Saturday, November 28, 2015

Investment Crystal Ball: Economic Distortion & Scare Mongering

If you are investing following macro-economic trends be-aware that our traditional methods of economic measurements are likely out-of-whack. The definitions of many economic gauges are ambiguous or unclear. Take inflation. What is inflation?  Inflation is defined as a sustained increase in the general level of prices for goods and services”, according to Investopedia. That is pretty vague!
With low interest rates, real estate prices tend often to rise. Wikipedia states: ”Asset price inflation is an undue increase in the prices of real or financial assets, such as stock (equity) and real estate “ Now, you tell me who decides whether the appreciation of your house is ‘undue’? Some economists think that asset inflation in Canadian real estate may lead to speculation and an asset bubble that will soon burst. There is no Canadian real estate market! Yes, maybe there is speculation in Toronto; yes maybe in Vancouver which seems to be the target of Chinese buyers for years now; but what about Whistler or the rest of the Fraser Valley? The media reported that Canada was not affected by the U.S. or better by the near global real estate crash of 2008; well think again! 
The oil price crashed during the financial crisis and two bedroom apartments in Calgary were down in price significantly between the summer of 2008 and 2010. Then we had relatively stable oil prices from 2011 to 2014 and Calgary real estate in generally went up; some single family residences went up by nearly 10% in 2014 but in 2008-2010 they never declined in value significantly as the two-bedroom apartments did . Rents increased between 2011 - 2014 as well, finally showing improved returns and cash flows for landlords. Meanwhile, recreational hotel-apartments in Canmore – just 100 km away from Calgary have been in the dumpster for years now going back to the financial crisis. The international buyers haven’t returned yet. But… single family houses in Canmore have recovered starting in 2010.
In such a fragmented real estate market; how can one seriously state that Canada is in a housing bubble?  And how can analysts say that Canadian banks will be dragged down in the next Canadian real estate crash?  There is a lot of speculation going on; especially by U.S. investors who ‘en mass’ are shorting Canadian Banks because of an 'overvalued Canadian real estate market' .  May they get the lid on their noses!
Canada is in recession because of low oil prices and also because of other low commodity prices. That statement may be true for Alberta – although Calgary and Edmonton housing prices have remained fairly stable for the year (sales volumes are dropping though or is that seasonal?). However, manufacturing and airlines are benefiting from the low oil prices and so are many industrial sectors in the U.S. What I am saying is that a lot of ‘macro-economic’ factors that make investors panic, rushing in and out of the markets, are often gross generalizations that have little to do with reality. So don’t build your investment decisions on that kind of headline news.
If you think, you can base your investment decisions on economic growth numbers from Europe or the U.S. think again.  Yes Germany may be slowing because of the Volkswagen scandal; but Spain is doing quite fine with a GDP growth of 3.4% lately!  Oops; The Netherlands have no Volkswagen factories and they do OK – better than Germany although not brilliantly. So what is a European GDP number indicating? By the way, how do we incorporate Europe's underground economy into these GDP numbers, as many small retailers systematically avoid reporting their true sales for taxation purposes.
China’s GDP is no longer growing at 9.5% but rather it is languishing at 6.5%. God, the world is coming to an end!  Last year Chinese stocks in Shanghai roared; while Hong Kong was kind of crawling up in spite of falling GDP numbers. This summer Chinese stocks fell like a stone: because of low GDP growth?  Oh, and during all that economic growth in the recent past, Chinese stock markets remained the lowest priced based on earnings and cash flow. How well does GDP growth correlate with stock market performance?  Not very well. In the U.S. we had a bull market for stocks and bonds between 2009 and 2014 when economic growth was ‘sluggish’. Now that the U.S. economy is approaching GDP growth of 3% the stock markets are lousy! So where is the connection?
Lots of S&P500 companies have a large portion of their earnings from non-U.S. sources and those earnings are distorted if not severely reduced thanks to a very strong U.S. dollar. What has the U.S. GDP number to do with that?  To top it off, U.S. taxation on foreign income is so detrimental to corporate earnings that profits are left in their oversea money bags and investors cannot receive the dividends associated with those earnings. The U.S. has one of the highest corporate tax structures in the world – talking about being competitive! How does that reflect in U.S. stock market performance and what, in G’s name, has it to do with U.S. GDP?
