These facts could change your mind too

Tuesday, 30 July 2019
Adelaide, Australia
By Bernd Struben

  • Prepare for the unthinkable
  • ‘Restrictions on the use of cash’ laws

When the facts change, I change my mind.’

John Maynard Keynes

There are a lot of reasons to be bearish on the price of crude oil. And bullish on the businesses that benefit from cheap fuel.

Regular readers will recall that through much of 2018, I said crude was overpriced.

In the run up to 3 October — when West Texas Intermediate crude (WTI) hit US$76.41 — a chorus of mainstream analysts were cheerily predicting crude would breach US$100 per barrel.

Not me.

The supply and demand dynamics simply didn’t stack up. Meaning demand was…and is…growing slowly. Meanwhile, supply has never been greater.

That supply glut continues to be driven by the fracking revolution in the US. This has seen the US become a net exporter of oil. The nation is set to pump a record amount of oil in 2019. And the US Energy Information Administration expects each of the next four years to set even higher production records.

But it’s not just the US. The world is awash in oil. If not for OPEC+ (which includes Russia) managing to cut their output, WTI would likely be trading for US$40 per barrel…or less.

With this picture in mind, in your 26 September Insider edition, I suggested you might want to consider shorting oil. Shorting simply means you gain when the oil price falls…and lose money if it rises.

My preferred method for shorting commodities like oil is an inverse ETF. There are several to choose from. Some offer leverage, so you gain (or lose) two- or three-times the amount of any changes in the price of oil. (Depending on the amount of leverage.)

And lo and behold, by 24 December WTI had dropped to US$42.53 per barrel.

In my opinion, crude overcorrected to the downside. As tends to happen. My forecast price range for WTI in 2019 was US$50–$60 per barrel. Anything above that, I’ve written before, presents a shorting opportunity. While any prices below this are a potential buying opportunity.

As oil marched steadily higher earlier this year, I’ve reminded you of that a few times. WTI recently peaked on 23 April, hitting US$66.30. Today it’s trading for US$57.21 per barrel.

Now that’s nicely inside my US$50–$60 forecast. So what’s the opportunity here?

We’ll get to that right after the markets…

Markets

Overnight, the Dow Jones Industrial Average closed up 28.90 points, or 0.11%.

The S&P 500 closed down 4.89 points, or 0.16%.

In Europe the Euro Stoxx 50 index finished down 0.89 points, or 0.03%. Meanwhile, the FTSE 100 gained 1.82%, and Germany’s DAX closed down 2.43 points, or 0.02%.

In Asian markets Japan’s Nikkei 225 is up 70.85 points, or 0.33%. China’s CSI 300 is up 0.67%.

In Australia, the S&P/ASX 200 is up 22.20 points, or 0.33%. If it can hold these gains to closing, that would mark a new record high.

West Texas Intermediate crude oil is US$57.21 per barrel. Brent crude is US$64.01 per barrel.

Turning to gold, the yellow metal is trading for US$1,425.51 (AU$2,065.36) per troy ounce. Silver is US$16.45 (AU$23.83) per troy ounce.

One bitcoin is worth US$9,513.32. It’s been mighty quiet on the bitcoin front of late. If you think bitcoin is getting set for its next big move, you’re not alone. Details here…

The Aussie dollar is worth 69.02 US cents.

Prepare for the unthinkable

Up top you’ll see the oft-repeated quote from economist John Maynard Keynes. Though in truth there’s doubt Keynes ever uttered these words.

But the point is that the facts around oil have changed. Or more precisely, they could change at any time…in a big way. And that’s changed my mind on the best way to play crude over the next month or two.

Oil nudged up about US$1 per barrel overnight. That tells me investor fears over a hot war breaking out between the West (it won’t just be the US) and Iran remain balanced with worries that the global economy and trade are slowing down.

On the demand side, I think the market has it right.

On the supply side, oil is slightly overpriced…so long as nothing goes seriously wrong in the Persian Gulf. And a lot could go wrong in the increasingly militarised Strait of Hormuz.

You can see that marked on the map below:



chart image
Source: Google Maps
Click to enlarge

You may have heard the Strait of Hormuz referred to as a ‘vital’ shipping lane for the world’s oil. That’s no hyperbole.

Some 21 million barrels of oil pass through the narrow strait every day. That’s around 20% of total global oil production.

As you can see on the map, Iran controls the entire northern front. Four of the world’s other top 10 oil-producing nations — Saudi Arabia, Iraq, Kuwait and the United Arab Emirates — also rely on the strait to transport their oil to international markets.

If a hot war erupts with Iran, all of that supply could be disrupted for weeks or even months.

Now, I certainly hope that won’t happen. But tensions are reaching the point where it won’t take much for things to spiral out of control.

