Saudi Arabia abandoned its role of OPEC’s swing producer, made possible by the sheer scale of its output, spare capacity and reserves, in November 2014. This was the catalyst for the most brutal oil price crash since Lehman’s failure triggered global recession in the winter of 2008-9. The Algiers pact does not negate the kingdom’s unwillingness to bear the disproportionate cost of an output cut that only erodes its downstream Asian market share. Iran and Saudi Arabia are also bitter geopolitical rivals in Iraq, Syria, Lebanon, Yemen and Bahrain. Just as the Doha output freeze deal in early 2016 fell apart after Iran refused to respect OPEC’s output ceiling, the non binding Algiers agreement can unravel at Vienna once the tortuous politics of country quotas are negotiated. Apart from Kuwait, Qatar and the UAE, I doubt if the other OPEC states, desperate for petrodollars, will comply with a Saudi Arabian output freeze diktat.
The Iraqi Oil Minister has publicly dissed OPEC’s output calculation formulas just a week after Algiers. Ayatullah Khameini’s cronies have insisted that Iran will increase output to its pre-sanction 4MBD level despite the “deal” Oil Minister Bijan Zanganeh reached with the Saudis at Algiers. These are hardly auspicious omens for a done deal in Vienna, as OPEC’s “Fragile Five” states (Iraq, Libya, Nigeria, Venezuela and Algeria) have the most political and fiscal incentives to ignore OPEC country quotas. If the Fragile Five cheat on their quotas, the Vienna meeting will unravel, Saudi Arabia and its Gulf allies could abandon the Algiers pact – and oil price could plunge below $40. I have been an OPEC watcher all my adult life, ever since I met Sheikh Yamani’s son Hani at Wharton and became an obsessive oil futures trader.
Libya is determined to increase its crude oil output to 600,000 barrels a day by the time OPEC meets in Algiers. Iran has increased gas condensate exports to Europe to above 500,000 barrels a day and Qom’s top theologian/political elites have denied that Algiers has imposed an output ceiling or limits on Kharg Island cargo liftings. Nigeria has dumped Bonny Light cargos on the spot market. Traditionally, as the market bids up oil prices, OPEC’s Fragile Fives (and Iran) raise, not cut, exports. This can well happen in the run up to the ministerial meeting in the city of Freud, Klimt, Sisi and Carlos the Jackal.
The tragic brutal escalation in Aleppo reduces the risk of a Saudi-Russian rapprochement. Vienna cannot be a success if Russia does not commit to cap or even reduce its output. Since the 2007 Kremlin budget is predicated on $40 oil, I doubt if a Moscow-Riyadh deal will precede the conclave in Vienna. In any case, Iran, Iraq, Libya and Nigeria alone will offset.
Saudi attempts to enforce an output cut down to the Algiers level of 32.5 to 33 MBD. The history of OPEC has taught me the hard way that countries ramp up output ahead of Vienna country quota negotiations to maximize leverage at the ministerial meeting. This process alone will spook the oil bulls in New York and London. While 94 million wet barrels are shipped each day in the tanks of the world’s supertankers, 1.5 billion barrels of “paper oil” are traded in the futures/options markets of the IPE and the New York Merc/CME. If speculators see Algiers unravel, oil prices will plunge below $40.
Saudi Arabia’s refinery maintenance season and lower power demand leads to a seasonal dip in output. Yet if Iraq, Nigeria and Libya raise output before Vienna, the kingdom will be forced to cut at a deeper level than it can afford, at a time of fiscal austerity and uncertain international appetite for its planned $10 billion sovereign Eurobond. This could make a deeper Saudi cut to accommodate Tehran and Baghdad politically impossible in Riyadh.
Currencies – The lessons of sterling’s ghastly crash!
