and lost an election. So maybe it's coming back to haunt the Liberals. If so, as far as my view of Canadian stocks, which has been that they will outperform US stocks, I've had that for the last four years. Nothing out there, no matter how the election goes, would change my view that that's the right way to go.
That's it, any questions?
Caller 1: Happy New Year. I have a question for you. It’s nothing that you talked about today, but specifically, there’s been some talk about the ballooning of M3 and its effects on the US market. I’m wondering what you make of that?
Don Coxe: Thank you. M3 was bound to balloon because of the Homeland Investment Act, which repatriated all this money which had, most of it had been in Eurodollar deposits abroad where it wasn’t measured anywhere. And the estimates are somewhere between 75 and 125 billion which was brought home. And until it gets spent on something, and it was supposed to have been spent on particularly on investment in technology, that was what people expected, it sits in deposits. And the kind of deposits it sits in, which are over $100,000, are the ones that are measured in M3.
And so the ballooning of M3 reflects a) that amount of money, which was out there before but it all of a sudden gets measured b) the amount of money investors have been putting into short-term deposits rather than into stocks and again, it’s measured in M3 and not in M2. It has nothing to do whatever with Fed policy because the Fed does not influence M3. And so, I regard that as…I do not oppose the Fed’s decision to stop publishing the M3 numbers because they are subject…I mean this distortion of the Homeland Investment act illustrates the limitation of that number.
If you go back to Friedman himself, he’s made it clear, right from the beginning, the signs of inflation are in growth of M1 and M2. When you consider over $100,000 figures, those constitute a form of savings at one time or another, or cash that’s being held pending major investments. And they are not the stuff of inflation. Inflation is the stuff of the kind of monetary aggregates directly created by the Fed and the Fed when it expands its own balance sheet, thereby by buying up T-Bills or by selling T-Bills, they directly influence the growth of M1 and M2. But M3 is fundamentally a form of savings product. And you could make a case that if M3 is growing faster than other monetary aggregates dramatically, it means there’s an increase in the propensity to save as opposed to a propensity to spend. Which is hardly the stuff of inflation.
So, this may be more than you wanted to hear, Laurie, but it’s…anybody who’s buying gold with somebody who’s using that as an argument is, I’m afraid, wrong. However, it’s nice to be right for the wrong reasons, too. So if somebody has gotten rich by buying gold stocks because of the ballooning in M3, I congratulate them, but frankly, that’s about as good as saying they were doing it because they thought they knew who was going to lose the Superbowl and therefore that it was going to be bad for the stock market and therefore it was going to be good for gold. Thank you, any other questions?
Caller 2: Don, hi, I’ve got two comments and one question. A comment first of all, Daniel Yergin, who’s been egregiously wrong in his predictions, was quoted in Forbes in September of 04 predicting flatly a $35 barrel price for oil towards the end of 05, in one years time. He has never been right in this thing and for the reasons that you’ve identified. Quoted clearly, $35 for oil. The second comment, on Nigeria, the Nigerian situation is somewhat much…and you know this certainly, but many of your listeners may not, Nigeria is particularly crucial to the world oil supply because it does supply sweet crude, very low-sulphur crude.
Don Coxe: Great point.
Caller 2: There is no, and I think there is general unanimity here, there is no surplus sweet crude, anywhere. Seventy-five percent or more of excess crude that supposedly is being held back in one form or another, is sour crude, certainly from Saudi Arabia. So, I don’t think you have a very promising situation in Nigeria and oil in general, because of the Nigerian situation.
My question is this, that one of the reasons floated out for the invasion of Iraq by the Bush administration, the current administration, was that Saddam Hussein had indicated and actually had begun trading oil in…receiving payment in Euros, which was conceived at that time as being a strike against the US domination of the Dollar. Whether or not it’s true or not, nobody knows, or I don’t know certainly, but there is this issue with Iran indicating they’re going to set up an oil exchange in which payment for oil would be in Euros. I wonder whether you can comment on that, whether that’s something of a pipe dream along the line of one of these people over there or whether it’s actually something they’re going to do and how would it affect the Dollar and general trading activities in oil? Thank you.
