Today the rebound in oil led a significant turnaround for stocks. With that, the broader sentiment of uncertainty across markets tends to abate. Broader commodities swung from negative to positive. And yields on the U.S. 10-year Treasury, which were in deep decline this morning, swung to positive territory by the afternoon.
If you own stocks, a house, have a job or need to eat, you should cheer for higher oil prices.
As we’ve talked about quite a bit in recent weeks, cheap oil, at this point in the global economic recovery, is a catalyst to destabilize the global economy. While consumers gain a few bucks from cheaper gas, the oil industry leans closer to the edge of bankruptcies and weak oil exporting countries toward default. That would be very bad news (global financial crisis, round 2). So the longer we’re down here, and the more persistent these low levels appear, the riskier the world looks. And when the world looks risky, people sell stocks, and other relatively risky assets and they hold cash or buy U.S. Treasuries (which pushes yields lower).
For proof, here’s a look at the 10-year yield on the U.S. Treasury note.
Keep in mind, the Fed raised rates in December! They did so when the 10 year was trading at a yield of 2.20%. The yield is now 45 basis points lower. And even though a voting Fed member said yesterday that in her view, a second hike was still on the table for next month, the market has still virtually priced out the possibility of any further hikes for the rest of the year.
Why? Because other parts of the world are moving (or are moving deeper) into negative rate territory, because economic conditions continue to soften, mostly driven by sentiment and weakening inflation prospects. A big driver of that mix is the oil price crash.
In the next chart, you can see how yields, despite the December rate hike, have tracked oil lower.
Again, when people think the world looks risky, they pile into the safest parking place for capital on the planet, U.S. Treasuries –and that drives yields on Treasuries lower. While that flow of capital has certainly occurred, the pressure on yields from speculators is also a big component.
If you recall, we discussed a couple of weeks ago how markets can have it wrong – sometimes very wrong. If indeed, the market is wrong on this one, there is a tremendous opportunity to ride yields back to the 2.25% area. And it may be a violent move.
But oil will be the driver.
As we said, oil turned the tide for stocks today. Here’s a look at the relationship of oil and stocks over the past three months.
In this longer term chart above, you can get perspective on where oil prices stand relative to history. You can see in this chart the sharp rise, the sharp fall and the rebound from the depths of the global financial crisis.
That rebound was all China. China stepped in and used their three trillion dollars in foreign currency reserves AND their massive fiscal stimulus package to gobble up cheap commodities.
And you can see this most recent price crash was triggered by move by the Saudis to block an OPEC production cut in November 2014. It was the night of the Thanksgiving holiday in the U.S. and oil was trading about $73. We haven’t seen that price since.
The low at the depths of the financial crisis was 32.40. That’s about where oil closed today. We’ve made the case in recent weeks that, if OPEC refuses to cut production (likely), the central banks could/should step in and buy oil (the ECB, BOJ and/or China).
Bryan Rich is a macro trader and co-founder of Billionaire’s Portfolio,a subscription-based service that empowers average investors to invest alongside the world’s best billionaire investors.
People continue to blame softness in global markets on China. For years, there has been fear and speculation of “hard landing” for the Chinese economy.
When we talk about China, it’s all relative. China was growing at double digit pace for the better part of the past 25 years. Now Chinese growth has dropped to below 7%. That’s recession-like territory for the Chinese economy.
But the Chinese have powerful tools to promote growth. And we expect them to use those tools, sooner rather than later.
As we know their biggest and most effective tool is their currency. They ascended to the second largest economy in the world over the past two decades by massively devaluing their currency, and then pegging it at ultra-cheap levels. It allowed them to corner the world’s export market, sucking jobs and valuable foreign currency out of the developed world. This is precisely what Donald Trump is alluding to when he says “China is stealing from us.”
Interestingly though, it’s China, most recently, that has been getting hurt by currency. Over the past four years, the Bank of Japan has devalued their currency against the dollar by nearly 40%. And other export-driven emerging market economies have had massive declines in their currencies (Brazil, Mexico, Argentina, Russia). Given that China has actually been appreciating its currency against the dollar for the past 10 years (albeit gradually), they’ve given back a lot of ground on their export advantage.
