The False Premise Worth Betting Against

Yesterday I mentioned that oil is trading on a false premise. Today I’m going to explain why.

But first, a quick note on the local market. The Financial Review laments that it’s going nowhere:

It’s almost impossible to find anyone these days who’s not frustrated about the lacklustre efforts of the local sharemarket when compared to Wall Street and how the major S&P ASX 200 index just can’t get much beyond the 5700 level in any meaningful way.

Unfortunately for investors, both trends look set to continue.

Earning and interest rates are always seen as the key drivers of sharemarkets and although it’s early days for this reporting season, it seems investors aren’t impressed with some of the latest results.

A quick look at the chart of the ASX 200 proves the point…

[Click to enlarge]

For the past two-and-a-half months, the index has traded between 5,650 and 5,850 points. In the past six weeks the range has been even narrower.

Frustrating? Yes. Unusual, no.

Markets often trade in narrow ranges for a prolonged period of time. This happens when there is an arm wrestle going on between the bulls and the bears.

And in Australia right now, there are decent arguments on both sides.

The bears (constantly) worry about a housing market crash and all the debt carried by the household sector. The bulls see ultra-low interest rates, an improving global economy and the good health of the corporate sector as reasons to buy.

This issue will be resolved soon enough. That is, the market will break out of its range, one way or another. My guess is that it will move higher.

But why guess? Why not wait for the market to tell you what to do. A move above 5,800 will be bullish, while a move below 5,650 will be bearish.

Right now, we’re around 5,750.

A breakout is not far away for the bulls…

One ‘problem’ for the Aussie market is that it’s highly concentrated. A major bullish move higher either needs the banks or the big resources stocks to participate…or preferably both.

Recently, resources have done well, while the banks have sold off. Hence the holding pattern of the broader index.

While resources in general have performed pretty well this year, energy stocks haven’t fared so well. Despite OPEC’s efforts to reduce supply and push prices higher, Brent crude prices, the international oil benchmark, can’t seem to get much beyond US$50.

Overnight, Brent fell nearly 3% to US$51.61.

There is a view in the market that OPEC has lost its leverage because of a resurgence of the US oil industry. Fracking technology has unleashed a huge amount of production and reserves from ‘tight’, or shale oil. You’ve probably heard of the Eagle Ford and Permian fields in Texas, or the Bakken field in the Dakotas.

Every time OPEC announces a cut in production, it is thought that US tight oil producers can step up and increase supply to fill the shortfall.

Indeed, that is pretty much what has been happening. It’s why the oil price continues to languish.

But this is where the false premise comes into it.

Over the past few weeks, I’ve been doing a lot of research into the US shale oil plays. From what I can gather, the optimism surrounding these oil fields is politically driven, and misplaced.

I’m just about to publish a report on this for readers of Crisis & Opportunity, so I’m not going to go into all the details here. But I can say there is a lot of evidence that these fields are undergoing, or are about to undergo, natural field decline.

The producers need higher prices to make it economic to access harder to reach oil. If this doesn’t happen, they will lose money at a faster rate, or production will start to drop sharply.

At both Eagle Ford and Bakken, production peaked in March 2015 and December 2014 respectively. In the Permian formation, which is the latest hyped US onshore oil field, production is still climbing.

But for how long?

The Permian field has been a hotspot over the past couple of years. It’s considered the hotspot in US oil. The price to gain a foothold in the region has skyrocketed.

In short, there is a lot of excitement and hype. But is it deserved?

Charts don’t lie

To answer that question, I took a shortcut. I found out the companies with the most exposure to the Permian basin, and checked on their share prices.

After all, I reasoned, if conditions were so good, surely these companies would have share prices at or near their highs, or at least in a healthy uptrend.

But that wasn’t the case. Have a look at the share price of Pioneer Natural Resources [NYSE:PXD], one of the major operators in the Permian…

Source: Optuma
[Click to enlarge]

It peaked at the start of the year, and has been trending lower ever since. The stock price plunged recently when Pioneer reported higher than expected gas recoveries from its wells. This suggests there might not be as much oil as first thought.

Charts don’t lie. But there is still plenty of opinion out there saying ‘it’s all good’.

It doesn’t look ‘all good’ to me. It looks like oil is trading on the false premise of coming US oil independence. It looks like that premise is wrong.

And if it’s wrong, it’s worth betting against. I’ve lined up a few junior energy plays to bet on, as these hold the biggest upside if I’m right. If I’m wrong, not much changes. Which makes it a bet worth taking.

If you want to get access to these plays, keep an eye out for a special report, coming soon.


Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

Official websites and financial e-letters Greg writes for:

Money Morning Australia