Don Coxe: Well, there’s no question that if enough countries who are selling oil choose to be paid in Euros, it would be a negative for the Dollar. It would be a negative for the Dollar because as it is now, one of the big reasons for demand for Eurodollars, which are on virtually all corporations balance sheets, no matter where they’re located in the world, is to finance inventories of commodities. And so, if you’ve got twenty-eight days of oil on hand, then you hold Eurodollars. Now, if we got away from holding them in Eurodollars and went to Euros, that would reduce the demand, very considerably, for Dollars. And so that would in itself, move the value of the Dollar downward quite significantly.
But once it readjusted, let’s say if the Euro’s at 1.20 and you took the inventory demand for Dollars out of it, let’s say that moves it, I don’t know, I’ll take a guesstimate here, ten or fifteen cents, once you’d made that adjustment there would be no further bad effects from it, but the one time adjustment would be significant. Then you come to the psychological effect, though, which is that if you took away the need to hold Dollars for multinational corporations, for inventories, what you’ve basically done then is dethrone the Dollar. Because it’s that absolute necessity of trading corporations to hold Eurodollars that backs up the form of the Dollar which is, as a world reserve currency, that central banks need to hold.
Central banks are unlikely to abandon the Dollar entirely because, who do they sell to? But, those are in order of importance, the first is holding by central banks, the second is global multinationals need to hold it to finance commodity inventories. So if you took that away, that would be a significant negative both in the short and in the longer-term for the Dollar.
But, frankly, I don’t think Iran is likely to exercise much leadership in this, because it seems to be that the only other country that is willing to follow Iran these days, is Venezuela, where Mr. Chavez distinguished himself by a Christmas Eve forecast, now that he’s got a close budding relationship with Iran and they’ve been seeing each other, that his Christmas Eve speech he chose to attach global Jewry and that was the message of peace and goodwill. Which he had never before done that kind of thing, but this was to show his kinship with those good men in Iran.
So, I don’t think frankly that if Iran does this, it would have much effect. But, if for some reason, this spread across the world, then we would have taken away the prime international role of the Dollar, other than the central banks. And that would be a distinct negative, you’re right. Thank you, any other questions?
Caller 3: Hi Don. I’d like to get your outlook on natural gas and on the equities markets of Latin America for the next year.
Don Coxe: Okay, the natural gas situation is…not really a global situation, now, because we don’t seem to be able to even move around what we thought we could have, liquefied natural gas. So, to the extent that there was an internationalization of natural gas proceeding, it still remained too marginal for a combination of reasons that I’m not going to get into now. So we’re looking at the natural gas that’s traded, the Henry Hub contract that trades on the screen here, is a North American situation.
And we’re up against the reality here that the North American natural gas industry is failing to replace its production. And in the lower forty-eight states, the decline rates on existing wells is double-digit. Which means that the rig count keeps climbing because you’ve just got to drill and drill and drill and drill and drill to try to replace what you’re consuming. But this is running to catch one’s tail. So, natural gas prices, which had gone to fourteen, fifteen dollars at the time of Katrina, because something like twenty-six percent of lower forty-eight production was Gulf of Mexico and a lot of that has come back.
But I think that natural gas fell then, simply because it is directly correlated to weather conditions and particularly in the Midwest where over sixty percent of homes are heated with natural gas. And so, to the extent that natural gas prices actually have stayed as high as they have, it illustrates that the substitutionality effect, which is another big user of natural gas, which is the industries that have a choice of using oil or gas, since oil prices are higher than people expected, that has propped up gas prices.
But in general, natural gas prices, the correlation is most directly with the weather and so, if natural gas prices can’t get back down to seven dollars with the kind of warm January we’ve been having, it suggests that prices could be quite a bit higher by summertime when we swing back to where heat does it as opposed to cold.
So, all in all, that is a big deal here. And of course with Bolivia being a major potential supplier of liquefied natural gas, apart from being a supplier directly, if they can manage the pipelines to Latin American neighbors, then the difficulties that we’re seeing as Chavez is destabilizing countries along the Andes mean that the kind of capital investment required to get out the natural gas from that part of the world isn’t going to help us.
So, with the Latin American situation, politically has deteriorated. No question about that. And that means that I think that you can expect higher energy prices throughout that region. It’s too bad, we’re talking all the way up to Mexico now, they’ve got an election coming and the kind of optimism that we had about Vicente Fox has dwindled and Pemex continues to be used as a source of revenues by the government as opposed to putting money back under the sea, particularly.