You’re likely aware Iran is less than pleased that the US pulled out of an international nuclear treaty endorsed by Obama. Trump — rightly or wrongly — labelled that among the worst treaties ever signed. One that still enabled Iran to construct ballistic missiles, enrich uranium to low levels, and sponsor proxy wars among its neighbours.

The US has since imposed harsh sanction on the Iranian regime, including an oil export embargo that’s crippling the nation’s economy.

In recent weeks, the US and Iran have shot down each other’s unmanned reconnaissance drones. The UK and Iran then escalated matters by commandeering each other’s oil tankers. And of course, Iran has been busy ‘allegedly’ sabotaging tankers plying the Strait of Hormuz. 

Then last Wednesday, Iran fired a medium-range ballistic missile that flew some 1,000 kilometres.

Meanwhile, the US and UK navies are building forces in the Persian Gulf while the US has recently sent troops to Saudi Arabia to prepare for the unthinkable.

And the Saudis — along with US ally Israel — would like little more than to see Iran bombed back into the Stone Age.

If you cram enough hostile soldiers, sailors and missiles into a narrow strip of land and seas, it doesn’t take much for something to go wrong. If US lives are lost due to Iranian actions, the US response will be overwhelming. Trump said as much when he showed surprising restraint and called off a counter attack following the downing of a US drone in the Gulf.

I don’t believe Trump wants to go to war. But if war erupts, I expect he will bring more force to bear than the world has seen before.

Last week, when he was asked about Afghanistan, Trump said he could win that war in 10 days. But he didn’t want to do that, as it would come at the cost of 10 million lives. As quoted by ABC News:

I have plans on Afghanistan that if I wanted to win that war, Afghanistan would be wiped off the face of the Earth. It would be gone. It would be over in — literally in ten days. And I don’t want to do — I don’t want to go that route.

Now Iran has an impressive military. That includes a coastal battery of missiles that could easily shut down the Strait of Hormuz and inflict heavy damage on US warships.

Right up until the time that they’re ‘wiped off the face of the Earth’.

All we can do is hope that calmer heads prevail. And that the Iranian regime comes to its senses, swallows its pride, and returns to the negotiating table.

In the meantime — if tensions continue to rise, if more tankers are hijacked or sabotaged, or if the shooting commences in earnest — the odds of a sharp spike in oil prices far exceed the odds of a deep slump.

The facts, you see, have changed. If only for a few months.

Should peace prevail, as I still think it may, WTI will likely trade in the low US$50 per barrel range this year and possibly lower next year.

But if hostilities ramp up and the Strait of Hormuz closes for business, oil could spike above US$100 per barrel in short order.

If you agree there’s a fair chance oil could be in for a short term price spike, there are numerous long oil ETFs to choose from.

If you have a higher risk tolerance and are willing to keep a close eye on your trades, you could consider the ProShares Ultra Bloomberg Crude Oil ETF. It offers two-times daily leverage based on oil futures prices. (Note, futures prices do not always align with spot prices.) Always proceed with care when using leverage!

Also, please remember that I do not make official recommendations here. You should do your own thorough research before investing a single dollar of your hard earned money.

Moving on…

‘Restrictions on the use of cash’ laws

That was fast.

In yesterday’s Port Phillip Insider we looked at the limited scope central banks have left to keep asset prices afloat.

With the Aussie cash rate at 1.0% — and likely to fall to 0.75% or even 0.50% later this year — RBA governor Philip Lowe’s powers of market manipulation are fast waning. That is, so long as we are allowed access to paper money. But you should never take that access for granted.

Here’s what I wrote to you in yesterday’s Port Phillip Insider:

So long as we have good hard cash to fall back on, negative rates on the consumer level just won’t wash. With that in mind, keep an eye open for a revived media blitz linking cash (and cryptocurrencies) to all kinds of nasty crime, terrorism and tax evasion.

Fast forward, well, 12 hours to today’s headline from The Sydney Morning Herald, ‘New cash transaction rules slated for next year’.

The new rules in question ban businesses from paying or taking in more than $10,000 in cash payments. Criminal penalties apply.

The SMH notes:

An exposure draft for the government’s “restrictions on the use of cash” laws outlines fines of more than $25,000 and possible prison sentences of two years for business owners who knowingly accept or pay large transactions in cash after January 1, 2021…

Minister for Housing and Assistant Treasurer Michael Sukkar said the government was “committed to continually ensuring our financial system is hardened against criminals and terrorists without placing undue burden on industry”…

Australia’s black economy costs the country more than $50 billion in lost revenue each year, according to [black economy] taskforce projections.

There you have it folks.

Cash is costing the nation $50 billion a year in lost revenue due to tax evasion. And Sukkar trots out the old ‘criminals and terrorists’ line without breaking stride.

All while the nation’s cash rate heads to zero…and lower.

Quelle coïncidence!

We’ll leave it there for today.

Questions or comments? Send them to letters@portphillipinsider.com.au. If we publish them here we’ll only use your first name.

Cheers,
Bernd