Oil's Bullish Future

The majority of predictions for oil are dismal.  Some have gone as far as to say that black gold will see $20 per barrel.  While possible, any fall to this level will be short-lived and driven by fear rather than fundamentals.  We expect a gain to the $45-$50 area to occur later in the year.  Our reasoning is simple; production for the first time in years will decline while demand will remain strong.  This will be in spite of world economic growth being slow.  

Oil prices can only increase as shortages will begin sometime during the next decade.  Out of all fuels it has the smallest reserves, roughly 80 years’ worth.  Furthermore, any huge new discoveries that might be found, especially at the poles, will only flat-line world reserves for a short period.  Given the importance of oil in our society, hopefully we can find a replacement within the next century. 

There are three countries holding the bulk of reserves.  They are Canada via the oil sands, Venezuela, and Saudi Arabia.  Russia is probably close, but like China it is hard to trust any data they release.  Evident in their attempt to diversify their economies, most OPEC countries will only have enough reserves left for their domestic needs within the next 40-50 years. 

Tesla and the like will never eliminate the need for oil because transportation is only a small use of the commodity.  Oil is literally everywhere. We use it for medicines, clothes, heating and manufacturing homes, plastics, fertilizers, lubrication - the list goes on.  So even if the world does evolve into a planet where transport no longer relies on oil, demand for the stuff is never going to come to a halt.  In fact, the only thing that can slow the demand of oil is a drastic change in consumer habits and progress in recycling and technology.

 

Contrary to what you hear in the media, the outlook for oil prices looks very bullish.  The demand for Canadian oil is going to grow for years, as it is today.  American shale reserves will only curb demand for foreign oil slightly, and by next decade America will become more dependent on Canadian and Mexican oil.  Yet, during the next decade, Mexico’s reserves will be falling and domestic demand will be increasing as the country continues to prosper, mostly at the expense of our southern neighbour. 

Like most commodities, the price is reflecting the above ground supply.  We spent the first half of this decade drilling and mining anything we could possibly get our hands on.  Naturally, the price is finally beginning to reflect this.  Prices are dropping making it impossible for many companies to operate.  The big guys will use this as an opportunity to swoop in and scoop up the assets at a discount, giving them more influence in the market.  Once this begins, the next bull market will begin.  Market forces are already correcting the imbalance.  In 2015 the number of oil rigs in operation across the globe fell by 40%. 

It is the future of other fuel prices that is bearish.  Both coal and natural gas have roughly 400 years’ worth of reserves, and demand for these fuels will also remain strong.  But, the supply of these two will keep a natural cap on prices.  Germany recently announced that their nuclear power plants will be replaced with coal fired ones.  America, the second biggest coal addict in the world, will also not cut back on its demand, and every day Australia ships greater amounts of coal to Asia.  For some unknown reason the politicians at the Paris Climate party did not protest, let alone mention a word.

Fortunately, Canada’s reserves will continue to grow in importance.  Our energy industry has a very promising future.  The only negative is that we are not immune to price drops and we must sit patiently until market forces create the next bull market, sometime before the end of this decade.

11 of our 14 current holdings increased their dividends in the last year. Subscribe to find out what two of our stocks increased their dividend over 10% in January. 

2016 in Preview

2016 is fast approaching and it appears that the year will be a repeat of 2015 where the world economy bounces along.  Global GDP will be lower but remain positive.  Last December we predicted the stock markets would trade in a 5% band which it has.  For 2016, we are extending the band to 7-8%, up or down from todays levels.  The increase will be due to an aging population coupled with the never-ending zero interest rates which are destroying savings.

Both the Baltic Dry Index (BDI) and the CRB Index are telling us the world economy will be weak.  The BDI tracks shipping rates which are currently setting new all-time lows, meaning world trade is slow and will be for most of 2016.  Likewise, the CRB Index, a basket of commodities, is trading at its lowest level in the 39-years of its history.  It too is forecasting a slow economy. 

Canada will continue to feel the effects of lower oil and natural gas prices, but that is to be expected.  Due to an abundance of natural gas we see the price falling to $1.50, a level experienced in the late sixties.  We feel the price of oil is nearing the bottom because global demand continues to grow.  More importantly, the Middle East needs more oil revenue.  At today’s price, it will take less than two years for Saudi Arabia to go bankrupt so it is in their best interest to have higher prices.  Oil will hit the $50-$55 range, but not overnight. 

Prices should not be the main concern in Canada’s oil market.  Getting the oil to the market place is the issue.  Canada must build more pipelines, not rail cars.  The pipeline is safer than rail, creates thousands of jobs and will open the European market to our oil faster and safer.  Today, there are 31 pipelines travelling between Canada and the U.S.  All of them are nearly full 24 hours a day, 7 days a week.  Shell Canada and Cenovus Energy have curtailed building their tar sands plant partly due to a lack of pipelines.  This alone has cost well over a thousand direct jobs.  The Trans Mountain Pipeline and the West to East Pipeline would prevent Alberta from heading into a typical contraction brought on by an NDP government.  But, the Alberta government does not care.

