Bringing a Squirt Gun to a House Fire - Bonds/Oil and the Markets

Interesting to start an energy portfolio update with a look at the bond markets, but that’s what’s deep on my mind this week.

Bonds are in free-fall. Don’t look at me for expertise, I have none. The bond markets have always been a ‘black hole’ for me – I know they’re enormous, overlay everything financial in the world, make stock and certainly commodity markets puny by comparison and are vital to understanding monetary causes and effects. They obviously affect corporate spending, the valuation of future profits and the confidence of stock investors. They move rates on homes, cars, heavy equipment – basically everything that matters.

It’s also a black hole – undefined in size, hard to judge at the margins and predict and mostly unfathomable (at least for me).

But here’s why I start there:

My two dollar read of the bond markets has important parallels to our energy markets and our portfolio. My read is that the bond markets are reacting to fiscal and policy decisions that have been made in the past two years that portended disaster but did not immediately bring them – for example, Tariffs, basically despised by every economist worth his name, yet, even in the most undisciplined and aggressively directed form that the Trump administration brought to them, did not bring immediate market distress as predicted – on the contrary, we saw some of the deepest gains in the stock market, particularly in the most capital intensive industries like tech.

In the last six months, the War in Iran and the specific trade war with Canada have brought ever more inflationary pressure, but again, we’ve not seen the stock market ‘collapse’ – even though inflation has ticked back up to a scary 3.6%

Finally, the new chairman of the Federal Reserve has refused to respond to pressure from Trump to leave rates alone or even cut them, and, recognizing the inflation threat, approved a small but important 25 point rate hike – signaling that the Fed would take inflationary risks seriously and Warsh would not be a pass-thru rubber stamp for the President’s wishes. This seemed to be the “last straw” to move the bond markets and its traders to bail on it, at least temporarily.

But even before that Fed decision, I’ve been asking myself – Who couldn’t see all of this coming?

I mean, I don’t know anything about the bond market – but who the hell with any knowledge of it was happily long bonds? Wasn’t it obvious that all of these inputs would, sooner or later, impact rates and send them off a cliff?

This may sound like some wiseass Monday morning quarterbacking – but really it’s not. And here’s where I pivot back to our energy portfolio, still up 9% since June, and my thinking about it today.

Back in the early summer, I looked at the energy markets, saw a war in Iran and a blockade of at least 12% of global oil, 20% of diesel and other ‘heavy’ products and at least 5% of LNG, even with the huge Asian demand cutbacks. I also saw the intransigence by the Trump administration to just leave. I saw the determination of the Iranian hard-liners to resist Trump’s ‘carrot – stick’ strategy for a settlement. And even though none of that made an immediate impact on energy and energy stocks, I knew you just couldn’t be short oil. It seemed obvious that this incredible supply shortfall would, sooner or later, impact oil and its refined products and send them soaring.

Now to our current “place” – Oil, having finally ‘reacted’ to the systemic shortage caused by the continued stranglehold on the Strait of Hormuz, reached $106 a barrel, but has spent the last week and a half retracing back to under $90 (!), clearly another huffing of the “hopium” that seems to surround this ever worsening supply shortage. I made these points on Chris Hayes’ show this week – see the video link above.

How does the old saying go? Fool me once…………

Let’s tackle some facts so we’re not fooled twice:

1- The ‘talks’ supposedly happening with the Iranian delegation after Trump’s UN speech will lead where the last 47 attempts at deal making with the Iranians have before – nowhere. When will we learn that the Iranians have no interest in a deal, at least until the midterms are over?

2- The reports of new flows through the east-west Saudi pipeline are a positive event, but only to the tune of – AT BEST – a million barrels a day of increased exports. This is nice, but like bringing a squirt gun to a house fire. Or a thimble to bail out your leaking rowboat. You insert your favorite funny analogy here, but it’s hardly a supply solution.

3 – Strategic stockpiles that have been used to supplement lost supplies in China and here in the US are getting increasingly stressed. Both here and in Asia, sovereign crude stockpiles are estimated at 40% of normal capacity. Remember, if it reaches zero, you cannot supplement those lost barrels at all – so that huge 2m barrel a day shortage in China, for example, gets expressed immediately as a global price increase. That’s the $200 barrel doomsday scenario. Therefore, the amount that China can supplement their supplies must decrease from its current 1m barrels a day so it never reaches 0% of capacity. But, every time you decrease the supplement, the price, obviously, has to increase too. BTW, here in the US, I don’t think Trump worries about using up the SPR completely, but he should.

4- Should we even bother to talk about the price floor that these depleted stockpiles will put on oil for the next several quarters and likely years? Lord knows the Chinese will be looking for any dip to refuel their strategic supply, which certainly came in very handy during this crisis. Does that mean they’ll get an opportunity to do that again at $80 much less $70? I wouldn’t bet on it, at least not in 2027.

All of this moves my thinking on our portfolio in two concrete ways.

One – In pursuing oil assets when the fund was starting, my thinking was that OIL was going to be the shortest term investment we’d hold – that we’d be banking on getting in front of a fuel transition instead of hanging on to a fossil fuel that seemed to be in the waning days of its preeminence. I’m rethinking that timeline.

Two - Strategically, stocks are a very mixed bag – the bond blow-up has me more than a little nervous about committing to stocks, even with tailwinds applied, when rates are signaling a lower re-valuation is likely coming on ALL stocks.

My instincts are to get incredibly aggressive on oil dips, like the one we just had – but I am somewhat tempered by what looks to be a terrible overall market environment. Some new ideas are coming to me, particularly in this unique environment. Stand by.

One more point I must make – and the 9% gains so far at Matrix Energy Partners should make it for me: If you are not yet a subscriber to MEP, this is a very opportune time to join -- a dipping oil market that is begging us to get more aggressive, while watching a bond market that has us simultaneously suspicious of valuations.

Those two kinds of warring inputs to investment have always brought unique opportunities to take advantage of, in my experience – and you’ll need to be part of the subscriber base to know about them immediately as they happen. They appear very quickly and normally disappear just as fast, like the last $6 that oil has rallied in the last two sessions. In other words, if you missed the first 9%, I’m telling you that the next move forward is setting itself up NOW.

Please let me know your thoughts, I’d love to hear them.

dan@dandicker.com