Can’t Find Totally Risk-less Conditions - Weekly Blog #775

 

Mike Lipper’s Monday Morning Musings

Can’t Find Totally Risk-less Conditions

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

  

 

 

A Real-World Problem for Investors

Investors turn to advisors to get assurances that they are not taking risks with their money and their future. We can discuss the numerous risks of losing some or all of their money and should do so. But the news of Silicon Valley Bank (SVB) being forced to close and then taken over by the FDIC shows that these types of discussions were not had.

 

This weekend I spent considerable time thinking about “risklessness” and concluded that it does not absolutely exist, nor can there be such an asset in an absolute sense. There are known and unknown opportunities to lose all or some value of an asset.

 

The reason is that we do not live in a one-dimensional world where all is known, or unknown conditions exist. We and our assets exist in multiple dimensions. Few if any of the investors who sold securities in an IPO and deposited the cash proceeds in SVB were waiting for an opportunity to buy appropriate assets. I suspect most investors felt their cash was being held at one or more underwriters for a short period, not at a corporate depository.

 

If they considered it at all, they were pleased that their assets in the company were unencumbered by loans. My guess is that they never considered they were at risk of a “run on the bank” by unrelated depositors. But such a run happened, putting the bank in an insolvent condition, which led to bankruptcy.

 

Ecology

While it may come as a surprise, some investors were concerned about changing climate conditions many years ago. They felt it was not being appropriately considered by institutional investors in making investment decisions. The “buzz” word at the time was ecology. Which meant that if something changed, more things could change.

 

Today’s investors should dust off the old studies on ecology. A current example might be a military battle in the Ukraine causing the price of flour to rise in Egypt, which in turn factors in the price of Mideast oil rising, which in turn impacts gasoline prices in middle America and consequently the prices of local homes in the Midwest.

 

The World View

Today, every consumer and investor is a globalist, whether he or she likes it or not. This impacts transaction prices for everything he or she does, including wages and taxes. Funds that invest in Europe are increasing in price as they attract flows from America, where prices of US dominated funds are going down, leading to a decline in purchasing power for the US dollar.

 

US Investors vs Washington Politicians

The current administration in Washington has proposed raising taxes while continuing to curtail domestic production of goods and services. This will add to inflation as the world continues to fund a major war. Similar to society turning its back on climate and ecology years ago, which resulted in today’s conditions. Our government is pro inflation through restraint of trade and raising prices.

 

Last Week: Another Warning ex SVB

While most of the financial headlines on Thursday and Friday were focused on the implications of SVB, there was worse long run news for American investors, consumers, and citizens. The Standard & Poor’s 500 declined -1.58% for the week ended Thursday, similar to its performance for many prior weeks. However, the depressing news was that China Regional Funds, the largest contributor to world growth, had declined -6.31%. While China exports more than its imports, the major exporter to China is the US. If the US is going to get out of its near recessionary condition, it will need to export a lot of US products and services.

 

What Are We Looking For?

Last week there was significant weakening of market conditions. While paying close attention to present conditions, we are nevertheless searching for the stocks and managers that will participate and, in some cases, lead the next significant “bull” market. We are in the early stages of our search and it’s still conceivable we may go through a longer period of stagnation. We are searching for the kind of corporate leadership and product/services that demonstrate superiority. Some may be overseas, but many will come from the US. Please help us.    

 

 

 

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Mike Lipper's Blog: Data Performance/Easy.Interpretation/Not - Weekly Blog # 774

 

Mike Lipper's Blog: “This was the Worst Week of the Year” - Weekly Blog # 773

 

Mike Lipper's Blog: A Terrible Week - Weekly Blog # 772

 

 

 

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Best Bet: More Sweaters and Parkas vs Overcoats - Weekly Blog # 708

 

Mike Lipper’s Monday Morning Musings

Best Bet: More Sweaters and Parkas vs Overcoats

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

I don’t like to lose bets, especially investments bets. That being said, I am highly confident those in the northern hemisphere will suffer a colder winter than expected. The streams of cold weather from Asia which flow over North America and Europe are moving south this year and will bring a colder winter to the US. (This contradicts “global warming” or climate change predictions.) The second and preventable driver is the need for politicians to be re-elected.