The Brexit vote had compelled me to publish several columns recommending UAE investors short sterling at the top of its trading range of 1.33 (if only to hedge steep losses on their UK property!). This strategy idea was vindicated with a vengeance as sterling plunged to 1.2360 as I write, after having fallen to 1.1850 (thus my next expected trading level) in a flash crash in Asian trading. This is the biggest money making idea in global currencies I have published in this column in 2016 that impacts most major investors in the Gulf.
Politics, not monetary economics, was the immediate catalyst for sterling’s ghastly plunge last week. Theresa May’s speech at the Conservative Party’s Birmingham conference was all about immigration policy and border controls, not the need to maintain the City of London’s passporting rights to the vast $16 trillion EU economy. So such as the Prime Minister invoked a timetable for Article 50 by next March, she revealed that she has now succumbed to the hard Brexit, xenophobic demands of the Tory backbenchers who have plagued every Conservative leader since Edward Heath in the early 1970’s EEC era.
Britain was once the world’s greatest trading power, a maritime colossus, Anglobalization was the first chapter of globalization in the Victorian era. No more. Theresa May has cast her lot with the Little England, anti-City, anti-EU, Remain populists, not the pro-finance, pro-City, pro-Europe Cameron/Osborne wing of the Conservative Party. This is a disaster for the bloodied sterling bulls.
France’s President Hollande’s triggered sterling’s biggest intraday drop against the US dollar since Black Wednesday in 1992, when U.S hedge fund billionaire George Soros made a billion dollar killing, broke the Bank of England and forced sterling’s exit from the European Rate Mechanism (ERM). Hollande’s tough stance against Brexit and promise to “go all the way through the UK’s willingness to leave the EU” proves that the Article 50 process will be tough and protracted. The Elysee Palace and the Reich Chancellery will punish Westminster for the epic gamble David Cameron took and lost with the Brexit vote. While a rogue algorithm (or a Savvy options trader in the Swiss Alps!) triggered the plunge to 1.18 on Friday morning, the verdict of the currency gnomes is clear. Sterling is now leprosy in Planet Forex and if the trend is your friend in currency trading, sterling’s trend, like London Bridge, is falling down my fair lady!
Sterling’s plunge will now turn toxic. Britain is the most open, most inflation prone economy in Western Europe and it is significant that inflation expectations have risen 80 basis points since the Brexit vote on June 24, while Governor Carney has cut the base rate and expanded the Bank of England’s gilt purchase program. If the Old Lady of Threadneedle Street is “behind the inflation curve”, expect another global run on sterling as Britain slips into recession. This makes Brexit Brittania’s third worst catastrophe of 2016, after the football team’s loss to Iceland and the blond Old Etonian clown’s promotion to Foreign Secretary!
The pound’s spectacular fall demonstrates that Britain will learn the bitter cost of Brexit the hard way. The uncertainty about Article 50’s political compromises will only rise in the next six months and chill corporate capex, High Street consumer spending, cross-border trade and FDI. Sterling punched above its weight as a reserve currency due to the British Empire, North Sea oil and the City of London’s role as the magnet for global finance. No longer. This has awful (amid negative!) implications for Britain’s huge unsustainable current account deficit. Lenin once observed that the Tsar’s armies voted with their feet – in our age of electronic finance, foreign exchange traders vote against a government’s idiotic policies by dumping its currency on their Bloomberg screens. In retrospect, the $5 trillion Planet Forex has given the thumbs down to Mrs. May’s UK. Something is dangerously wrong in a world where sterling can crash from 1.30 to 1.18 in a mere week.
I expect the current bloodbath in the bond market will intensify – and lead to foreign panic selling in gilts. The cost of borrowing will surge as the markets, not Carney, hedge inflation risk from the sterling crash and $52 Brent (So taxi rides from Heathrow to West End hotels rise to £100 a pop?). London property prices can well fall by 20 – 30% as the macro milieu unravels. Tessa has gone populist to compete with UKIP’s loony right. The Bank of England is clueless about inflation risk. The French want to avenge Brexit, Waterloo and Agincourt. I remain a sterling bear!