Oil prices do affect Canada’s GDP; but in many regards those prices are controlled by resource management of countries such as Saudi Arabia. And note, what makes countries such as Russia, Venezuela, Iran and Saudi Arabia tick?  Their capacity to grease the hands of their subjects. Even China is dependent on keeping their population under control through economic prosperity. So how much influence does our government have on those near random factors? Yet the resulting depressed oil prices (much more so than being caused by North American supply and demand) are causing a near-recession in Canada and massive lay-offs in Alberta. Did you see that coming by looking at Canadian GDP numbers? Then again, one may wonder about what constitutes GDP even if it does not actually predict or indicate future investment or stock market performance?
Let’s first look at the era we are living in. There is economic turmoil in the State of Denmark! Is that what Shakespeare says?  Well there is also turmoil in the rest of the world.  Even more disturbing, there is always turmoil and something to worry about in this modern world and in its history. Yet, we always seem to make our decisions based on economic parameters such as U.S. inflation or Canadian inflation.  Maybe better, use the consumer price index – after all we can apparently not use asset inflation!
Well if the price of oil drops by 40% do you think that a 1% price increase in school supplies is going to affect the price index?  Hmm. So how do you think inflation is affected by cheap imports from China and what will happen with consumer prices now that wages rise in China along putting a greater emphasis on the Chinese consumer and local services?  Just five years ago my dentist charged me $1500 for a crown; last week, I was quoted $860 for a crown. Wow, is that due to improved technology and expertise?  Many prices these days are falling because of technological and medical advances.  In 1994 I bought a new Nissan Altima for $23,000 now I get one for $30,000. You may shout: there inflation!  But the $23,000 was for a near base model while the $30,000 model has a sunroof; leather heated seats; blue tooth; navigation system; rear-view camera; proximity detectors and… heated mirrors! Yes, cheap labor and pretty soon in a factory near you, even cheaper robotic labor due to the explosive progress in AI (artificial intelligence) have reduced the costs of producing ever better products. In many cases we experiencing deflation rather than inflation. What has a central bank to do with that kind of inflation control?  Nothing! And what has inflation to do with the stock market or GDP growth?  GDP seems to fall while we get everyday more efficient gadgets for lower prices. GDP does apparently not reflect our improving lifestyles nor is it strongly reflecting stock market performance.
Economical metrics are often inaccurate or better they are bollocks. They are great for headlines that scare the masses and retail investors but they have very little to do with stock market performance and measuring our true prosperity! With exponential rates of change; our economic parameters appear to be obsolete and in great need of overhaul.  They are gold in the hands of stock market pundits and the media that seem to have us twisted up in fear and agony. We are so afraid to invest without the opinions of the fear mongers that it becomes pathetic. We have lost the confidence, thanks to our daily medicine dose of alarmist, and often misleading, stats that we don’t dare to think for ourselves.
 For everything we need an expert!  From investing to putting in an electric receptacle!  Rather than being handy, we phone up large corporations of handymen that charge $95 per hour to clean our house; to put in a light bulb and to scare us into buying more and more insurance. Does anyone dare to have an independent thought without the fear of being quoted out of context by a self-entitled know-it-all with access to twitter or Facebook?  We live in an era of fear and suppression where we are told by gurus how to decide, in a politically correct fashion, and what to do!  In a world where century old universities are being renamed because its founder was, based on today’s standards, a racist!  Welcome to a new era of re-writing history in newspeak or doublespeak. Welcome to George Orwell’s 1984. Don’t trust your neighbor who may record your domestic spats with a smartphone and release it on Facebook. Welcome to a world without privacy and outdated economic metrics. 

It is really difficult in this world to be an independent thinker and to develop a worldview to make well thought-out investment decisions.  Start by throwing all noise out the door; instead focus on the individual business or investment opportunity; focus on its corporate numbers and judge its products, just like the billionaires of Shark Tank. They can make decisions in a few seconds by judging the entrepreneurs that run the business; by reviewing its products;its competitive moat AND… then check the numbers (Kevin’s favorite being ‘valuation’). Forget about all the macro-economic fantasy numbers. Have you ever heard a Shark say:” I won’t invest in your little enterprise because this month’s GDP is down 10 basis points?  Leave the economic noise to the scaremongering masses of pundits and gurus; to the practitioners of the dismal science and to the hot-air salesmen of Bay Street. Focus on real investments – forget the market noise; buy at a good price and sell at a high!

