Wednesday, October 15, 2008
Oil, Auto, Main Street, Global Economy
I have been trying to bring in the price of oil to my arguments to show how the world is changing, and how the media can be over-focused on certain issues when it blows up, to the detriment of other broader issues, just as important.
We have seen massive de-leveraging from all assets classes over the last few weeks. Three of the top US investment banks now no longer exist. Demand destruction in commodities everywhere. Real estate collapsing not just in the US but parts of Europe, in particular UK and Spain. Hedge funds saw massive redemptions. The Icelandic internet banking fiasco. Credit frozen, nobody wants to lend. Emerging markets all down nearly 40%-50% already this year. All taking about recession for sure and maybe even depression... why then is the price of oil today still about US$10 higher than what it was a year ago???
1) It tells you that the inherent demand, though weakened, is still very firm, especially from China and other emerging markets. It also tells you that the global economy is not as small as it was 10 years ago. Since 2000 till now, the global economy has grown by 70% in size - guess where the bulk of the growth in trade came from? Even though you may see absolute devastation in US property market, much of the wealth destruction hit investment banks and mortgage lenders capital base. Yes many of the broader property owners are feeling the pinch as well, it is not debilitating so.
2) Watch for the auto sector - this is where the pain will shift to. Big companies will fail or be merged and job losses will be massive - the auto sector consolidation has been brought forward by the events over the last couple of weeks. The auto sector combustion will cause the media to focus away from the carnage on Wall Street to carnage on Main Street. Expect markets to be wobbled by this. Keep cash at least 50%, trade out on weak signs - the worst may be over, but the general conditions still shifty. Jobs is where we should really look at. We can expect more job losses in the coming weeks and even months. I forsee some industries will see MASSIVE failure - the first to go will be the US auto makers.... pension problems, no credit or loans for people to buy cars, consumers delaying changing of cars now, problems with unions... very difficult to refinance their lines of credit moving forward... watch for at least two of them being merged or absorbed by a foreign competitor at cut throat prices. The auto industry are big employers, and that will hurt employment, and drag property prices weakness in those states where auto industry is strong.
3) The price of oil is higher today than a year ago because th cost of bringing oil to the market is now "very high". Forget about the easy low hanging fruits where the cost is less than US$20 per barrel. The average cost of a barrel to the market is now in the US$65-70 per barrel. If the price of oil drops below US$70, OPEC would just prefer not to produce. In fact many of the smaller producers may even produce less. Better to leave them in the ground. If that being the case, we can safely say the price of oil will not dip below US$75. I would also like to go very long on oil contracts again at US$80-81, rolling till March next year. From that alone, we can safely say that things are bad, but not as bad as the Western media makes them out to be. Focusing maniacally on one issue can desensitise us to other issues.
p/s photo: Uli Auliani