The only game that counts in Washington DC is getting elected, which importantly is based on money deployed from all sources. Despite food prices reflecting rising transportation costs, the central government is determined to hurt the states supplying energy for heating. Three states in particular are being targeted: Wyoming, West Virginia, and Texas. The first two are the leading exporters of coal to the rest of the nation, with Texas being the leading exporter of oil and gas. (Natural Gas is a major source of heating for much of the northern portions of the country.) These three states have significant Republican majorities, both in terms of votes and more importantly political contributions.) 

The game of war often relies on misleading the enemy regarding your intensions. In Washington this is done by a friendly media focusing on stimulus, even though it is a major contributor to inflation. While inflation is the cruelest tax on the poor, those in power believe the loss of some votes in the city districts won’t endanger the city progressives.

There are already a lot of predictions regarding the sharp rise in the cost of heating this winter. Landlords, already having difficulty collecting rents, may cut the amount of heat. Non-profits, including government bodies without actual or equivalent “rainy-day” funds, may face similar problems. Schools in low-income areas may similarly have shortages of students, teachers, and administrators.

Many of the aggrieved or their representatives will appeal to the media for help in sweaters (inside) or parkas (outside). Those appearing in overcoats will be considered tone-deaf, no matter how well intentioned.

Faulty Responses

Many of the shivering responders shown on television will emphasize the spike in heating costs causing an increase in “common colds”. The number of non-workers will be blamed on “acts of God”, due to shifts in northern wind blasts. They will not likely admit that part of the problem was self-administered, either out of The White House or Capitol Hill. By curtailing the capital generation of energy producing industries the government has caused the US to be an energy importer. It is no longer the net energy producer and exporter it was two years ago. They did this by causing pipelines to close, or not be built at all. Furthermore, in a stretched global market for oil, bureaucrats are increasing the industry’s burden by holding price investigations.

Multiple Year Transitory

As is often the case, economists look at the top-down government numbers of goods produced or shipped for problems, not the services or labor required. In their calculation of supply chain shortages, they fail to recognize the nature of the labor shortage. Not only are entry level workers missing, skilled workers and competent/trustworthy supervisory employees in service functions are also in short supply. (A good bit of these absences can be attributed to "educational" sector unions from pre-nursery through PhD programs.) These issues will not be addressed in the coming cold winter.

Long-Term, the Federal Reserve is Trapped

The favorite tactic of those in Washington is to change the rules if they are losing. Members of Congress are trying to make various economic/government financial agencies into social arbiters, including the Fed. Neither the Fed nor their supervised banks are equipped or authorized to perform these functions.

To the extent central governments want to spend a lot of others’ capital on controlling climate conditions, they will sponsor increased spending. This will result in both the Fed and the debt market increasing global debt massively. One wonders whether present low interest rates will become generational lows. Will higher rates drastically change the allocation of credit to the detriment of consumers at the low end?

Causes of Inflation

Inflation is caused by having too much money and borrowing power relative to the level of goods and services on offer. By itself it would be self-correcting through changes in price, including foreign exchange. However, when central banks create more money than their economies can immediately use, it leads to inflation. This is exactly what has been happening, so much of the current inflation has been caused by stimulus (bribes) payments. Thus, governments are a source of inflation.

Investing Choices

Perhaps the only wise reason to own securities today is the belief that the managers of some companies will be able to grow dividends above average inflation after taxes. 

If you have other reasons let us know. 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/11/lessons-from-london-mistakes-repeated.html

https://mikelipper.blogspot.com/2021/11/do-you-believe-congratulations-are-in.html

https://mikelipper.blogspot.com/2021/10/mike-lippers-monday-morning-musings.html

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The Confidence Game - Weekly Blog # 701

 

Mike Lipper’s Monday Morning Musings

The Confidence Game

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

The Rules of Life

Whether voluntary or not, by taking our next breadth we display confidence in knowing it is beneficial for us. Consciously investing relies on a series of confidences:

• That we can make a difference having a favorable impact.
• That we have the skills needed to achieve the desired goal. 

