Different week, same three “Fs”. Food, fuel, and finance. We mentioned a few weeks ago that these three investment themes intersect, interconnect, and generally get all tangled up. Expect more tangling this week. Let’s try to untangle them a bit for you today.
First, fuel. Crude oil reached US$119.41 on the NYMEX. That’s a nominal record. The latest big story is that British Petroleum shut down a key pipeline from the North Sea that carries nearly 40% of the U.K.’s daily oil output.
The company shut down the pipeline because of a strike at a refiner that supplies nearly one-tenth of Britain’s refined fuels. The strike at the Grangemouth refinery is important though, because the refinery also produces power that goes to a neighbouring facility which processes oil coming on land from at least 70 oil wells off shore in the North Sea.
A strike shuts down power. Power shuts down the refinery. And if the refinery ain’t refining, you don’t pump crude oil to it. It all makes perfect sense in its own way.
The strike at the refinery is a ‘finance’ issue. The employees apparently want better pensions. The company who runs the refinery, Ineos PLC, does not seem willing to oblige. The resulting impasse has led to 15 straight days of higher fuel prices for British motorists.
This little fuel crisis has nothing to do with an actual shortage of crude oil (though production from the North Sea is falling). It does show, however, how quickly a “system of systems” can be laid low by any interruption, man-made or otherwise. In the modern world, there’s a thin line between light, mobility, and abundance on the one hand, and darkness, immobility, and scarcity on the other hand.
For its part, oil is rising on both supply issues (in Nigeria), demand strength (everywhere), and dollar weakness (seemingly perpetual). On that score, some of oil’s 40% rise this year (and 20% in the last three weeks) is probably anticipation that the U.S. Federal Reserve will cut its target funds rate when it meets Tuesday in America.
We asked Friday if the Fed had reached the limits of effective monetary policy via interest rates. It’s kind of a Zen issue at this point, isn’t it? If a target rate is lowered but banks still won’t borrow or lend money, have rates really been cut?
The U.S. Fed, like the Reserve Bank here in Australia, finds itself helpless to control inflation in two key components that do not usually figure in ‘core inflation,’ food and fuel. Yet as you know, food and fuel prices are, indeed, rising.
For consumers at the margin, increases in food and fuel prices are very real factors on the household bottom line. They are not balanced by declines in the price of imported white goods and electronics. You can’t eat a dishwasher.
There is now a great deal of speculation in the press that the RBA should abandon its inflation targets. Pundits worry that the RBA will slam the economy into recession by raising rates to contain inflation that it can’t really contain anyway. Rate rises won’t contain price gains in food and fuel, they’ll just make houses more expensive, so the argument goes.
We don’t have an answer for the Bank here at the Old Hat Factory. In fact, we’re not even sure there IS a good answer. A decade of low interest rates has led to a surge in global growth (not least in population). That’s led to an increase in demand for real resources. Fiddling with the money supply may reduce investor’s appetites for speculation, but it is not going to make people in China and India less hungry.
The idea that fixing the price for money solves all economic woes is central to the Age of Finance. But maybe, along with the age of cheap oil, we’ve passed the peak of cheap money. Peak Finance!
“For the past three decades,” reports Justin Lahart in the Wall Street Journal, “finance has claimed a growing share of the U.S. stock market, profits and the overall economy. But the role of finance the businesses of borrowing, lending, investing and all the middlemen in between may be ebbing, a shift that would redefine the U.S. economy.”
We can only hope. The business of making money by moving money is nice work if you can get it a(especially during a bull market in credit). But it doesn’t really add economic value. Nothing real is produced, and obviously, the capital itself hasn’t been allocated more efficiently. Just ask investors in mortgage backed securities or bank and brokerage stocks that have taken billion in losses on bad loans.
The bubble in finance is popping just like the bubble in dot.com stocks popped. The deflating of the finance bubble has much bigger real world consequences, though. And in the stock market, the stocks that led the last bull market never lead the next one. We wouldn’t waste too much time picking through the rubble of the financial sector. Instead, you want to figure out what’s going to lead the market up next.
The trouble is, the market itself may not be headed up at all. That is, the indexes could move sideways or down, in real terms, over the next few years. Passively owning “the market” through an index fund will probably be a losing strategy. We reckon that the bear market in credit favors tangible assets.
We also reckon that investors who have outstanding investment returns will get them by focusing on asset quality, low debt levels, businesses with regular cash flow, and businesses that have a competitive advantage of some sort.
That all sounds pretty routine. And truly, there’s nothing revolutionary about it. But it’s amazing how many fund managers have been getting by on rising index values alone. Time to start working for your money again boys! Let’s hear it for good old fashioned securities analysis.
“Golden future emerges for precious metals,” reads a headline in today’s Financial Review. The fundamental appeal of gold as an inflation hedge still looks good.
Markets and Money