$115 Oil, Contagion, Central banks, Markets & Rome
March 5, 2011
David R. Kotok
“… there’s so much unrest that one can actually sense or imagine unknown nano-particles of rage colliding in mid-air…” (Source: a private person who screens Middle East media for me and with whom I correspond frequently)
“It ain’t over till its over.” –Yogi Berra
We have no empathy for those who bought into the “head fake” rally last week and sold their energy positions because Venezuela’s Hugo Chavez was their peace broker. One doesn’t make a peace until at least one of the antagonists has reached the point of exhaustion. And, usually, the peacemaker needs credibility. Chavez? A peacemaker? Really?
This turmoil hasn’t peaked yet.
The contagion in the Middle East and North Africa (MENA) continues to grow. In addition, the spread to Sub-Saharan Africa lies ahead, as the media images of social network-induced protest encourage copycats in those countries. We are now tracking the 20 MENA countries as well as others like Cameroon and Nigeria.
One needs to put this MENA contagion into the millennium old perspective of the Shia-Sunni schism in Islam. Discussion of that is beyond this short missive. But we must note that Iran is now the dominant sponsor of Shiite Islam and Saudi Arabia is the keeper of Sunni tradition. Readers and serious investors are encouraged to study this schism. Think about it as you think about Catholics vs. Protestants or the War of the Roses. Put that type of historical enmity into an Islamic setting. No way is this over.
Stratfor put the Bahrain situation in this context. “There are negotiations under way between the Shiite-dominated opposition and the Sunni royal family… If there is to be a negotiated settlement, then the royal family, the al-Khalifas, will have to shed some powers, which means that the Shia are likely to be empowered. If that happens, that energizes Shia in Kuwait… And then, of course, Saudi Arabia is next.”
Let’s get to oil prices, financial markets and, lastly, to monetary policy in Europe vs. the United States.
Oil prices are headed higher and maybe much higher as inventory cushions diminish and as markets recognize the quality differences in crude oil. Sweet Libyan crude cannot be replaced by Saudi crude on a barrel-by-barrel basis. As Ed Yardeni wrote, “Saudi crude is cruder.”
Brent crude is reflective of a truer world price. The US standard is West Texas Intermediate (WTI. It is trading at a discount to Brent. It normally trades at a 5% premium. The discount has widened to about 15% or nearly $15 dollars per barrel. This is more than two standard deviations from average. (Thanks to Strategas for data.)
US dependency on imported oil reveals the multi-decade failure of our nation’s energy policy. We will now pay that price in higher gasoline, diesel, and other energy-related costs. Every dollar a barrel translates into about 2.5 cents per gallon of gasoline. Every penny in the gas price translates into about $1.5 billion in a national annual sales tax that extracts part of 305 million American citizens’ incomes and sends it abroad to mostly despotic regimes. Results: GDP growth will be slower, headline inflation will be higher, housing prices will stay weak longer, and the US employment recovery will be diminished.
Financial markets reveal the energy upward trend. XLE is the energy “spider” component of the S&P 500 index. It is the only sector in the S&P 500 that has consistently outperformed the index in the last 6 months. Energy was in this uptrend due to emerging-market economic recoveries and well before the MENA events exploded in the news.
Furthermore, since Egyptian event news hit the TV, XLE has achieved a total return of 9.59% vs. SPY of 1.91% (January 27-March 4 closing prices). Extract energy, and the rest of the US stock market components have been flat or down. We expect these trends to continue; US stocks have stopped discounting robust economic growth. There is a lot of history demonstrating the coincidence of recession and an oil price spike.
Cumberland is at maximum overweight in energy ETFs. We continue to maintain a cash reserve. We believe the US stock market will provide better redeployment opportunities for that cash.
We are also overweight the media ETF, whose symbol is IGN. Ned Davis databases strongly argue, “Media, advertising, broadcasting, Cable TV and movies & entertainment sub-industries, stand out as sector outperformers when the oil prices start to spike.” Note that IGN has also outperformed SPY consistently during the last 6 months. Our US portfolio weight is 3%, which is about as high as we would take a small sub-industry like this.
Let’s move on.
Monetary policy and interest rate outlooks are diverging between the US Federal Reserve and the Eurozone’s European Central Bank (ECB). This has several implications.
In the US, the Fed is worried about employment and not about headline inflation. US policy looks at “core” inflation for estimates of the impact of monetary policy. Energy and food price spikes are viewed as “exogenous.” They are shocks to systems but they are not caused by monetary policy. They can do economic damage that may require monetary policy to ease longer than otherwise would be needed. Bernanke continues to affirm his worry about jobs and the economic recovery. At Cumberland, we consider the chances of aborting QE2 to be zero. The Fed will finish the QE2 program and then pause to review data at the end of the summer. Shorter-term interest rates in the US are likely to remain where they are for all of 2011 and, perhaps, much longer.
In Europe, the focus is more on headline inflation. Europeans tolerate higher unemployment rates more easily than we do. Moreover, they manage their monetary policy on the overall inflation rate outlook and not on the “core.” Thus food and energy prices are encouraging the ECB to tighten policy sooner rather than later. Our colleague Bill Witherell just discussed the upgrading of our outlook for Europe; he gave some specifics on how we are positioning within those portfolios. See www.cumber.com for Bill’s latest missive.