When we apply these hurdles to investing we are applying the following articles of faith. 

• That on balance the positive trends we see can be extrapolated into the future.
• That perceived negative threats will be moderated, or at the least don’t represent insurmountable hurdles.
• That we have enough skill or luck to execute. 

The range of executions vary from radical active changes to passive acceptance that we are in an acceptable condition for the moment. Regardless of our decisions, we are making choices that affect us and others.

Our level of confidence impacts where on the spectrum of actions we are likely to reside. I sense a number of people investing as fiduciaries or for themselves losing confidence, causing them to contemplate making contrary investment decisions. In addressing these signs of change I rely on history as a guide. This is a blog about investing for the long-term and is not an instrument of political criticism.

What’s Changed

The ways policy decisions are made and communicated has changed dramatically since the mid1930s. Both Hitler and FDR were expert on the use of Radio speeches or “fireside chats” to move their populations into accepting war as the only answer for their ultimate protection. Other political leaders did not fully grasp this change. (Wendell Willkie counted heavily on his positive relations with the major newspaper publishers and editorial boards. Unfortunately, his support was lacking in a couple of midwestern states, costing him delegate votes at the 1940 Republican convention. My ever-vigilant brother noted that I misspelled his name in the last blog.)

JFK’s telegenic personality vs.. the dour faced Richard Nixon cost him many young voters. LBJ, President Kennedy’s successor, had little choice in running his own election campaign due to constant negative television coverage of the Vietnam war.

Donald Trump had the benefit of a more intense polling, harkening back to the packed and enthusiastic crowds attending Revivalist meetings 100 years earlier. He generated these crowds in many states and communities where network television was not a believable presence. 

Throughout history, the one constant has been the increased speed of communication. Currently, most people get their political news through their computers. This was particularly true during the “lockdowns”. Two critical differences from the television network reporting of earlier years are:

1. The absence of the FCC’s mandated “fairness doctrine”, giving some acknowledgement to the opposition’s point of view, has filled the news hole with paying commercials.
2. Today, social media appeals to their perceived audience and rarely takes time to give a balanced view. The commercial art of visuals has also greatly improved. With a global platform of news and uncensored opinion the world is constantly being “informed”. 

Confidence in the US is Changing

As is often the case, the US bond market is directionally ahead of the US stock market. Many investors outside the US are very conscious of our economic/financial problems. As is customary for good investors, they hedge their bets. If they are high quality fixed income investors the standard way to hedge their currency risk is to buy US Treasuries. On a secular basis the foreign exchange value has been regularly declining vs other “strong” currencies, in part due to our expanding deficit. Markets adjust to perceived risks and in order to offset the currency risk the yield demanded for US paper in the global markets has been higher. However, in the last couple of years the perceived risks in other currencies seemed lower and their yields were consequently lower than those in the US.  

A couple weeks ago this attitude changed, with the yield on US paper rising and prices declining. This “shook-up” the equity markets which were selling at record levels. As almost all traded markets are priced off other markets, if Treasury yields rise the future return in other markets will also have to rise to remain competitive. Consequently, other fixed income rates will rise and if fixed income yields go up equity prices will go down. Market analysts are very conscious as to the inverse price trends of high-quality bonds vs high price/earnings ratios stocks e.g., FAANG and other tech stocks.

Causes of Declining Confidence 

 There is no mathematical formula for confidence. Psychologically, investors consider many different factors important to them. The reason for the long review of political communication is that government is one of the major contributors to individual and institutional investor confidence. In a simplistic model, governments have two broad buckets of policies and executions. Using this approach I will briefly list some of the critical elements in each bucket.

Policies addressing the following challenges:

Belief in US promises

Big Central Government

Borders

Business Relations

COVID

Inflation

Military Leadership

Political Leadership

Taxes

Executions

Afghanistan – For 20 years we have hired both US contractors and local people, including military and police forces, to keep our commitment relatively small. We made actual and implied promises of the eventual relocation of these people to the US and broke these promises with the way the US pulled out. (Many other countries may be questioning the steadfastness of the protection we are providing them. Are they at risk of high social spending in the US leading to financial constraints which might result in a hasty and poorly planned/executed retreat?)