Source: Reuters, Billionaire’s Portfolio
In the chart above, you can see the yen weakening dramatically against the dollar (the purple line moving higher = stronger dollar, weaker yen). The orange line is the dollar vs. the Chinese yuan. You can see the relative advantage that the BOJ’s QE program has created (the gap between the purple and orange lines). With that, the orange line rising, since 2014, represents China backing off of its pledge to appreciate its currency. They are fighting to preserve their export advantage by weakening the yuan again.
In August, they devalued by less than 2% in a day and global markets went haywire. That move is nothing extreme in currencies, especially an emerging market currency. But given China’s currency history and their policy stance, since 2005, to allow their currency to appreciate under a “managed float” (managing a daily range for the currency), it has markets confused. When people are confused, they “de-risk” or sell.
Now, China will likely continue this path. Our bet is that markets will finally realize that, in the shorter term, this will be good for global growth and good for the health and stability of global financial markets. Better growth in China, at this stage, is good.
Among their other tools to stimulate growth, China has interest rates. While most of the world is pegged at zero rates (or close to it, if not negative) China’s benchmark interest rate is still 4.35%. And their inflation rate is running 1.5%, well below their target of 3%. That’s a recipe for aggressive rate cuts, which would be a boon for the Chinese economy and for the global economy.
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Oil has surged to open the week. If you’ve been reading our daily pieces over the past few weeks, you’ll know how important oil is for global markets at this stage. With that, strong oil today has translated into higher stocks, higher broad commodities, a slight bump higher in interest rates and better investor sentiment in general.
It was just fourteen days ago that Chesapeake Energy, one of the largest producers of oil and natural gas was rumored to be choosing the path of bankruptcy. That rumor was immediately denied by the company. And soon thereafter, the reality set in for markets that a scenario like that would conjure up post-Lehman like outcomes. Oil has since put in a bottom and bounced more than 25%. Chesapeake has now bounced 46% from the lows just the last six trading days.
It’s at extremes in markets where the biggest and best investors have historically made their money – running into risk, when everyone else is running away.
With that, today we want to take a look at a few stocks with the biggest upside, and an important “risk buffer” in what is a high risk sector at the moment (energy). This risk buffer? Each stock has the presence of a big-time billionaire investor.
Self-made billionaire energy trader Boone Pickens has said he expects oil to return to $70 this year. On his $70 prediction, he’s also said that if he misses it will be because oil is “over $70, not under $70.” If Pickens is right about oil prices, each of these stocks below have huge upside:
1) Oasis Petroleum (OAS) – Billionaire hedge fund manager John Paulson owns nearly 4% of this stock. The activist hedge fund SPO Advisory owns 14% and has been buying the stock on almost every dip. When oil was last $70, OAS was trading $25 or 500% higher than current levels.
2) Chesapeake Energy (CHK) – Billionaire investor Carl Icahn owns 11% of CHK and recently added to his position around $13. The last time oil was $70, Chesapeake was $25. That would be more than a 1000% return from its price today.
3) EXCO Resources (XCO) – Billionaire investors Wilbur Ross and Howard Marks own more than 30% of this energy stock. The last time oil was $70, EXCO was $3.30. That would be almost a 330% return from its price today.
4) Consol Energy (CNX) – Billionaire David Einhorn owns 12.9% of this stock. When oil was last $70, Consol traded for $40 or almost 500% higher than current levels.
5) Williams Companies (WMB) – Carl Icahn Protégé, Keith Meister of the activist hedge fund Corvex Management, owns $1.1 billion worth of WMB. The last time oil was $70, WMB traded for $50 – more than 300% higher than its current levels.
As we’ve said, persistently cheap oil (at these prices) has become the new “too big to fail” — it’s a systemic risk. It’s hard to imagine central banks will sit back and watch an OPEC-rigged price war put the global economy back into an ugly downward spiral. And time is the worst enemy to those vulnerable first dominoes (the energy industry and weak oil producing countries).
The best investors like to go where the biggest risks are — that’s where the biggest returns can follow. And they’ve been getting aggressive in energy and commodities.
Without question, energy stocks have been beaten up and left for dead. If indeed Chesapeake is a leading indicator that it’s all backing away from the edge, there will be big money to be made in these stocks.
We already have one of the best performing stocks in the entire stock market for the month of February in our Billionaire’s Portfolio, billionaire-owned Freeport McMoran. Click here and join us!
