‘Invest in what?’ is the eternal question.
Well, oil and precious metal prices have strengthened recently. Is this a revival of previous long-term uptrends? Is something fundamental going on with hard, ‘real’ assets?
Let’s have a look…
For now, consider the fundamentals. There’s positive economic news from the long-suffering eurozone. Economies are strengthening from Britain to what the Germans call Mitteleuropa, albeit inconsistently. Economic doctors even report a pulse in southern Europe, in Italy and Spain. Finally! But can it last? We can only watch and wait.
Here in North America, the energy boom continues. Our friends at Baker Hughes report 1,776 rigs drilling in the US as of last week. Hey, that’s the spirit! (Sorry, I couldn’t resist – it’s an old Groucho Marx line.)
Good things are not confined just to the oil patch, either. There’s admirable strength in aerospace (Boeing and its many vendors) and surprising momentum in big-ticket items like autos (the usual US names and many others). That’s a lot of steel, aluminum, copper, electronics and more. Plus, paycheques. Where will this take us?
Let’s revisit the Agora Financial Wealth Symposium in Vancouver this past July. One great speaker – Barry Ritholtz – made a fabulous point during the Whiskey Bar. We were discussing fracking and the energy revolution in North America. Barry said:
‘The good news is that all this new, low-priced energy and feedstock will bring industry and manufacturing back to North America from overseas. The bad news is that with advances in software and automation, much of the work will be done by robots and not translate into new jobs for people.’
Another speaker discussed how, in general, stock markets are ‘priced for perfection’. That is, major indexes, collective share prices, price-earnings ratios, etc. indicate a market psychology that everything is fine and getting better.
Another way to describe the situation is that investors have bid all sorts of things – banks, tech, transportation, etc. – up to a frothy high or near high. Of course the frothy top is far from the case for mining companies, despite a mild August rebound from deep lows in June and July.
So the question follows, why should investors buy into this allegedly ‘perfect’ market just now? Metrics indicate many sectors and companies are priced as if nothing can go wrong. The flip side is that many plays are poised for a tumble, and we just have to await the triggering event.
What triggering event? All sorts of bad things can happen, but let’s start with the Syria mess. Right now my biggest concern is that events in Syria and across the Middle East could quickly drive energy prices through the roof – which will cost you at the pump, but still offer other strong investment opportunities.
Nervous Energy Markets
Global energy markets bid up strongly in the past three weeks, as Western powers – especially the US – talked tough on Syria. Too tough, some might say. I won’t go deep into details of who might bomb what with what weapons or what role Russia will play in this powder keg. You’ve surely seen the wall-to-wall news coverage.
The investment point is that Brent crude prices recently traded above $115 per barrel – very high by recent standards. West Texas Intermediate (WTI) crude prices are down from the $110 mark. The numbers are firmly above the 30-day averages.
Current oil price levels support strong drilling programs in North America and across the world, meaning far from the turmoil of the Middle East. So expect continuing support for North American land drillers, oil service companies and offshore plays.
The Oil War Scenario Playing Out
So where will oil prices go in the short term of 2013 and into 2014? We have to wait and see. Still, the European and North American economies are strengthening, which favours higher oil prices. And looking back, oil prices have climbed over 16% since April. Something is going on.
On the one hand, world oil markets are ‘comfortably supplied’, as Saudi oil gurus like to say. But savvy oil buyers worry that despite good fracking news out of North America’s oil patch, there’s no major global supply cushion in the event of shortages related to expanding turmoil in the Middle East.
Egypt is a basket case, to be sure. But right now the crisis spotlight is on Syria, which has been engaged in civil war for over two years. Syria’s version of the Arab Spring in 2011 quickly deteriorated into a government crackdown, with violent blowback from disaffected masses.
That is, the Syrian ruling regime is mostly ‘Alawite’ Muslim sect, which is fairly close to Shiite. For the most part, Syrian rebels are Sunni, who despise getting pushed around by Shiites. Basically, this is the ‘Oil War’ scenario I’ve discussed for several years.