Stock Pick – Tactical ideas in global stock markets
If bull markets climb a “wall of worry”, 2016 proved it. Despite last winter’s Chinese yuan spillover, Brexit the bungee jump in crude oil, Deutsche Bank, Italy woes and fears about the Donald Trump circus, the US market has continued to be a winner, though nothing like the money gusher my favourite markets Pakistan, Taiwan, Russia, Indian banks/autos and Philippines property developers proved to be. However, as I see sterling collapse to 1.2350, gold plunge to $1250, King Dollar on a rampage against the Swissie and the Canadian dollar (my loonie collapse scenario is happening in real time – 1.33 now, 1.36 target), a massive spike in US, German and Japanese bond yields amid prospects for a Fed rate hike and an ECB taper. As a strategist, I cannot afford the luxury of dogmatism. When the world changes, my trades change with it. As Dr. Johnson might have put it in Georgian England, leverage, like hanging, concentrates the mind!
The easiest directional call in global equities is to remain long the Financial Times (FTSE 100) index or the Footsie, in the lingo of the City. Almost 70% of British large cap earnings are generated outside the sceptered isle, so the Footsie is a classic beneficiary of a sterling that is getting slammed in the world currency market. Europe will get nasty over Article 50 so I would short names like Easyjet, Tesco, British Land and Ryanair while load up on greenback earners. Rolls Royce, BP, Shell and Pearson PLC. Follow the money to London Town, hedge sterling and surf the Footsie to 7800.
Barclays new CEO Jes Staley (Jes could still one day run the House of Morgan when Jamie Tyranncus is finally booted off the banking Mount Olympus!) and his strategy of slashing non-core assets, including sacred cows like Africa. Yet I fear Little England banks like Lloyds and RBS will be hit by slower loan growth, higher funding costs, a grimmer High Street and a free fall in UK property prices as the Brexit talks turn ugly.
In Europe, the spike in German Bund yields on the prospects of a Draghi (or let’s face it Bundesbank!) led taper consensus in the ECB Governing board, could be a signal to buy my favourite banks in Europe. (BNP in France, ING in Holland, Credit Suisse in Helvetica). The Euro bank Stoxx 600 index has underperformed by a colossal 25% in Europe and a steeper German Bund yield curve could be the catalyst to unlock deep distress value. Insurers Axa, Swiss Re, Aegon and Allianz also benefit from a steeper global debt yield curve.
While I expect the Algiers deal to unravel in Vienna, the logic of squeezing black gold shorts means Brent could well rise to $56 – 58. While the hottest action is in pure play shale oil E&P firms in West Texas and the drillers, I believe widows and orphans will sleep far easier owning the shares of French supermajor Total SA. The firm has slashed capex from $28 billion three years ago to $10-12 billion next year while reducing its per barrel operating cost to $6, the lowest oil cost producer among the Seven Sisters. I love Total’s 6% dividend (No risk of a cut) and discount valuation to Shell and BP while its Angolan, LNG and Russian (Total owns 19% of Novatek) projects could well deliver 5% output growth. My put sale strategies on Total are designed to earn $60,000 in premium income on 60 contracts of high delta May 2017 puts on the New York ADR.
Even though the IMF slashed its growth forecasts again, Wall Street wants to accumulate industrial shares on both sides of the Atlantic (though please avoid the value traps of Marounuchi in Japan!) I will reiterate my conviction that United Technologies (UTX) shares simply do not discount Pratt and Whitney’s growth potential in narrow body aircraft engines (with long life aftermarket services the usual cash cow), the $9 billion sale of Sikorsky helicopters will finance higher payouts and share buybacks and the China property boom will boost earnings growth in Otis elevators and Carrier cooling systems. The recurrent revenue services model deserves a valuation rerating above 13.6 times forward earnings. This is one of the world’s great engineering, technology and product innovation franchises that is no Honeywell.