Sunday, November 22, 2015

Investment Crystal Ball: Energy

Investing is about creating the means of building a good life wherein you can pursue goals that you deem worthwhile achieving. Those goals may be reached or they may change; this happens all the time and thus aiming towards goals is a bit like going after a moving target. Achieving your goals can be satisfying; but make sure that the journey towards your ever changing goals is both enjoyable and worthwhile as well.  In this context the term retirement is devoid of meaning; it is more about reaching the goal of being a financial adult – a stage in your life where you are no-longer financially dependent on one particular job. 
That doesn’t mean that losing your job during financial adulthood is without pain; after all you consider it worthwhile doing.  However, in financial adulthood, you are in control of your life and your lifestyle regardless of such a set-back and you’ll be back to fight another day or to achieve your goal another way. Reaching financial adulthood is not tied to your ‘65th birthday’, or to ‘freedom 55’ – an insurance slogan you find in many ads. For example, my son aims to be a financial adult by age 35 – a bit rosy but not impossible. He is quite entrepreneurial and works hard on his salaried job. His dream is to work on a new living community format – quite an ambitious goal. Will he reach it? Who knows but at least he is moving in the right direction. If you don’t have goals or dreams and if you don’t work towards those goals you’re just drifting through life rudderless and you are unlikely to achieve anything or better you are unlikely to achieve the things you feel are worthwhile.
My life revolves around geology and energy – in particular oil and gas. But hey, maybe I’ll get a chance to go into geothermal energy. Right now I am working on old oil reservoirs somewhere in between the non-conventional and conventional realm. You may not realize it but many of those projects are comparable in scale with a small heavy oil sands project. Despite the whining and complaining by the masses including their current unrealistic hatred for fossil fuels and their distorted views of climate change; I personally feel that oil and gas, maybe even coal, are key ingredients for our society’s prosperity. Climate has changed since the beginning of our planet’s existence and it will change until its end. Sea-level will rise and fall throughout time (which in my scale of thinking is hundreds of millions of years). When you build a house on a spit or near the beach, don’t be surprised that nature will somehow destroy it - don’t blame ‘Global Warming’.
I have lived and worked in the energy industry through the Club of Rome Era; the era of the Peak Oil theory; the fear for a new ice-age in the late 70s; through the introduction of hydraulic frac’ing in vertical wells;  through the initial stages of horizontal drilling; 3D seismic; then the energy revolution of the first decades in 2000 when we started to apply hydraulic frac’ing to horizontal wells and today with multi-lateral (horizontal) wells and multistage hydraulic frac’ing which coincides with this new and deep, unjustified, public hatred for fossil fuels. Today everyone uses pipelines and oil sands as political footballs and it is easy to do so when the industry along with all other types of commodity producing industries are trying to adjust to the latest hysteria regarding oversupply and collapsed pricing.
Many forget that the current malaise is due mostly to an overvalued U.S. dollar.  If you invested in gold as a Canadian, you may have actually made money in gold bullion or at least broken even over the last 4 years, while expressed in U.S. dollars, gold bullion has lost nearly 40%  of its value.  We forget that thanks to the advances in oil and gas production technologies, the U.S. has gone from a state of huge trade deficits and dependence on rogue nations such as Saudi Arabia; Iran; Venezuela; Russia; etc. to a state of near North American energy self-sufficiency where the U.S. can afford to tell Syria to take care of its own problems rather than getting the West involved. You may think that we have Obama or Justin to thank for avoiding military involvement in Syria or Iraq but rather it is our reduced dependency on foreign oil and gas that allows us to care less about these failed states in the Middle East. This of course does not detract from the human tragedy that plays out in those areas and its spill-over effect into our and other countries.
