IAAM: Following the Oil Experts Down the Rabbit Hole?


oildollarAs people listen, read and see the content we produce at IAAM they’re always trying to glean tidbits of inference of what actions they should take as it regards their portfolio. Should I go long gold or short it? Are interest rates going higher or lower? Will the Government actually try to take my retirement plan? My intention as always, is to give you the facts, and by doing so help you make an informed decision.

However, breaking tradition, most recently one of, in my opinion, the most asinine investing decisions has been Wall Street’s bottom picking of oil and the corresponding support by financing domestic oil companies. Most specifically, I am referring to the shale oil asset class.

I say it is asinine because in order to be successful, I don’t simply mean a day trade, but success commensurate of intratesthe long term dollars being deployed, one has to believe in two things. First, the interest rates will never rise again and second, that the laws of supply and demand will never be repealed.

Let’s deal with the first, interest rates. Much has been discussed and written about the Fed’s ultimate decision to raise rates. Such things as employment and GDP weigh heavy in the ultimate inevitability of higher short term rates. The question is not if but when and that could be a long time in the future. Considering the impact on US indebtedness it could be stated that the US is not unlike Japan, which still, after more than two decades, is cowering under the threat of a return to normalcy.

To sustain floundering domestic companies, Wall Street, with fee enhancement, is pouring billions into junk bonds. Payrolls, capital, research and development, and even daily expenses are being met by the floating of long term indebtedness.

Good business sense says that revenues minus expenses equal profits but expenses minus revenues equal loss. Where the losses mount it’s usually time to close the doors. However, in the Keynesian world, no one except the investors loses, therefore, the strategy is to sustain losses via the debt market until things can be turned around, if ever.

junkWhen interest rates rise, these junk bonds will fall and fall hard. It is simply the law of rising rates and falling bond prices regardless of whether they’re treasuries or junk. In addition, the money borrowed by Wall Street to buy bonds will no longer be at almost zero rates. Cost of carry will accelerate. The buyers of these bonds will not only lose the interest on the money that’s being borrowed to enter into the investment, but also will lose principle, dramatically. This will become too much to handle. A very bad rabbit hole.
The Street, however, believes it is worth the daily losses, if in fact, they have caught the bottom and many believe that the bottom is in for oil. Maybe?

But in order for that to happen we are brought to the second asinine assumption, the repeal of the law of supply and demand.

Following the herd, buying the dips, becoming a lemming, many times in the past, was the right thing to do. However, now, in my opinion, it is simply following idiots down a rabbit hole.

Most recently, OPEC has announced the continuing of their over supply production. As a matter of fact, total production is as much as 10% above their daily stated quotas. This is all before the expected ramping up of production by Iran when a new nuclear treaty is signed and sanctions are lifted.

Trying not to lose market share is every producer’s goal including the United States. They are all running full boar to extract as much oil as possible out of the ground.

Much has been made of the reduced rig count in the US but on closer examination it is simply the older less efficient that are being taken offline. This reduction has had little to no effect on the actual daily oil production.

As supply has increased over the past few months, so too, strangely, has the price risen from the $40 range to $60. Could increased demand be the culprit for these rising prices? The answer is NO. As a matter of fact, one of the world’s largest consumers, China, has recently announced the completion of their strategic reserve acquisitions. Another buyer bites the dust contrary to what most pundits hope and believe.

Demand dries up and supply jumps daily and yet we are asked to believe that $100 oil is right around the corner. Asinine.

But aren’t these people making these investment decisions the smartest ones in the room? Shouldn’t I follow their lead? Unfortunately too many times in the past, such as dot com, housing, finance, these same fellows have been wrong. Not just a little wrong but dead wrong.

They will tell us that this time it is different especially when they play with other people’s money. Unfortunately it never is.

Interest rates up or interest rates down? You pick it. But eventually what goes down must go up and what goes up must go down.

However, there will be no repeal of the law of supply and demand and eventually oil will fall and fall hard.

Follow the so-called experts down the rabbit hole if you must but remember there will be no escape. That is the unfortunate fact of life.

Till next time,

Written by
With his passion for economics Bill Tatro has been entertaining audiences on the radio and in seminars for decades. Bill is an economist that provides weekly paid content to subscribers, and offers a free daily "lite" version as well.