Interest rates are a tough call.  On one hand we have the Carbon tax; a brilliant marketing scheme for all governments to raise taxes.  The Carbon part is an easy sell because it makes consumers feel like they are spanking big business and protecting the environment at the same time.  This feel good moment will all come to end once the consumer realizes that all tax hikes on business are passed onto the consumer through higher prices.  This may cause deflationary forces and could be what keeps interest rates from increasing.  This is obviously what all governments want because it keeps their borrowing costs low.  You just know the politicians are all high fiving each other behind closed doors.  On the other hand we also have a weakening Loonie which increases the cost of everything.  This could be what the market needs to drive interest rates up.  One thing remains though; as long as there are low interest rates the economy will not be robust.  

It will still take a few quarters to decide where our heart throb PM is leading us.  Right now it does not look promising.  In Ottawa, the politicians prefer to talk instead of take action.  The potential for Canada remains amongst the best in the world because demand for resources will continue to grow.  Only the politicians can delay the future.  Today, they appear hopeless and do not know what direction to take.  In other words, be careful in your spending and investing.  2016 is not going to be a very profitable year.

We are not sure what Alberta was thinking when they voted in the NDP.  But, after decades of responsible fiscal management and pro-business policy that was admired by the rest of Canada, it is official that they have voted in a government that wants to try to close down their province.  Each day the dreamers in Edmonton decide to do nothing to help their businesses and citizens the slow down can only intensify.  After six months in office as premier, Mrs. Notley’s only accomplishment has been to get further into debt and raise corporate taxes, which are being passed on to the consumer.  To improve the Alberta economy she announced she will hire more civil servants.  Where is the money going to come from to pay them and what are these people to do?

Mrs. Notley wants to switch all electrical power from power stations to the very expensive solar and wind power.  It is too bad she has not taken the time to ask Ontario homeowners how their government’s shot at green energy has worked.  It has destroyed jobs, caused hydro bills to jump, and all excess power is sold to the U.S. at a huge loss.  She also wants to close up all coal mines in the province which are big exporters to Asian countries.  To do so will cost thousands of more jobs.  Thankfully, I doubt Ottawa will allow this to take place because they are big tax payers. 

Since becoming Premier I have never heard Mrs. Notley mention anything on their second biggest industry, the farmer and the rancher.  We're not even sure if she knows they exist? This might be a good thing since it’s something she cannot destroy. 

Thankfully, the loss of Keystone pipeline means little to Alberta and the rest of Canada because 8000 miles of pipeline has already been laid in the U.S. since 2010.  Keystone was simply a direct route, so it would have been a safer route technically.  The demand for pipelines is not going to disappear.  One common claim by oil companies in Alberta has been that Canada needs more pipelines.  They are the safest means of moving liquids but the Greens want to shut them down in favor of shipping by rail.

President Obama refers to our tar sands oil as dirty, even though a record amount of the stuff was shipped down south in August.  Not surprising though, after 7 years in office he has done nothing to clean up his own country’s environment.  After China and India, the U.S. is the world’s biggest polluter due to the use of coal, which is dirtier than our tar sands.  The U.S. is becoming an unreliable trading partner.  Thankfully, Canada’s future economic growth relies on Asia and Europe.

The oil and gas industry have given 37,000 people the boot with more to come by year-end.  The cut in income the loss of these jobs have created is forcing other businesses to lay off employees.  It is estimated that total job losses will reach 70,000 in the days ahead.  This will only force a larger house correction that is currently taking place in most of the province.  Alberta experienced the largest decline in house prices so far this year in October, with the average price in Calgary and Fort McMurray down 6.1% and 13% from a year ago, respectively.  Edmonton prices are flat. 

Thankfully, Albertans will wake up shortly, say “what were we thinking?” and vote the NDP out in four years.  Until then, Alberta’s economy will continue to contract and lose businesses and citizens to their neighbouring provinces.  These two provinces are the future of Canada and are open for business.  We remain super bullish on Western Canada.

Subscribe to the Sacola Financial Investment Newsletter to find out what three pipeline stocks we are recommending.

During what is considered the greatest economic depression throughout modern history, interest rates during the Thirties fell to around 2.5%. By the time interest rates finally bottomed, the Dow Jones Industrials lost 89.9% of its value between August 29^th, 1929 and mid May 1932.  The global economy did not recover until after World War II and it was not until 1954 that the Dow Jones made a new high.