And with the second biggest oil field in the world in decline, all in all, all I can say is the kind of optimism that we had about greater energy supplies coming out of Latin America, that has dwindled to a considerable degree, but if we get more political stability and if Venezuela does not manage to destabilize some of these other countries, then what you’re looking at is potentially large amounts of LNG coming there. Thank you, any other questions?
Caller 4: Hi there, Don. Yes, it’s not only Phelps Dodge management that seems to be having low prices for metals going forward, it seems to be the case that the basis of analysts for the brokerage firms also have low prices going forward. But yet today, just one analyst, a fellow from Raymond James, Tom Mayer, has raised copper to two dollars and sixteen cents, I believe, average for 2006, way above anybody else. Any comment as to why they are so low?
Don Coxe: Well, this…it’s a little bit difficult for me to comment, as an outsider on all this. But I’ll just say that temember that the number of metals analysts fell along with the market capitalization of metal prices during the triple waterfall crash of minerals and of the mining stocks. And those that kept their jobs through that period were those who had cautious metals forecasts. And so, in addition, it’s a sort of a clubby industry and so the analysts who’ve been around for years know the people in the companies very well. And my maxim, as you know, is the best investment opportunities comes from an asset class where those who know it best love it least because they’ve been disappointed most.
And so, as somebody who couldn’t see any reason for owning these stocks during the 90’s because of the ghastly situation in the industry and then became very bullish on them, I find that I’m…I’m regularly upset by what I see as Wall Street’s minimal forecasts for metal prices. And, so in some sense it’s an uphill forecast problem. And, you know, they know each other, they talk to each other, they know far more about the subject than I do. And my definition in my book of shared mistake is where everybody who knows a lot about the subject agrees and they’re all wrong at the same time.
So I think that in terms of the forecast for metals prices, that it is a question that people who are really experts on this have been surprised by the sheer level of demand that’s come out of China and India. And since we still have this large cottage industry predicting a collapse in China, these people are unwilling to bet their companies futures on the idea that this will continue. So you can applaud them in one sense, for saying that they’re being cautious and protecting, because after all they’ve now got something really good to protect. They were sheer survival up until three years ago. And, you know, when you’re struggling to stay alive for years and now all of a sudden you’ve got riches beyond your wildest dreams, the temptation is to say “Well we’re never going to get in to that mess again. And in the past, every time we didn’t sell forward when prices went up, prices went down. So we’ve learned from that.”
There are two ways to deal with history. One is not to learn anything from it and the other thing is to learn the wrong things from it. And that seems to be the case in too many cases. So I agree with your point, Stephen, but here we are. Phelps Dodge stock has broken down again, it’s back down to a lower low than the day they came out with the announcement of their, the breakdown on their forward sales.
So, it’s a problem, but I think those investors out there who’ve followed our viewpoint have to realize that they’re up against a situation where virtually so many of the accounted experts are wrong and are continuing to be wrong. So you have to bet against them. And oddly enough you have to bet against the insider selling. Insider selling has been a perverse indicator. Thank you. Any other questions?
Caller 5: Yeah, hi Don. You know, I’m just sort of thinking through some of your scenario because it’s quite easy to see here where we could get a dramatic move in oil prices and things could go, as we know in these sort of situations, quite quickly. Obviously, it could cause a lot of damage in the markets and the response would likely be lower…a cut in interest rates at some stage, I would assume. I would be interested in your thoughts on that, but at a time when we already have huge amounts of liquidity, what would you think would happen, in terms of where that liquidity would find itself? And do you think inflationary pressures, inflationary threats could come back? I’m just trying to think of what would happen tomorrow if oil finds itself at a hundred dollars, which is totally possible.
Don Coxe: Well, one that would happen if we had a hundred dollar oil is that we would have a global recession. Because that would just be too much. Then the oddity would be that the central bankers would have no choice but to re-liquefy. And, you know, we already have what people are calling is a bubble in long bonds, particularly bonds denominated in Euros and in pounds and maybe even in Dollars in terms of where the Ten-Year Treasury note is.
This liquidity is finding itself into odd areas. It’s driven up the precious metals, but it’s also driven down interest rates at the long end, which ordinarily move inversely. So, there’s been so many things that have happened in this decade, which are contrary to the experience of the entire fifty years before that, that it’s very difficult for forecasters. So, what is clear is that the industrial capacity figures, which in the past used to be a sign that central banks needed to tighten, no longer are as helpful because the Chinese keep creating such massive extra capacity for goods that do get measured in the CPI. And they still have massive amounts of excess capacity.
