Yet another shoe to drop?

This is not going to be an "I told you so" post, because I agreed to it.
But GS have been down sharply this week while XLF has been rallying; the divergence seems to be +20% over just a few days. Anyone know/hear what's up??

When Will the Oil Bath End?

This market has been painful. I have been mainly bullish on oil because of the supply dynamics, and I have underestimated the degree of demand destruction that a recession can bring. I really did think that oil prices could remain high even if the rest of the economy was slowing. It has been scary watching how quickly entire economies are unravelling, not to mention its stock markets! It's been difficult to keep a level head as you see your capital evaporate, but I've been trying to focus on some investing principles.

Buying around the bottom is as good as you're going to get. Timing the actual bottom is probably luck.

Buy companies with little debt. Even blue chip GE is suffering because of the huge amount of short term commercial paper that it needs to roll over.

Buy companies that make essentials. This has been covered with our previous investment in consumer staples as opposed to more luxury items. I believe energy companies and oil service companies fit the bill here too!

Buy the long term trends. This one I have found difficult to use investment wise. For example, the demographics of the baby boomers suggests that nursing homes and funeral homes will become big industries in the future but this is not easily investable in the near to medium term. Even the price of oil is long term upwards, but that doesn't mean that oil is a buy now!

Having said all this I believe that oil service companies are good investments today. Most are trading in the low single digit forward P/E range, and many have backlogs of orders that extend out further than the next oil cycle.

There was a good article in the FT today about the world's oil fields maturing faster than anticipated. The higher decline rates approach 9% without reinvestment and will still be 6.4% with massive investment. All this required reinvestment bodes well for the long term fundamentals of oil service companies. I find it hard to believe that a recession can cause demand destruction of 6.4% a year. (only a depression of historic proportions could decrease energy use by 6% a year!) The article cited that any slow down in oil field reinvestment would eventually magnify the decline of oil flows!

I won't give any price predictions for oil as my recent track record has been weak! It will be interesting, however to see where the price of oil eventually levels out, as everything has been sold off in this great global credit unwind.

Deal Hangovers!

There was an article in the G&M business section last week that tweaked my interest. It was about announced takeovers that were trading below the takeover price because of the global credit crisis. The biggest case of this was/is BCE which has been much blogged about including here on Fulton Associates.

Of course the one that caught my eye was an oil and gas producer, Tanganyika (TYK), an oil producer in Syria. It has had an impressive increase in production this past year, but the more impressing thing is the buyer - Sinopec. This is a Chinese national refiner and petrochemicals company which is partially owned by China Petroleum and Petrochemical company. Did I say this is a Chinese national oil company already? Sinopec Group last month lost to India's Oil & Natural Gas Corporation (again state sponsored) in the tussle for Imperial Energy Plc (a Russian firm)

Bottom line is that even with the credit crisis, who else has the cash to make a modest $2 billion acquisition?

TYK was trading at $26 a day prior to the takeover bid. The bid is for $31.50. On Friday Oct. 24, it closed at $23.98. This is a 31% upside!

It has been well reported that Chinese companies have been buying up resource assets throughout the world to secure supplies for their growing domestic economy. While nothing is risk free, the board of directors of TYK unanimously support this deal and other insiders and officers of the company have signed on to a lock up agreement with Sinopec that represents 16% of the outstanding shares.

Please tell me why I shouldn't back up the proverbial truck and load up!

Shorting US Treasuries

Macroeconomics has always been part of our blog's discussions in our attempts to profit from trends. Over the last year I have had internal debates about whether inflation or deflation will predominate our investing landscape and how do we invest accordingly. I have been very much a gold bull for most of my investing career but recent events have me wavering!

To summarize the arguments for continued deflation: longest and largest credit expansion in history has to be repaid, de-leveraging in general, worldwide economic slowdown, physical limits to the growth of fossil fuel supply.

The arguments for inflation follows this line of thinking: monetary and credit expansion by central banks, coordinated and competitive devaluation of national currencies, continued increases in energy input costs.

Although recently the scales have been tipping into deflation, the overall outcome is hard to predict. Can there be an investment that can capture both outcomes with less risk? Recently there has been a massive flight to safety with an incredible rally in the $US as well as US Treasuries. This has been a normal response many times in the past and yields recently on short term US Treasuries have been close to zero. Investors are willing to accept almost a zero real rate of return (and possibly negative) for the assurance of return of capital.

So one option is to do like other investors and buy government T-bills. If hyperinflation (unlikely) prevails you get less real capital back. If there is just modest inflation then your return is small to zero. It there is deflation you win.

What if there was a way to short US Treasuries? The reasons for shorting is an expectation of higher rates of interest for the US government in general. The bailout packages and nationalization of private business has been unprecedented and all this money needs to be funded by selling more US Treasuries. The US debt keeps climbing and its fiscal position has never been worse. So my thesis is that even without inflation, the US faces higher interest rates and potentially much higher. I am unaware of many ways to play this aside from buying the Proshares short fixed income ETF's. They have two - PST which tries to replicate the inverse of the 7-10 year Treasuries and the TBT which replicates the inverse of the 20+ Treasuries.

If inflation takes off due to all the re-inflationary efforts of the Fed and Treasury and government, then bonds will sell off. If deflation continues to ravage the economy there is a boundary of coupon rates that should provide a ceiling on how high these bonds can be bid. Some short term US Treasuries are already close to zero percent yields, and the official Fed rate of 1.5% isn't that far off from zero either.

There are probably other ways to play interest rates in the futures markets but I don't know how at the moment.

Stupid Analysts! how can we sue?

Lulu is down 10% based on an analyst downgrade! In the worst bear market in 80 years, the stock drops $30 to $20 in 3months (not bad), and on the day the market capitulates, the stupid analyst comes out with a downgrade! What's the point!?!? Is someone paying this guy to observe this stock is down, along with every other stock in the universe? If you are brave, and still have some cash, this stock will pop 25% over the next few days as the market recovers.

I also want to highlight the role of the Ratings agencies in this mess. They use the i-banks stocks price as part of their credit scoring, so when the stock drops, they cut the rating, which in turn makes the cost of borrowing/capital higher for the distressed bank which in turn drops the stock. No wonder there was a run on Bear and Lehman, this was the easiest money for the short hedge funds!
Nevermind they were complicit in the initial AAA investment grade of subprime CDO's, by taking the fat payouts from the dealers across the street!
These Ratings agencies have to go!

Fear, Greed, ... Hunger?

Like most market participants, I am gripped with fear, but with a tinge of greed! Templeton/Buffet have made a lot of money when others were selling in panic.
Is it my imagination or am I seeing a bounce in the Ag sector? I mean DE, POT and MON have fallen a long way down so it could be a dead cat bounce but they were outperforming the broader markets the past few days. Are they going to lead the way out? People have to eat... don't they?

Are we there yet?

I am referring to the capitulation stage of the market bottom. The down turn has been scary to say the least, but the selling has been so orderly and rational, with average volume, I wonder if we've hit the panic selling phase yet?
I think there's a better than 50% chance we're headed lower from here.

Conventional Oil and the Price of Crude

I read the following interview from Forbes with the CEO of Schlumberger today and he had some interesting insights into the future for oil and gas service companies.

Article

He said that even a global recession wouldn't change demand for drilling of traditional oil basins but the higher priced more difficult stuff like shale and tar sands projects would be affected first.

I still think that although the price of SLB has come down with everything else, this industry is the best way to play the end of cheap oil and natural decline rates. When the economy recovers, or when decline rates become more transparent, the actual producers of oil and gas will be better to own.