/By Matein Khalid/The oil market has been a rollercoaster in 2016. A global financial panic triggered by China’s yuan depreciation caused Brent crude to fall below $30 a barrel in late January. I was amazed at the sheer scale of the speculative short positions accumulated by oil traders and hedge funds in both West Texas and Brent futures markets, the highest since the oil crash of 2008. The oil market had taken an extreme, consensus, ultimately wrong bearish view on prices in late February. Even though OPEC’s Doha meeting failed to resolve the vast policy rifts between Iran and Saudi Arabia, rumours began to circulate that the Kremlin wanted to broker a production freeze with Riyadh, a scenario later sketched out by Igor Sechin, chairman of Russian state oil firm Rosneft and Vladimir Putin’s key lieutenant. This resulted in a brutal short squeeze in the oil futures markets, the reason black gold surged almost 50% in the next few months, offering a fabulous money making opportunity for nimble traders who could read the geopolitical smoke signals coming out of Riyadh, Moscow and Tehran. Hedge funds slashed their speculative short positions by two thirds in both the Brent crude and West Texas crude oil markets.
However, by late summer, it was clear that $50 oil had led to a rise in the US land rig count to 377, a signal that the 4000 odd shale oil producers in Texas, Colorado, Ohio, North Dakota etc. were poised to raise output while gasoline priced failed to rise during the US summer driving season due to high inventories. There was a global oil glut and oil traders once again began to short West Texas, which fell 20% from its peak to $40. Then new Saudi Oil Minister Khalid Al Falih hinted about a shift in the kingdom’s oil policy at the OPEC meeting in Algiers, setting off another short squeeze in the markets. Oil prices rose to $47 even though Chinese economic growth is at 26 year lows, leading to a fall in diesel demand while Brexit has led to a stronger US dollar in the currency markets.
The key variable in the oil market is whether Iran will finally agree to any joint OPEC agreement to cap output. Even a production freeze at current levels could well lift prices to the higher end of their current 45 – 50 range and a credible Iran-Saudi agreement at Algiers could well lift prices as high as $60 a barrel this winter. This does not necessitate that Saudi Arabia resume its pre November 2014 role of OPEC’s “swing producer”, only that the kingdom and Iran not engage in a price war for market share that only causes oil prices to plunge.
It is also unwise to ignore Iraq in the geopolitical equation at Algiers. Basra Light exports have been unaffected by the US led coalition’s air war against Daesh, since Iraq’s major oilfields and export terminals in the Gulf are all in the government controlled Basra province. Kurdish oil has also begun to flow from the northern pipeline to the Turkish port of Ceyhan. In Libya, the UN brokered agreement between the Tripoli National Accord government and a rival militia has caused the Zuwetina oil ports to reopen. The ceasefire between secessionist Niger Delta rebels and President Buhari’s military could also cause Nigerian output to rise. Iraq, Libya and Nigeria all have the potential (and definitely fiscal incentive) to increase oil output and thus contribute to the global glut.
Sheikh Yamani liked to joke that the Stone Age did not end because humankind ran out of stones. The Oil Age will also not end because the world runs out of oil. Technology is history’s biggest game changer. We are at the dawn of the Electric Car Age, way? beyond Tesla, thanks to advancements in batteries and fuel cell technologies. For now, I am just obsessed by the outlook for prices in September and October. Bijan Zangeneh will attend the meeting in Algiers. Low prices have stimulated oil demand growth in Asia and the US. Saudi Arabia has indicated it is willing to cooperate with Russia. OPEC net revenues have fallen $400 billion since 2012. After six failed attempts to engineer a production freeze, I am no giddy oil bull. Yet Saudi output is at a record 10.7 million barrels a day (MBD). The closed Yangtze River refineries and petrochemical plants will reopen. Crude oil can rise from $46 to $60 in the Panglossian best of all possible worlds!
Market View – The Federal Reserve and global financial markets
The Federal Reserve has a dual constitutional mandate. Maximize employment consistent with a 2% inflation rate. Eight years after the failure of Lehman Brothers forced the US central bank to slash the overnight borrowing rate to zero and expand its balance sheet from $900 billion to almost $4.5 trillion via money printing, the Fed has reached the limit of its dual mandate. Money market futures contend a 80% probability of a rate hike by December.
The US economy created 299,000 jobs in June, 255,000 in July and 151,000 in August. The unemployment rate is now 4.9% while wage growth is above 2.6%. This is good enough for a Fed rate hikes at the December FOMC, which is after the election and thus allows the central bank to preserve its “political independence”.
Last December, Janet Yellen raised rates for the first time since 2007 and warned the world to expect four rate hikes in 2016. Then China’s financial markets went ballistic in January and Europe’s bank stocks lost 30 – 50% due to fears above systemic risk in Italy, Brazil/Russia recession and Brexit. When Chicken Little did not see the sky fall in 2016, the Yellen Fed began to talk tough on rate hike. China, Brexit and Italian banking have stabilized for now but global risks will continue to concern the Federal Reserve. There is still deflation risk in Europe and Japan while Chinese growth has fallen to 25 year lows. A rate hike in December is now Wall Street’s consensus scenario.
The stock market rallies in the US and Europe since January mini-crash triggered by China were due to central bank money printing and a fall in interest rates, not earnings growth. Now $12 trillion in global securities, one third of world sovereign debt, trades at negative yields while the S&P500 index trades at 17.8 times forward earnings, up from 11X in 2011. Interest rates will now rise and hyper rate sensitive global markets trading at stratospheric valuations will pay the price.