The word China is often thrown around to explain why markets are in turmoil. China doing well was a threat to western civilization. China doing poorly is now a threat to Western civilization.
Which one is true?
First, a bit of background. Over the past twenty years, China’s economy has grown more than fourteen-fold! … to $10 trillion. It’s now the second largest economy in the world.
During the same period, the U.S. economy has grown 2.5x in size.
So how did China achieve such an ascent and position in the global economy? One word: Currency.
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For a decade, China maintained a fixed exchange rate policy — the yuan was pegged against the dollar. One U.S. dollar bought 8.27 yuan. This allowed China to undercut the rest of the world, churning out cheap commoditized goods, competing on one thing: Price.
But in 2005, China changed its currency policy. It abandoned the peg.
After political tensions rose between China and its key trading partners, namely the U.S., China adopted a “managed float.” Under this policy China agreed to let the yuan trade in a defined daily trading band, while gradually allowing it to appreciate. This was China’s way of pacifying its trading partners while maintaining complete control over its currency.
Over the next three years the Chinese yuan climbed 17 percent against the dollar, enough to ease a politically sensitive issue, but far less than the relative economic growth would warrant. In fact, China’s economy grew by 43 percent while the U.S. economy grew only 10 percent.
That timeline leads us up to the bursting of the global credit bubble. What caused it? The housing bubble can be credited to a key decision made by the government sponsored credit agencies (Fitch, Standard and Poors, Moody’s), all of which stamped AAA ratings on the mortgage bond securities that Wall Street was churning out.
With a AAA rating, massive pension funds couldn’t resist (if they wanted to keep their jobs) loading up on the superior yields these AAA securities were offering. That’s where the money came from. That’s the money that was ultimately creating the demand to give anyone with a pulse a mortgage. That mortgage was then thrown into a mix of other mortgages and the ratings agencies stamped them AAA. They rinsed and they repeated.
But where did all of the credit come from in the first place, to fuel the U.S. (and global) consumption, the stock market, jobs, investment, government spending … a lot of the drivers of the capital that contributed to the pin the pricked the global credit bubble (i.e. the U.S. housing bust)? It came from China.
China sells us goods. We give them dollars. They take our dollars and buy U.S. Treasuries, which suppresses U.S. interest rates, incentives borrowing, which fuels consumption. And the cycle continues. Here’s how it looked (and still looks):
The result: China collects and stockpiles dollars and perpetuates a cycle of booms and busts for the world.
That’s the structural imbalance in the world that led to the crisis, and that problem has yet to be solved. And the outlook, longer term, for a solution looks grim because it requires China to move to develop a more robust, and consumer led economy. That structural shift could take decades. And going from double digit growth to low single digit growth in the process is a recipe for social uprising of its billion plus people.
In the near term, the likelihood that China will fight economic weakness with a weaker currency is high. We’ve seen glimpses of it since August. And the hedge fund community is ramping up bets that it’s just starting, not ending.
Above is a look at the dollar vs the yuan chart (the line going lower represents yuan appreciation, dollar depreciation). Longer term, China’s weak currency policy is a threat to economic stability and geopolitical stability. But short term, it could be a shot in the arm for their economy and for the global economy.
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When housing prices stalled in 2006 and then collapsed over the next three years, the subprime lending schemes quickly became exposed.
Mortgage defaults led to a banking crisis. Due to the highly interconnectedness of banks globally, the problems quickly spread to banks around the world. A banking crisis led to a global credit freeze. When people can’t access credit, that’s when it all hits the fan. Companies can’t meet payroll, don’t have the liquidity to make new orders. Jobs get cut. Companies go bust. Finally, the microscope on overindebtedness of consumers and corporates, turns to countries. Deficits leads to debt. Debt leads to downgrades. Downgrades leads to defaults.
For the most part, defaults were averted because central banks and governments stepped in, in a coordinated way, to backstop failing banks, failing companies and failing countries. From that point, continued central bank stimulus has 1) enabled banks to recapitalize, 2) foiled additional shock events, and 3) restored confidence to employers (to hire), to investors (to invest) and to consumers (to spend again).
As we’ve discussed in the past two weeks, persistently low oil prices represent a risk on par with the housing bust. And in recent days we’re seeing the signs of another global financial and economic crisis creeping uncomfortably closer to a “part two.”