Big Central Government - The main reason it took 12 years between The Declaration of Independence and the issuance of the US Constitution/Bill of Rights was the fear of tyranny by a strong central government. The result was a Constitution limiting the power of the central government, with most power left to the states. In two clever ways the Founding Fathers deemed that the Capital should be built in a swamp, having high humidity in the summer and cold during the winter. Furthermore, under President Washington the original cabinet had only four members: the secretaries of State, Treasury, War, and the Attorney General. Currently, there are 24 members plus 9 Principal officers. The current attempt to have a national law governing how elections are handled, considering individual states have that responsibility, is just what our founders were afraid might happen.

Borders protect and enhance all states. With most of the developed world facing shrinking populations, the US needs more workers and future students to continue our growth. However, they should be people who will contribute to our society, as most legal immigrants have in the past. We must control all our borders to make this happen.

The government’s role concerning businesses should be kept as small as possible. Businesses are not licensed or set up to serve the social needs of a community. They should choose to be good citizens, as it is good for their business and their people. Misapplying the anti-trust statues will reduce employment and send more jobs overseas. Practical companies, including professional practices, have already established foreign production capabilities to supply both US and international clients. I often see new CEOs of global companies coming from beyond our borders. They have the experience of running smaller versions of their US companies, whereas domestic candidates have not experienced managing a complete unit. We need these executives working with us rather than for international competitors.

The COVID pandemic was amazingly well handled in the production of vaccines. Compared to other countries, the deployment of the vaccines and related regulations and services was not as good. (It may or may not be important that the deployment was under a different administration than the initial production.) My real concern is whether most children, particularly those with special educational needs, will ever catch up with students educated beyond our borders. Longer-term, this will have an enormous impact on our long-term wealth production.

Increasing inflation has many causes, some caused by the present administration. I Increases in living costs are most painful for lower wage people, including the current rise in the cost of gas, with more expected for this winter’s heating. The increases are due to the US government restricting the growth of the petroleum production and pipelines. In addition, the cost of increased regulations is forcing businesses to add expensive people, which customers will eventually pay for through higher prices or lower wage increases and job numbers.

For some time, Military Leadership has been heavily influenced by relatively junior generals or admirals being promoted because of a perceived relationship with critical members of Congress or the White House. This may be why the President “didn’t hear” any objections to the way the pull out of Afghanistan was planned. The Chairman of the Joint Chief of Staffs, by calling his opposite number to assure him that our senior most military officer would alert the target’s command structure if President Trump ordered an attack on China, might also be a symptom of this problem. I will let others decide if this was close to being a Benedict Arnold act. What concerns me even more is that we are meant to have the military subservient to civilian control. We would like to see other countries follow the same practice so that the world not be governed by an international group of military officers.

The current day-to-day political leadership of the country is centered in two places, the senior, unelected, staff in The White House and the aged leadership in the two houses of Congress. We have never seen a less impactful political gang in control of the Presidency, the Senate, the House of Representatives, most lower court judges, most permanent government workers, and the media. The “circular firing squad” they have created suggests they are not ready to govern effectively. For those responsible for planning future investments, this chaos introduces more questions than answers.

The Founding Fathers knew, and many political leaders know that tax legislation is the power to destroy. The current administration’s tax motivation is to deploy tax revenue from the “rich” to pay those with lower wages. One might call these “bribes”, under the theory that these people will show their “gratitude” by voting for the source of their grants. As bad as this is for democracy, it may not be the real motivation. The real motivation might be income tax regulation to destroy or curtail a major source of contributions to the Republican Party. (During our history we have only had income taxes during wartime. Through close to half of our peace time existence, tariffs collected on imports were the main source of running our small national government.) As a matter of financial history, any large-scale deployment of money creates leakage from both sides of the transaction. Some of the leakage will result from inefficiencies created by not having appropriate procedures and some will be easy to plunder. More impactful will be the legal diversion to put elements of income and wealth beyond the scope of the regulations. (The lawyers and accountants will earn their high fees.)