The financial markets no longer believe that there will be no rise in interest rates in 2016. This is the reason gold fell to two month lows at $1315 an ounce. Bank shares have begun to surge since late July, the reason an activist hedge fund (and this columnist!) accumulated Morgan Stanley, up 30% from its recent low. HSBC Holdings has surged 20% in London and Hong Kong in the past six weeks as its $400 billion Treasury excess deposits makes the shares soar when the US Treasury debt yield curve steepens. Even Japanese bond yields, the Empire of the Rising Sun and Helicopter Money, have just risen 25 basis points on no news.
I am also worried about the rise in three month London Interbank Offered Rate (LIBOR), the rate at which global banks lend to each other, a barometer of global bank risk. The rise in LIBOR does not just reflect regulations over US money market funds, but a rise in systemic risk in global banking. A higher LIBOR means higher cost of bank funding and a potential shock to the leveraged global economy. Foreign central bank reserves at the Federal Reserve Bank of New York have begun to fall. As I learnt in 2008, this means a shortage of US dollars in the world currency markets. US inflation, dampened by the 60% fall in crude oil since June 2014, will only rise in the next twelve months. This means the world could be on the eve of a major US dollar uptrend – King Dollar on steroids. It also means the yield on the ten year US Treasury note can rise from its current 1.56% to as high as 2.50% by next spring. This will be a financial neutron bomb on global risk assets, mainly property and bond proxy equities. This will mean a bloodbath for Private Bankerji’s leveraged bond clients. This columns caught the 100% rally in the Gold Miners index fund (GDX). Now is the time to book profits and short the miners and yes, even spot gold, to my $1270 target. The big money will be made shorting the long end of the bond market and buying the world’s most interest rate sensitive banks – Bank of America, Daiichi, HSBC. Short? Utilities and telecom. My credo from a lifetime in global markets? Risk is a four letter word. So is ruin!
Stock Pick – Making money in Wall Street takeover shares
Pfizer won the frenzied war on Wall Street to take control of oncology biotech Medivation (MDVN), outwitting Sanofi, Merck, Astra Zeneca, Celgene and Gilead. This was a windfall for investors prescient (or lucky!) to own Medivation, whose shares soared from $28 in February 2016 to the Pfizer offer price estimated at $84 a share. Pfizer is a paying a steep price in its $14 billion bid for a company that could barely accrete its earnings per share by 2% in the next few years. In essence, Pfizer paid a nosebleed 180% takeover premium to acquire Medivation’s lucky shareholders in February. Sadly (for me), I was not among them, even though I have written about the oncology revolution in biotech ad infinitum in these columns since 2012.
The obvious question that every biotech hedge fund in the world needs to ask. Who is the next late stage pipeline oncology biotech on NASDAQ that will be takeover bait for Big Pharma? Bio Marine Pharma (BMRN) and Incyte (INCY) surged the most after Pfizer’s bid and have that rare mix of oncology drugs plus a late stage pipeline. The thwarted bidders for Medivation are still on the hunt for oncology assets, notably Gilead Sciences and Sanofi. Roche Holdings covets late stage oncology/orphan drug pipelines.
While biotechs are still 25% below summer 2015 highs, thanks to Hilary Clinton’s political campaign against drug price hikes. Biotech have rallied an incredible 28% since the Brexit bottom. This sector is a speculative, high beta puppy!
Viacom is a conglomerate 80% owned by legendary Sumner Redstone, now 93 and gravely ill. His daughter Shari Redstone has engineered a boardroom palace coup that saw the ouster of Philippe Dauman and other crony executives from Daddy’s era. I do not blame Shari Redstone. The shares have plummeted from their 94 peak to only 40 or a $16 billion market cap and earnings multiple of 9. Viacom’s MTV, Nickelodeon, Spike TV cable networks have had falling ratings and lousy affiliate fees. Comedy Central ($800 million in revenues) lost global superstars Jon Stewart and Stephen Colbert. Cord cutting is a fact of life. Kids have abandoned cable for online streaming video – and Viacom has not yet done a major deal in this sector. Paramount Pictures was once a major Hollywood movie studio but its recent flops “Ninja Turtle”, “Zootopia” and Ben Hur are truly awful, even by mass market box office standards. Viacom’s founding family heir Shari now controls the board, will handpick the next CEO (Tom Dooley is interim) and will be in deal heat.
So what’s the Street grapevine de jour? A potential merger with CBS, spun out of Viacom in 2006, whose CEO Les Moonvens is a programming genius. Now that Dauman is gone with a $ 72 million golden parachute, Shari’s new CEO could well sell a strategic stake in Paramount to China’s Wanda for deal multiples similar to Disney/Dreamworks. Shari also controls CBS whose content (Homeland)/programming DNA could goose Viacom, which also needs to scale up digital and do a streaming video/ad tech deal that will make the world gasp.
Lord Rothschild advised us to buy financial assets when there is blood on the street – in the killing fields of Belgium, in the case of Rothschild who made a fortune on the stock exchange since his spies gave him advance notice (carrier pigeons were the algo traders of the Napoleonic era) of Waterloo. There is blood in the management suite at Viacom. The satellite dish/cable distributors are as doomed as black and white TV in a digital world. My teenage twins have no use for the 46 inch flat screen TVs foolishly bought them for stellar A levels. Who needs TV or cable in the age of Netflix (now in UAE) and Youtube? Dauman was a disaster at Viacom and he has sold $17 million in Viacom shares. Great. If Shari Redstone can get Viacom in play, this becomes the hottest media stock on the planet. Note my call on Morgan Stanley was hugely profitable as it rose from 24 to 32 or 25% as activist hedge fund ValueAct accumulated the shares Happy campers R Us, habibi!