And now you have India coming in there. The tech stock that did have the best earnings last week, of the ones that I saw, was Wipro, Indian company. And that illustrates the fact once again, that we are getting competitive pressures on a scale nobody imagined coming out of China and India, which are driving down prices of goods that are measured in the CPI.
So things that aren’t…there’s no competitive pressure, like university educations with tenured professors who can spend their time then with…they only teach a few hours a week and they can spend their time denouncing free markets, apart from that, which keep going up in cost, where there is a market pressure out there, it’s holding it down. This is the kind of economy that Adam Smith envisioned in his great moments of what might happen in a true free trade environment. And it’s illustrated that it’s very hard to get inflation in that.
So I still don’t think that the price of gold is measuring the fact that there is real inflation out there that isn’t being measured. The oddity is, that if you’ve got a 0.6% yield, real yield, on a fifty year Treasury, inflation hedged guild, that shows you that there is another kind of rush for liquidity to move into. And, never seen it before, you’ve just got to adjust to the fact that the old ratios can be misleading. Thank you. Any other questions?
Caller 6: Good morning, Don, I’m more of a bear on natural gas than others on your call and it just seems to me that at some point, the weather does have to have an impact. I was reading an article last night and there was a quote from an old gentleman from West Texas who used to say in similar situations “It ain’t right, but it’s true.” I just don’t get it, frankly, with natural gas, the huge amounts in storage. So it’s more of a question. How much can the geopolitical risk relating to oil continue to prop up natural gas prices where at some point the utilities are going to say “We don’t need to buy any more at these prices because we have more than adequate storage”?
Don Coxe: Very good point. The figure that I last recall, and it may have changed, that something like twenty-six percent of natural gas usage is industrial. And of that, about half is subject to substitution for oil. That includes plastics and chemicals and so forth. Well then, if you take those numbers as being some rough level of accuracy, then sixty-seven dollar oil means that at least thirteen percent of natural gas usage, you can bet that the users are switching away from natural gas to using oil.
Now, of course when they do that, it means that more natural gas stays in storage. So…but the utilities are in the awkward position that because of the Clean Air Act, those utilities that are based in nuclear or coal, since of course building a new nuclear plant is completely impossible and if you have a coal plant you aren’t supposed to expand the output without a special Presidential permit, under the Clean Air Act, you have to, for peaking, and unless you get a whole new plant commissioned, you have to use natural gas for excess demand.
So, that, this was built into the law and nothing was built into the law which said you don’t have to rely on this if natural gas prices are above six dollars an MCF, because nobody ever thought they’d go there. So those are two constraints…you’re being rational about the supply/demand situation and with all that in the ground. And there’s times when being truly rational was a way to lose money. As a matter of fact there’s probably lots of people on this call who say “Yeah, well we’ve thought that about you for a long time.”
So those are two examples. I’m not saying that they completely explain the situation, but it illustrates that there are reasons why we can’t just equate it. It does look as if, based on the past, with all that gas in storage we should be back down to five or six dollars an MCF. But it ain’t happening and who knows, then, the worst of all scenarios could be we could have a cold February.
Caller 6: Yes, thank you.
Don Coxe: Thank you. Well, I think I’d better call it quits at this point. I realize I’ve been away for a couple of weeks, but you’ve been very good those of you who’ve stayed with us on this call, but we’ll be on the call next week with lots more to talk about. Thank you for being back and let’s hope the rest of the year gives us as much good stuff to chew on.
Don Coxe Profile from the BMO websites:
Donald G. M. Coxe is Chairman and Chief Strategist of Harris Investment Management, and Chairman of Jones Heward Investments. Mr. Coxe has 27 years experience in institutional investing, including a decade as CEO of a Canadian investment counseling firm and six years on Wall Street as a 'sell-side' portfolio strategist advising institutional investors. In addition, Mr. Coxe has experience with pension fund planning, including liability analysis, and tactical asset allocation. His educational background includes an undergraduate degree from the University of Toronto and a law degree from Osgoode Hall Law School. Don joined Harris in September, 1993.
Don Coxe Weekly Conference Call – Current
bmoharrisprivatebanking.com
Basic Points – Archive
Basic Points is a monthly publication of opinions, estimates and projections prepared by Don Coxe of Harris Investment Management, Inc. (HIM) and BMO Harris Investment Management Inc.:
harrisnesbitt.com |