The point to keep in mind, though, is that whatever the media tell you, the Syria mess is NOT some heroic, French Revolution-style battle between oppressed masses and their terrible dictator. No, Syria is, at root, a religious war.
Westerners tend not to understand religious wars. Europe fought its last big religious battles – Christian, to be precise – in the 1600s. Since then, Christian interfaith passions have cooled, replaced by nationalism, ethnicity and tribalism to some extent (long story). That, and a postmodern cultural ennui that may yet destroy us all (another long story).
In the oil markets, the major concern with Syria is the prospect of open-ended Western intervention in an intra-Islam blood feud. That is, oil prices are rising because traders discern deep-seated, long-term problems with the US, France and possibly other NATO allies inserting themselves into an admittedly ugly war, but one that’s more or less regionally contained.
If Syrian fighting spreads – outward to, say, Israel, Turkey (a NATO ally) or other locales – then problems could quickly arise with global oil trading patterns. Hence the latest ‘war premiums’ on barrels of Middle East oil, which, of course, benefit oil producers far from the fighting fronts.
Expanding Instability Across the Middle East
Don’t be confused about the idea of Syria’s struggle being ‘contained’. There’s nothing clean or tidy about what’s happening there.
Syrian combatants include Syrian government forces shooting it out with homegrown Sunni and Shiite militia members, as well as fighters from neighbouring Lebanon. Then there are Salafi Pakistanis from Waziristan, and disaffected Chechens, Libyans, Egyptians, Saudis and more, all looking for a brawl. Advisers include all manner of Iranian troublemakers, plus Russian technical specialists and any number of mercenaries.
One lesson is already crystal clear. It’s that traditional US influence is in free fall across the region. That’s bad in many ways, certainly for the credibility of the ‘petrodollar’ standard that has prevailed since the Second World War.
Another key angle is that a new axis between Russia, Iran and the Syrian leadership cadre now controls the course of Middle East events. In Syria, to be specific, Sunni rebels and their foreign allies (including the Saudis) are in retreat, which is why Western powers are discussing intervening.
Whatever happens from here on out – cruise missiles or no – the US has been gravely embarrassed, if not disgraced and humiliated, by gross political ineptness. We’re witness to historic US government miscalculations at the highest geostrategic levels (it’s a bipartisan hash, to be accurate).
Meanwhile, Russia and Iran have proven to be effective and resolute allies to their Alawite/Shiite Syrian clients – certainly more than the Western and/or other Arab powers that have backed the Sunni opposition (who take no prizes for being ‘good guys’ on even the best of days).
Of course, the Kremlin and mullahs in Tehran have a clear, singular objective, which is to keep the Syrian government in power. And in the end, firepower and logistics are what win real victories. That’s exactly what we see.
Expect Continued Danger of a Price Melt-Up
Syria exports virtually no oil. It’s not a player in global oil markets. But oil buyers perceive the threat of an expanding war destabilizing other parts of the Middle East. In that case, the global supply situation could tighten in a hurry. Oil prices could melt up overnight. I mean $120, $130, $140 and more per barrel.
Global oil trade patterns are already in flux. In other missives, I’ve discussed how North American fracking has increased supply for the US, with outward effects on global trade. Entire tanker trade patterns have been redrawn in just the past two or three years as US oil imports collapsed from entire nations – Angola, Algeria, Nigeria and more.
Now, just as global oil markets are adjusting to increased US-Canadian oil supply, we face the prospect of possible interruptions in oil supplies from the substantial wellheads of the Middle East. The way markets cope with this kind of confusion is to elevate prices to make up for higher risks from many directions.
Oil output from Libya has fallen by 85% and more in the face of turmoil there. This could be a harbinger of things to come elsewhere in the Middle East if the Oil Wars scenario continues to play out.
Meanwhile, we watch and wait…and invest in energy that’s located elsewhere.
Byron W. King
Contributing Editor, Money Morning