Readers are also advised to consider the shifts in global preferences for reserves. Oil exporters have a lower USD preference than oil importers,” says Barclays. Barclays expects this shift to favor the euro. By analyzing the Treasury flow data, they derive an estimate that every $10 a barrel increase in oil price results in a $2.4 billion per month of reduced demand for USD. Barclays admits this is a difficult estimate to quantify. As to the direction, they are “confident.”
Lastly, we remind readers about a special meeting in Rome on April 6-7-8. When we planned the GIC conference a year ago, we had no idea that Libya would implode and that Italy would be the point country dealing with the energy impact and the Eurozone effects. Now we have an all-star lineup in Rome; and the issue of Europe’s recovery, monetary policy, and the energy impact will be part of the discussion. The GIC delegation is up to 34. We typically cut that off at 40 or so. The other participants are from many European countries and there is a significant number from Italy. Call GIC for details while there are still a few seats left. 215-898-9453.
We have pasted the latest version of the GIC conference lineup below. Cumberland Advisors is a proud sponsor of the Global Interdependence Center, www.interdependence.org.
Capital Markets in the Post-Crisis Environment Part IV: Rome • April 6, 7, 8, 2011
Join GIC as we bring together leading Italian, U.S. and European experts in central bank policy, the capital markets, the economy and professional investors as we continue our International Conference Series in Rome this Spring.
Wednesday, April 6th
Arrival in Rome. GIC Welcome dinner on Wednesday evening. Location: The Rooftop Garden Restaurant at the Forum Hotel.
Thursday, April 7th
Full Day Conference in partnership with, the Bank of Italy, the Italian Banking, Insurance and Finance Federation, and the Council for the United States and Italy. Location: Sala della Clemenza (Main Hall) at the historic and beautifully restored Palazzo Altieri.
9:00AM – 9:30AM –Registration & Continental Breakfast
9:30AM-9:45AM – Welcome
Paolo Garonna, General Manager of the ANIA Federation of Italian Insurers
David Kotok, CIO, Cumberland Advisors and Vice Chair, Global Interdependence Center
9:45AM – 10:45AM Session I: Central Bank Policy followed by Audience Q&A Chairman: Paul McCulley, Chair, GIC Society of Fellows
Sandra Pianalto, President of the Federal Reserve Bank of Cleveland
Salvatore Rossi, Chief Economist of the Bank of Italy & Managing Director for Economics, Research & International Relations
10:45AM – 12:00PM Session II: Sovereign Debt Issues followed by Audience Q&A
Chairman: Hubert Fromlet, Linnaeus University and Jönköping International Business School
Herbert Taylor, Vice President and Secretary of the Federal Reserve Bank of Philadelphia
Kozo Koide, Chief Economist, DIAM Co. Ltd.
Timo Tyrvainen, Chief Economist of Aktia Bank
Gregorio De Felice, Chief Economist of Banca Intesasanpaolo
12:00PM – 1:30PM Session III: Finance and Economic Recovery followed by Audience Q&A
Chairman: Emanuele Ravano, Managing Director, Financial Institutions, PIMCO
Matteo Bugamelli, Economic Structure and Labor Market Division in the Research & International Relations, Bank of Italy
Andrea Battista, CEO, Aviva Italia(15 mins)
Manuel Balmaseda, Managing Director, Chief Economist, CEMEX
1:30PM – 3:00PM– Lunch
3:00PM – 4:00PM Session IV: Investing After the Crisis followed by Audience Q&A
Chairman: David Kotok, CIO, Cumberland Advisors and Vice Chair, Global Interdependence Center
William Clark, Senior Vice President and Chief Investment Officer, Federal Reserve Employee Benefits System
John Mousseau, Managing Director and Portfolio Manager, Cumberland Advisors
Constance Hunter, Managing Director and Chief Economist, Aladdin Capital Holdings
4:00PM – 4:15PM Coffee break
4:15PM – 5:15PM Session V: Italian and U.S. Business in the Global Economy followed by Audience Q&A
Chairman: John Silvia, Chief Economist, Wells Fargo
William Dennis, Senior Research Fellow, NFIB Research Foundation
Riccardo Perissich, Executive Vice Chairman, Council for the United States and Italy
Maria Pia Camusi, Director, R.ETE Imprese Italia
5:15PM – 5:30PM Conclusion provided by J.Paul Horne, Independent Market Economist & GIC Board of Directors
Friday, April 8th
GIC’s Private Roundtable Discussion. Location: Sala Verde at Palazzo Altieri
Held under Chatham House Rule, and open only to the GIC Delegates and invited guests, our Roundtable Discussion has become a hallmark of GIC’s international conferences. This conversation will focus on European and other sovereign debt issues. Featured speakers are Joe Mason, Hermann Moyse/LBA Chair of Banking at the Ourso School of Business, Louisiana State University, and Jim Lucier, Managing Director at Capital Alpha Partners.
Conference Registration for GIC Members $250 •Non-Members $350 (incl. one year membership with registration.)
Please visit our website for online registration at http://www.interdependence.org/Event-04-06-11.php
David R. Kotok, Chairman and Chief Investment Officer