Today, the unemployment rate in the U.S. is 5.1% (supposedly), only once the Labour Participation Rate is factored in.  Ours is slightly higher but many jobs go unfilled as there are not enough people willing to work at minimum wages.  Interest rates across the West, except in Australia and New Zealand, are stuck around 0%.

Two weeks ago U.S. 3 month Treasuries were trading at negative .04 of 1%.  This means every buyer was paying the U.S. government to hold their savings.  For 6 months the yield was .01 of 1%, or a yearly return of 1 cent per $100 invested, before taxes.  Over the last 4 months, the 10 year Treasuries has gone from 2.5% down to 1.92%.

Savers are slowly being destroyed.  Without these investors there cannot be any long term recovery.  Around the world not one politician or economist understands this basic economic fact.

When interest rates begin to rise it will take at least 2 years for them to hit a fair rate of return (around 4%).   Today, we are at least 3 years away from getting there since income earned is paid at the end of the term.

The real danger today is the world is heading into a period of deflation.  Prices for everything are set to fall or have already dropped.  As we have reported in the Sacola Financial Newsletter, we believe house prices throughout North America, Europe, Australia and Hong Kong are today at their peak.  Starting next year we will experience falling house prices that could easily last a decade.

Adding to the woes will be government and personal debt at record highs.  This debt is hurting the economy.  The pain will get worse once interest rates rise.  Today, it has not been noticeable but from here on out, governments will be forced to cut back  on spending from falling tax revenue for the next few years, at least.  With no inflation and prices falling, all debt becomes 100% destructive because it overshadows the assessment that they represent.

The only recommendation is to pay off all debts as fast as possible.  Stock markets today are discounting the economic slowdown, so they will do little for the next couple of years.   Dividends will remain the main source of returns for most investors.

From today on zero interest rates are slowly destroying the world economy because  every saver is becoming poorer.  We will not repeat the Dirty 30s but we will have a long slowdown.  It will be 100% induced by politicians as they are clueless on economics.  The longer interest rates stay around zero the worse it will be and the longer it will last. 

The Road to Nowhere

To the surprise of everyone, but us, China’s economic data has not been accurate.  We have repeatedly stated never believe in Chinese figures.  Generally, there are three sets of financial books; one for the government, one for Wall Street, and the real books are for management.

The boom in commodities was in large part due to China importing large quantities to stockpile for future use and to build infrastructure and cities.  Some of the cities built over the past 15 years remain pretty much empty today ( https://www.youtube.com/watch?v=0uxv5_GoY80 ).  Similar to Japan during the 1990’s, they built roads that led nowhere.  During July, the so called experts were telling us the Chinese economy was on the way up because they were big buyers of copper and oil.  The truth is China is taking advantage of low prices and is buying to stockpile.

Contributing to their exceptional growth over the past decade was the West going on a debt fueled spending spree.  Thanks to record high debt levels among the rich nations, the demand for Chinese goods will not exceed the levels of the past for years.  That does not mean the Chinese economy is toast though.  It will still bounce along because there are over a billion people that must be fed, clothed and sheltered. We often forget that the average Chinese income is roughly $5,500 (2013), and hardly an amount to put the world economy into overdrive.  

One of the biggest reasons why all stock markets are going nowhere is due to zero interest rates.  Rather than providing stimulus, they are slowly destroying the world economy by shrinking savings. After taxes and inflation the risk-free rate earns a negative rate of return on the cash (purchasing power is falling).  This is now affecting real estate because people must wait longer to save for a down payment.  This is why today all real estate prices in almost every corner of the globe has peaked or are falling. 

Two Indexes that are telling us the global economy is slowing are the Baltic Dry Index and the CRB Index (commodities).  The Baltic Dry Index measures the price of shipping dry goods index.  While the index is up 15% this year, it still remains down 44.7% from 2 years ago.  The 15% increase this year is more of a sign the world economy is bouncing along.  It signals that we are in a slow down, but nothing serious.

The other metric we use is the CRB Index.  Only three times, since being created in 1976, has the CRB index gone under 185.   Last month marks the fourth.  The index peaked on July 2^nd, 2008 at 473.52.  The number to watch, which initially was hit on Oct. 25, 2001 is 181.94, the all-time low.  Two consecutive days under this number will mean the world economy is contracting and the risk of recession increases dramatically.  It is also telling us that deflation is gaining strength.

With the index bouncing around the 190 area today it is telling us stock markets will be flat to slightly down.  However, based on today’s earnings and dividend yields, stock markets are trading at their long term norms. 

Our recommendation is be careful in investing and avoid taking on debt.  Invest in companies that have a strong dividend record.  Watch the Baltic Dry Index  and the CRB index to see how the stock markets will be acting. Cash is becoming the best asset to hold.