Reactions

This is a continuing movie. While we may think we know the end, we don’t know the timing. Based on history we should now be in the midst of a meaningful correction, although in evaluating the indices it hasn’t really started yet. Only a small minority of stocks in small industries rose this week. 74% of the Wall Street Journal’s list of market changes declined.

One of my worries is that on the Monday the trading markets dropped, I assume a higher than usual portion of the transactions were not reported on the relevant exchanges. One possible indicator is the after-hours price drops. In a list of stocks I am following because my accounts own them or are considering them for future purchase, 31% had further declines of 2.3% to 4.9% below their last sale on their formal markets. I am worried there is not sufficient capital available for the trading desks to absorb a major decline.

Tactics & Strategy

 In terms of trading tactics. After almost every decline there is some sort of price recovery of market averages that takes many stocks near the levels they were selling at immediately before the decline. (Some issues won’t get that bounce.) Certainly, by the second day I would be a seller of any position that I would not choose to own for years into the future.

Strategically, as a long-term investor I would hold positions that should be held for competent heirs until new information questions the long-term, after recognizing the need to pay capital gains. I would also use down markets to look beyond one’s normal comfort zone to broaden the opportunity set.

What do you think?     

   

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https://mikelipper.blogspot.com/2021/09/two-confessions-weekly-blog-700.html

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

https://mikelipper.blogspot.com/2021/09/3-thoughts-to-ponder-weekly-blog-698.html

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“Fox” Forecasting vs. Data Dependent Hedgehog

 Introduction

The great and late Yogi Berra, said "You can observe a lot by just by watching." I will attempt to see the future by observing the results of the recently concluded third quarter of 2015. My attempt will be as a “fox” forecaster rather than a “hedgehog,” as described in a new book, The Art & Science of Prediction by Philip Tetlock and Dan Gardner. They divide predictors into two animal groups the hedgehogs who focus only on a very few variables in order to hedge future results and the foxes who recognize that the future is too complex for simple forecasts. I am with the second group.

Hedgehog Capsules

The third quarter saw almost every asset class decline in price except US

Treasuries. The two largest economies in the world showed signs of slowdowns, albeit China from a much higher growth rate than the US. The manipulations of the leading central banks continued. Those that were data dependent extrapolators did some selling and less buying for their long-term obligations.

Foxes Look for Changes

As dependable as the laws of gravity, I look at various declines as setting up a change in direction. As a young analyst I got frustrated at market bottoms because they very rarely got to be real cheap or almost steal price levels for long. What I neglected to put into my mathematical projections is that other potential buyers were also waiting for a good entry or re-entry price. These buyers were less patient than I was because they had fiduciary responsibilities and had a lot more money that needed to be deployed. They bought the cheap stock at good prices and didn't wait for my bargain basement prices. This experience taught me to begin buying when prices get into the fair level in view of their long-term future value. This is not to say that I am unworried about a major rip in the market structure that could delay the turnaround for a long time, and there is a potential one today that will be identified later.

How Should Analysts Work?

All too often what passes for analysis is a description, often detailed, of what already exists. Analysts should focus their attention on the future risks and opportunities. In other words, they should recognize that they are part of the tribe of foxes as predictors. To be successful more attention should be paid to the forks in the road as turning points and far less on trends and the determination of central values.

My Analytical Applications

I start with the absolute certainty that no narrowly defined trend will continue in its present configuration. Thus, I look at extreme performances as the most likely trend reversals at some point along their route. Guessing that there are strong odds on a trend reversal is relatively easy. The timing of the turning points is more difficult. It may be sufficient to recognize early that a turn has already happened or is in process. One of the great advantages of being a chart reader is the emotional ability to accept the turn without fully understanding the causes for the turn. Often the people and the conditions that cause the change in direction will be learned later, long after the easy early money has been made.

Currently I am focusing on the worst performing sectors of various markets. I recognize that not all of the poor performers will turn to be good performers and not at the same time. Some of the bad performance is due to poorly executed or too expensive strategies. Nevertheless, when there is massive under-performance by activities that were formerly viewed to be well managed, the instincts of the fox in me want to explore further. After assuring myself that what I am seeing is cyclical behavior, as a good US Marine Corps officer I start to prepare my plan of attack.