The fast expansion, rational or not, of China resulted in the early 2000s in a shortage of all kinds of commodities. So characteristically to the nature of all things in the commodity world, money poured into all kinds of mining and drilling projects; we over-invested both using equity and borrowed money. With China now transforming into a more service and consumer driven economy and with the construction follies such as China’s ghost cities coming to an end; we’re suddenly in a position of commodity oversupply – especially when combined with a sluggish world economy. The energy industry is adjusting through the destructing first of equity capital and next the destruction of credit (not to mention all the lost livelihoods). In the meantime commodity investing hasn’t been this much hated for decades; mines shut down; oil sands projects are no longer expanding and oil companies are on the verge of mass default. Pundits as a class, announce that prices will stay low for decades and that investing in gold mines, or in oil and gas is a value trap. Hysteria all around. Signs that we are approaching a bottom. Think back to the fall of 2008 all through March 2009 and recall the desperation of every pundit. Many of them had still not recognized in 2010 or 2011 during the so-called European Debt crisis that we had been in a bull market since the spring of 2009. The same is happening to oil and gas, as well as in the overall commodity complex. Yes, a turn-around is in the making.
Have you noticed that there is rarely a week that storage numbers estimated by pundits compared to the actual IEA numbers is correct? Did you notice that, more often than not, the discrepancy between estimate and actual numbers is epic in scale?  Do you follow the stories of massive tanker fleets holding millions if not billions of barrels of oil in storage?  When was the last time you heard that story? Was that in 1998? What happened during those days? And a couple of months later, all those experts announced that the other experts couldn’t find the phantom fleet of tankers!  In a matter of weeks all pundits claimed that they had never believed in such an oil tanker fleet.  Reality is that nobody really knows what is exactly going on.  We don’t even know how many barrels of producible oil are stored in the Saudi subsurface nor what their maximum daily production capability is, let be that of the entire globe.  Estimating oil and gas supply and demand is nearly as futile as predicting climate change!
What I do know is low energy prices are typically good for oil consumers. That during the low energy prices of the 1980s and well into the 1990’s the oil industry somehow survived and that the U.S. economy enjoyed an enormous revival that culminated in the High Tech Boom followed by its unavoidable crash. I know that the explosive supply of cheap goods from China contained inflation – probably more so than Paul Volcker’s high interest rate policies that led to the severe recession of 1982.  I know we are now living again in a period of low energy prices; with enough supplies that may last decades! This may make oil and gas producers, just like farmers, highly dependent on short-term weather patterns. In the future, inflation will probably remain low due to demographics and due to the robotization of the manufacturing industry which will keep costs low.  With the coming of age of the Millennium generation – a generation that is possibly more numerous than the baby boomers – combined with the cancellation of China’s one child policy we are at the dawn of a new era of  population rejuvenation, prosperity and economic growth that may resemble the Clinton Era.
Canada will probably look at a decade of slowly recovering commodity prices because the world population has to eat and fart J while playing video games along with the re-balancing of commodity supply and demand. Prosperity often leads to more peace and vice versa. Let’s hope that in the not-too-distant future, the Islamic world has outgrown its repressive clergy and its under-educated angry masses; that Islamic society returns to an open society where free thinkers can blossom and help create the prosperity so badly needed in those countries.
I have no idea whether fossil fuels will remain a main component of our energy supply; electricity is typically generated from fossil fuels and as such, electric cars will not free us from carbon emissions. Sorry, Elon Musk! But I suspect you already know that.  Solar energy and wind energy may supplement our energy needs. When I look around me in the world though, I see energy everywhere. It is not about whether there are sources of energy, conventional or alternative.  It is about generating energy at an economic price (typically the cheapest) and the only thing government meddling with market forces leads to is distorted markets with severe collapses.  Oil and gas is a very competitive industry with very little or no subsidies – regardless of the contorted claims of many fossil fuel opponents. Ultimately, it is economics that will determine where we are going.
For me, my vision is geothermal energy not extensive wind or solar farms. With hundreds of thousands of wells drilled into the subsurface of Alberta combined with its young and entrepreneurial population, I foresee this province to be ideally situated to become a hotbed (pun intended) for geothermal energy – in part thanks to the legacy of oil and gas wells as well as pipelines from the hydrocarbon energy complex. But only when geothermal proves to be more economically attractive than oil and gas; because I doubt we will ever run out of fossil energy.