I had warned about the risks of an oil price crash and doomed commodities bubbles as early as March 2008, when Goldman Sachs’s super-spiked economists (whose lemonade was surely spiked!) predicted that black gold was headed to $200. I had argued the bearish case for sterling, the Kiwi dollar, the Iceland kroner, Sensex, Hang Seng, shipping/container shares (DP World is now 36 cents) since at least last November, when I sensed the mother of all stock index shorts as the bubbles peaked in Shanghai and Mumbai. I had postulated that credit leveraged real estate speculators faced the kiss of death as property bubbles imploded all over the world with the Black Death in the international money and capital markets. Last week, my crystal ball finally shattered into crushed glass as the wicked witches on Wall Street condemned the financial world to a decade of the most brutal Darwinian shakeout since the Great Depression of the 1930’s. This time, sadly, the wolf is not at the door but prowls in the bedroom. Irrational? Not at all. Lord Keynes taught us that markets can stay irrational a lot longer than we could stay solvent, particularly if one was a client of the 4X leveraged structured note, preferred shares private banks of the Gulf where the golden goose is invariably slaughtered just to grab the golden eggs of 8% upfront, but hidden broker/banker payouts. Keynes again. In the long run we are dead, in the short run we get wiped out with margin calls.
OPEC’s decision to slash output by 1.5 million barrels a day made no impact on the oil market, which fell to $63. Oil has lost 60% of its value since July or $84 a barrel, making the oil crash of 2008 as vicious as the crashes of 1983, 1986, 1999 and 2001. Even Saudi Arabia’s agreement to cut 2% of world demand, OPEC biggest production cut since the 1990’s, means nothing since an epic oil glut will slash gasoline demand this winter. However, it is significant that Brazil, Norway, Russia, Mexico have not agreed to any production cut, making any OPEC decision meaningless. So I doubt if Saudi Arabia, Kuwait or the UAE will be willing to enforce quota discipline, particularly on cash strapped maverick producers like Iran, Nigeria and Venezuela. Saudi Arabia will not concede its market shares in the Far East refineries during a supply cut if Caracas, Lagos, Baghdad and Teheran all refuse to cut production because every petrodollar foregone hits the odds of regime survival. During an oil glut, Saudi Arabia is no longer willing to play the role of swing producer, the proverbial central bank of oil. So, OPEC geopolitics, Saudi oil policy, the Kremlin’s need for cash (Lukoil is oligarch owned and Kurdistan has given out its own oil concessions), the Baltic Dry Fright Index SOS (now down 90% from its May peak), the $52 prices for dated Ghawar Light, global recession all suggests that the real crash in oil prices will only now begin in earnest.
Could oil prices fall below $50? Absolutely. OPEC could not defend $100, they cannot defend $50. The If quota discipline is violated in OPEC, US inventories rise and the global oil glut deepens, crude oil markets will behave exactly as in 1999 and drive prices down to $10 – 20 a barrel. The reaction of the West Texas/Brent crude oil futures markets to the Vienna production cut convinces me that the smart money does not believe that OPEC will have the production discipline to cut quotas as refining demand collapses. Does Iran really intend to cut 200,000 barrels a day? If not, why should Saudi Arabia slash another 400,000 barrels as the Vienna conclave dictates?
I doubt if America’s friends in the Middle East will prevent a fall in crude oil prices because the White House criticized the Vienna pledges as “anti market production decisions” and called for open, competitive oil markets. This message will not be ignored in Riyadh, Oslo, Brasilia, Mexico City, Kuwait and Abu Dhabi.
What signs of life in the global markets? One, stock markets price a 50 – 80% fall in EPS in 2009, which simply is loco. Two, sentiment and volatility are at extremes. It is an axiom on Wall Street that stocks bottom before the economy. I define an economic bottom as a 8 – 9% US jobless rate. Three, the money markets are unfreezing from the Ice Age LIBOR (but not EIBOR) has fallen 100 basis points. Warren Buffet is dead right. If you wait for the robins, spring will be over. Four, valuation metrics are no longer expensive in the US. I think SP500 earnings are in the 65 -75 range, not the $85 – 90 implicit in valuation models. So I believe risk lies in the market till SP500 trades down 10 times or 650 points. This is not the time to capitulate. I repeat. This is not the time to capitulate. Five, Europe trades at 1.2 times book value and 6% dividend yields and cheapest to Germans Bunds. The last time the world saw such valuation metrics, Uncle Adolf was Chancellor of the Third Reich.
What shares do I nibble for my value (5 year Rip Van Winkle portfolio?). Cash rich beauties like Microsoft, Exxon, Cisco Systems. Horror stories? The merchants of debt in Las Vegas and Macau, like MGM Mirage, Las Vegas Grand, Blackstone or any of the crumpled doll hedge fund IPO’s. My ideal shorts? Auto drillers and MENA banks. Play close attention to credit default swap spreads. They never lie, unlike brokers, press releases and self styled pundits/bandits on Wall Street. Where would I find triple bagger plays? Convertible bonds, volatility arbitrage, leveraged loans, sterling range accruals. Hedge funds? History’s ultimate death wish margin call. When the selling gets crazy, the time to buy is near. How about an Asian REIT with 25% yields and 100% NAV upside when the robins twitter next spring? Private equity? Dead as a dodo asset class.