First I am focusing on investments that have declined around 20% compared with general declines of 5 to 10% through the end of the third quarter. In a gross over-simplification most of these formerly very successful investments have for many years reacted to falling commodity prices. In most cases (in an age old pattern of increasing supply too far in advance of demand) the clearing of the demand level was achieved by lower prices. Quite possibly prices would

have eventually declined without the slowdown of growth in China and the widespread application of lower cost extraction techniques for oil and particularly gas. Combining these factors with the two largest economies becoming less manufacturing and more services-oriented, the general price levels’ secular rise fell off their trend line to reported slower augmentation.

Having been exposed to past industrial cycles, I expect the excess supply will be eventually absorbed or removed from near-term production. Further, while population growth is slowing in many countries, the existing populations are increasingly exposed to more expensive lifestyles. Thus, I expect we will see reported inflation rise. As a matter of fact, I believe the cost of living for the readers of this blog and many of those who they are responsible for are already

experiencing upward effective price changes, above the vaunted 2% level.

How Do My Portfolios Represent These Concepts?

I have a number of portfolios for different purposes and timespans. (At your leisure I would be pleased to discuss the application of the Timespan L Portfolios^TM to your specific needs.) Most of my timespan oriented investments are long-term and some very long-term. The guiding principles of my choices are to avoid substantial long-term losses with major positions and at the same time produce a more than acceptable return. This translates into some Canadian and Australian investments. I wish to stay within my circle of

competence as is often suggested by Charlie Munger and Warren Buffett. Thus, I invest in each of these commodity based currencies in mutual fund management companies and closed-end funds. I also have a position in the largest commodity fund management and selling organization. Further, in believing in the continuing treachery of central banks to savers, we have a significant portion invested in global fund management organizations as they are avenues for people all over the world to partially escape the debasement of their currencies. For those that must have some of their money in fixed income, we have used TIPS (Treasury Inflation Protected Securities) and for clients who can accept some volatility, income loan participation funds.

Changes in the law may improve the quality of these loans if the banks must keep a small portion of the loans on their balance sheet.

What Should You Do?

My recommendation would be to begin a buy program of investing in the prospect of a long-term increase in inflation either through a commodity, direct or related investments, and in the worst performing US government issues of the last year, TIPS. I would slowly average into these positions by adding to them 1% a month or a quarter. When they move up in price by at least 9%, you may want to consider taking a full normal position.

However, There is a Big Disruption Risk

When there is a large scale disruption in the marketplace all securities and investment plans are impacted, as a rapidly falling level of trading capital needs to be quickly redistributed from strong holdings to meet pressing repayment demands.

The history of monetary demand management by the Federal Reserve is that market bubbles are reduced by opening new arenas for speculation. When we were facing the collapse of wide-scale speculations in "Dot-Coms" the Fed and the Federal Government made highly leveraged, poor credit quality attractive to new home owners and institutional investors. The result was the "sub-prime" collapse. As this was getting painfully unwound a new and bigger bubble was created in using US Treasuries on leverage for collateral purposes in “carry trades.” Because the credit quality of the Treasuries were unquestioned by all except Standard & Poor's, one could borrow heavily against them. The borrowed capital was then used to buy higher rate paper, often emerging market debt. These countries were borrowing US dollars at lower interest rates than what was available in their more knowledgeable local markets. Many of these borrowers were reliant on commodity prices remaining firm which currently is not the case.

At the very same time with the advance of high computational and communication speed, high frequency traders were attracted to the market. These inter-market dealers with their use of algorithms already represent, I am told, over half of the trades in the market. Many believe that they are abusing the market dynamic in Treasuries as they have in other markets. A number of sound, well known hedge funds have complained about these activities in terms of stock prices not representing real demand levels. My guess is that

something will be done about these specific abuses. My further guess is that the regulatory authorities will be reluctant to further constrict the Treasury market when the US government has to continually borrow money. Eventually the regulators will be forced to curtail these activities, but that is only likely to happen after a major disruption.