As we’ve said, this time would be much worse because governments and central banks have exhausted the resources to bailout failing banks, companies and countries. But central banks, namely the Bank of Japan and/or the European Central Bank do have the opportunity to step-in here, become an outright buyer of commodities (particularly oil), as part of their QE programs, to avert disaster. But time is the oil industries worst enemy and therefore a big threat to the global economy. The longer policymakers drag their feet, the closer we get to the edge of global crisis — a crisis manufactured by OPEC’s price war.
Unfortunately, there are the building signs that the market is beginning to position for the worst outcome…
Key bank stocks in Europe are trading at levels lower than in the depths of both the global financial crisis (2009) and the European sovereign debt crisis (2012).
Source: Reuters, Billionaire’s Portfolio
The credit default swap market for key industries is sending up flares. This is where default insurance can be purchased against a company or country – and the place speculators bet on a company’s demise. Billionaire John Paulson famously made billions betting against the housing market via credit default swaps. Now the fastest deteriorating companies in Europe are banks. And the fastest deteriorating companies in North America are insurance companies (a sector that tends to have investments in high yield debt … in this case, exposure to the high yield debt of the oil and gas industry).
Source: Markit
The early signal for the 2007-2008 financial crisis was the bankruptcy of New Century Financial, the second largest subprime mortgage originator. Just a few months prior the company was valued at around $2 billion.
On an eerily similar note, a news report hit this morning that Chesapeake Energy, the second largest producer of natural gas and the 12th largest producer of oil and natural gas liquids in the U.S., had hired counsel to advise the company on restructuring its debt (i.e. bankruptcy). The company denied that they had any plans to pursue bankruptcy and said they continue to aggressively seek to maximize the value for all shareholders. However, the market is now pricing bankruptcy risk over the next five years at 50% (the CDS market).
Still, while the systemic threat looks similar, the environment is very different than it was in 2008. Central banks are already all-in. On the one hand, that’s a bad thing for the reasons explained above (i.e. limited ammunition). On the other hand, it’s a good thing. We know, and they know, where they stand (all-in and willing to do whatever it takes). With QE well underway in Japan and Europe, they have the tools in place to put a floor under oil prices.
In recent weeks, both the heads of the BOJ and the ECB have said, unprompted, that there is “no limit” to what they can buy as part of their asset purchase program. Let’s hope they find buying up dirt-cheap oil and commodities, to neutralize OPEC, an easier solution than trying to respond to a “part two” of the global financial crisis.
Gold has been a core trade for a lot of people throughout the crisis period. When Lehman failed in 2008, it shook the world, global credit froze, banks were on the verge of collapse, the global economy was on the brink of implosion – people ran into gold. Gold was a fear-of-the-unknown-outcome trade.
Then the global central banks responded with massive backstops, guarantees, and unprecedented QE programs. The world stabilized, but people ran faster into gold. Gold became a hyperinflation-fear trade.
In the chart above, you can see gold went on a tear from sub-$700 bucks to over $1,900 following the onset of global QE (led by the Fed).
Gold ran up as high as 180%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply. Still eight years after the Fed’s first round of QE (and massive global responses), we have just 13% cumulative inflation over the period.
So the gold bugs overshot in a big way.
Why? The next chart tells the story…
This chart above is the velocity of money. This is the rate at which money circulates through the economy. And you can see to the far right of the chart, it hasn’t been fast. In fact, it’s at historic lows. Banks used cheap/free money from the Fed to recapitalize, not to lend. Borrows had no appetite to borrow, because they were scarred by unemployment and overindebtedness. Bottom line: we get inflation when people are confident about their financial future, jobs, earning potential … and competing for things, buying today, thinking prices might be higher, or the widget might be gone tomorrow. It’s been the opposite for the past eight years.
After three rounds of Fed QE, and now mass scale QE from the BOJ and the ECB, the world is still battling DE-flationary pressures. If gold surged from sub-$700 to $1,900 on Fed/QE-driven hyperinflation fears, and QE has produced little to no inflation, it’s fair to think we can return to pre-QE levels. That’s sub-$700.
We head into the weekend with stocks down 3% for the month. This follows a bad January. In fact, the stock market is working on a fifth consecutive negative month. The likelihood, however, of it finishing down for February is very low. It’s only happened 18 times since 1928. So the S&P 500 has five consecutive losing months just 1.7% of the time, historically.
