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For What Its Worth: December 11
Financial markets are made up of folk who look full time at the future earning potential of businesses. Generally they spot an economic upturn about six months ahead of it happening and re-price equities accordingly. The scale of cash build up globally is truly staggering – well exceeding pre-Second World War levels as investors bailed out of risky assets where the over-riding emotion was raw fear that there wouldn’t be an economy worth a dime at the other side of this crisis. When fear and panic takes hold, as it has in past crises, rational thinking gets pushed temporarily out of the window. It’s all sellers and no buyers. Under these conditions, even the most fantastic assets plummet below their fundamental value.
So what changes the mood? The answer is a catalyst, usually some move happens, much like a straw that breaks the camel’s back, that adds to a series of unsuccessful previous moves, the deadlock breaks and cash surges back. A catalyst needs a rallying point, something that people desperate for good news cling to and, undoubtedly the top candidate is President-elect Obama. His economic team are already talking about overreacting rather than under-reacting (that’s short hand for the mother of economic stimuli in the US to add to the hundreds of billions of extra money being pumped into economies ranging from China to Europe and the UK). The US, where the problem originated, is likely to see a stimulus touching two trillion dollars by the time it’s done. The impact on the ground will be a gradual recovery in confidence, in lending and in economic activity, but watch out for a flattening of house prices in the US and a sustained rally in stock markets as early indicators that the worst is over.
It may seem very early to be looking beyond a potential economic rally in the second half of 2009 because lots can still overwhelm it and there’s still a huge amount of work to be done to reignite banking markets. But if the deflation, depression and despairing doomsayers are wrong, what’s the next cycle likely to look like? Well it’s not pretty, and certainly not a return to business as usual, far from it. For starters, the huge overhang of extra government borrowing, especially in the US, must lead to high inflation but lurking in the undergrowth and largely missed in the melee of coverage on the credit crunch is something a lot more permanent – the oil crunch.
“To meet demand and make up for the loss of production from declining oil fields, five new Saudi Arabia’s will need to be discovered by 2030.”
The most recent report from the International Energy Agency (IEA), long an optimist on cheap oil, nails it. The IEA, after conducting an exhaustive study of oil reserves and future demand growth – especially from fast growing non-OECD countries – states that the age of cheap oil is over. Welcome to the age of scarcity. At best the IEA report points to an oil crunch until 2015 at which point it hopes that investment in oil and gas infrastructure will ease the high price spikes. Some of its findings provide irrefutable evidence of a long-term high inflation cycle as energy costs rise to absorb 5 per cent of global GDP – that’s five times more than in the early ‘80s. Power is shifting rapidly away from the oil majors like Royal Dutch Shell to national oil companies with OPEC becoming even more dominant. Non- OECD countries will account for 87 per cent of future demand with China and India accounting for 50 per cent. To meet demand and make up for the loss of production from declining oil fields, five new Saudi Arabia’s need to be discovered by 2030. Up to 2015 the IEA has identified a gap of seven million barrels of oil a day to meet demand as a consequence of past under-investment in infrastructure. What it doesn’t say is that the impact will be much higher oil prices.
As we enter a high inflation cycle, investment tactics will be forced to change. The huge sums of money still hanging around in the banking system in disbelief that a recovery has arrived will get caught in the vice grip of rising inflation that no amount of interest rate rises will dampen since it will be oil based. Oil won’t be the only tax on the economy. Unless the global energy mix moves sharply way from fossil fuels – especially coal, upon which China and the US are most reliant – global temperatures will rise. We can then expect a headlong rush into renewable and nuclear power to lessen the cost of CO2 emissions. We’ve been covering energy and oil from the get-go of You & Your Money two years ago. It’s hard to see beyond the smog created by the current recession but early movers into funds that cover conventional and alternative energy, index-linked Eurobonds and other high inflation-sensitive assets including geared property will do best, especially if they buy at today’s cheap valuations anticipating the recovery.