With Possible Disruption Ahead

Invest cautiously. When and if the disruption does occur, treat it as a periodic change in market structure unrelated to the underlying economy and as a buying opportunity.

Question of the Week: Are you preparing to change your style of investing?

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Additional Views on US Energy Independence

Should the US pursue a policy of  energy independence?

Today I am continuing a discussion began in last week’s blog about the economics of  international energy policies.  I offered opinions about these topics prompting a response from my long-time friend and adviser, Dr. Philip M. Neches,  the founder of Teradata, who has spent a great deal of time studying the Energy sector.  Phil Neches received his BS, MS, and PhD from the California Institute of Technology;  he is a successful entrepreneur, writes a thoughtful blog and sits with me as a trustee of  Caltech. 

Last week a portion of my blog explored an Adam Smith-inspired hypothesis that would have the US buy up and deplete as much of the world’s oil as possible, using its own production and reserves for long-term international competitive advantage.  Berkshire-Hathaway’s Charlie Munger, among others, have also discussed this approach.

Oil pricing as a factor

Phil Neches began his response by indicating that he thinks my analysis of oil did not take price sufficiently into account.  He writes, “Yes, the US depends less on imported oil than major economic competitors, but that matters only in the extreme.  In the more ordinary course of business, it will take several more decades of consumption for oil to actually become scarce,  and, as you point out, that can be stretched out by more efficient use.”

He continues, “The short term issue with pricing is not as much about the ultimate depletion of world oil reserves but by the imbalance between demand, which can shift quickly with economic circumstances, and supply, which can only change slowly through expensive development of fields, refining capacity, and transport. Bad actors can make quick changes in supply, and this causes the risk perceived, correctly I think, by the general public and politicians of all stripes.”

US Strategic Petroleum Reserve

Last week I buffered my position with the fact that the US Strategic Petroleum Reserve provided some solace for future emergencies.  Phil offered an offsetting  point I had not mentioned, that today’s military depends upon the civilian economy much more than in the past.  As Phil states, “If the civilian economy is crippled, the military may still be able to operate, but will be far less effective.”

Natural gas

I am mostly in agreement with Phil when he writes that “The most obvious strategy for the US is to encourage substitution of natural gas for oil and coal.”   He continues,  “the biggest win is in electricity generation, for a number of reasons: 

 

First, it would permit early retirement of the dirtiest coal burning plants.   From a Pareto analysis standpoint, this is the best thing we could do to reduce not only carbon emissions, but other pollutants.

Second, gas-fired plants can be sited closer to loads, stretching out the investment in the distribution network.  This is important because there is more capital tied up in distribution networks than in generating capacity.

Third, to the extent that people adopt electric vehicles (either plug-in hybrids or all-electrics), then demand from the transport sector can shift away from oil.”

My thanks to Phil Neches for his additions to this conversation

Investment implications

Careful long-term focused investments should be considered to take advantage of the transportation of oil, gas and coal. The use of energy will go up, adjusting for the cyclically of the global economy. As long as the sources of energy are distant to its users, energy in some form will have to be transported. In the intermediate time period that would include ocean-borne oil, gas and coal. In addition, land-based pipelines and railroads will still have good payloads. I suspect that these thoughts are behind the disproportionate current and future capital expenditures in these areas by Berkshire Hathaway* and other large capital investors. Currently many of these stocks are down from recent peaks because the level of shipments and prices are down. I cannot accurately predict when they will go up, but I believe they will as the world recovers and we move toward rational energy independence.

Disclosure: I personally own a position in Berkshire Hathaway, as does the private financial services fund that I manage.

Historical context

In the United States we celebrate Memorial Day on Monday, May 28^th.  Officially the holiday was started to recognize the death of so many Union (Northern) forces in the Civil War, which some still call the War Between the States. Over time the holiday was combined with a similar day of remembrance for the fallen Confederate soldiers.  For the US, the Civil War was responsible for more total deaths than any war before or since.  In addition to the many domestic causes of the American Civil War, economic forces, particularly international trade, played an incendiary role. As European harmony deteriorates, this holiday weekend I am reminded of the curse of one citizen/nation fighting another on the basis of economic interests and tariffs.

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