A Warning for Oil Investors

Elon Musk's latest stunt... Why the 'Cybertruck' is appealing for Tesla... The greatest threat to one of our favorite whipping boys... This burgeoning competition is critical for silver... A high-profile train wreck in Saudi Arabia... The kingdom isn't getting what it wants... A warning for oil investors...

Editor's note: Our Stansberry Research offices will be closed on Thursday and Friday as we celebrate Thanksgiving with our family and friends. Look for some timeless advice from our colleague Dr. David "Doc" Eifrig in this weekend's Masters Series. And then, we'll return with our usual Digest fare on Monday, December 2. We hope you enjoy the holiday.

It was just another stunt, like most things Elon Musk does...

Musk, the attention-hungry CEO of electric-car maker Tesla (TSLA), unveiled a prototype for an electric-powered pickup truck during an event last Thursday outside Los Angeles.

Musk's presentation included a video of the new truck – which he's calling the "Cybertruck" – hitched to the back of a Ford F-150 in a game of tug of war. And of course, the Tesla dragged the Ford uphill with ease.

As you can imagine, the fix was always in with the tug of war...

I (Carli Flippen) don't want to descend too far into "Car Talk" territory, but the high-end version of Tesla's Cybertruck costs more than twice the amount of Ford's baseline F-150. And it's configured to have much more towing power, according to Barron's. The publication noted that a fairer fight would pit the top-of-the-line Tesla versus Ford's similarly priced F-450.

Ford apparently issued the challenge... And Musk responded on Twitter, "Bring it on." We'll see if the battle between the F-450 and the Cybertruck ever materializes, but we wouldn't hold our breath.

The clip was just part of the circus Musk staged to show off the prototype...

Starting with the truck's Cubist-like triangular design... and including his sledgehammering the door... Musk once again put his real genius on display – drawing attention to himself. (Look, it worked!)

The antics aside, breaking into the truck market is important for the maker of luxury electric cars, which just began eking out profits earlier this year. According to Wired magazine...

Cybertruck represents a potentially big part of Tesla's future, as the automaker seeks to expand its footprint and improve its financials. Pickup trucks make up roughly 15% of U.S. vehicle sales, a share that has steadily grown since 2009, according to research shop IHS Markit...

More important, pickups produce serious profits: [News service] Reuters has reported that General Motors nets, on average, $17,000 per pickup. On high-end models with the sorts of options that push sale prices above $100,000, that margin can reach $50,000.

You can see why that would be appealing to Tesla.

We've written for years about the company's shaky finances. Of late, our colleague and Empire Financial Research founder Whitney Tilson has been highly pessimistic on Tesla's outlook.

Perhaps the greatest threat to the company is that...

Tesla's unique selling proposition isn't so unique any more...

As Whitney has pointed out, irrespective of its balance-sheet problems, Tesla does make an attractive car. And it has leveraged that strength – its early mover status in electric vehicles – to secure 78% of the market for U.S. electric-car sales. As Whitney wrote in an April update to his Empire Investment Report subscribers...

Tesla makes great cars. I enjoy driving them, and every one of my friends who owns one loves it. More important, Tesla has almost single-handedly forced every major auto manufacturer in the world to invest billions of dollars into developing electric cars.

But that leadership position is quickly vanishing...

Carmakers around the world were planning to launch 66 new electric-vehicle models this year and another 101 models next year, according to research firm McKinsey.

Well-known short-seller Mark Spiegel, who is bearish on Tesla, took up more than 10 minutes of his presentation at our recent Stansberry Conference in Las Vegas simply listing the new models coming out from makers as diverse as Kia, Nissan, Ford, BMW, Maserati, and Aston Martin.

And it doesn't matter if any of these new models outsell Tesla. "If 5,000 [of its sales] go to the Mercedes and 4,000 go to the Audi, at the end of the day, [Tesla] will get crushed," Spiegel said.

The burgeoning competition in electric cars is important for other industries, too...

Take precious metals, for example.

John Doody and Garrett Goggin, the editors of our Gold Stock Analyst-Silver newsletter, dedicated their most recent issue to what's happening in this corner of the car market.

Why?

Because the growth in electric vehicles is going to create huge demand for silver.

Unlike gold, its more popular precious metals counterpart, silver has industrial uses because it's highly reflective, antimicrobial, and is an excellent conductor of electricity. That last quality makes it a key component in the batteries that power all these electric vehicles.

As John and Garrett noted in Gold Stock Analyst-Silver, the London Bullion Market Association, a global authority on precious metals, projects that silver demand for use in the electric vehicles is expected to balloon 246% over the next two decades – from just more than 1,300 metric tons in 2015 to 4,500 metric tons by 2040.

And they point out that the picture is even more complicated because...

The wave of new demand is hitting just as silver supplies are plummeting...

John and Garrett looked at the top five primary silver mines in any given year. And they saw that production dropped 26% among these mines – from 100 million ounces in 2014 to 74 million ounces in 2018.

And at the same time production levels are falling, so are the average grades of the silver mined. That makes the operations less and less efficient. As John and Garrett concluded...

Unless the silver price increases – or someone finds a miraculous high-grade deposit – miners' margin on average will continue to be squeezed. Total silver production will likely drop further. A silver supply shortage could result. Prices could scream higher as silver is revalued.

And of course, because of the way silver stocks are valued, a big rise in the value of silver could drive the prices of mining stocks to the moon. Already this year, their recommended silver stocks are up 69% – seven times greater than silver's 10% year-to-date return.

If you don't follow John and Garrett's work, they maintain a model portfolio of the best five silver-mining stocks to own at any one time. They call it the "Fave 5." (It's modeled after the Top 10 model portfolio of gold producers that they keep in their flagship Gold Stock Analyst-Pro newsletter.)

While their recommendations are significantly outperforming silver this year, it could be just the beginning if this silver supply shortage materializes as they predict. So we encourage you to consider buying some precious metals stocks if you don't already hold any.

If you'd like to learn more about how to follow John and Garrett's work in their Gold Stock Analyst publications – and access all their top gold and silver recommendations – click here.

Elsewhere in the markets, Kim Iskyan highlighted another high-profile train wreck in the making...

Longtime Stansberry Research readers will recognize Kim's name. He has made a career writing from and investing in far-flung places. In the past, Kim wrote the Global Contrarian newsletter... And then, he helped us launch our publishing efforts in Asia.

Now, he's serving as our international editor. A few days ago, Kim wrote to us about how...

Global investors just gave the Saudis a lesson in how markets work...

The Saudi Arabian government has been gearing up to take Aramco, its national oil company, public in December. Aramco will become the world's largest, most profitable publicly traded company after its initial public offering ("IPO").

Saudi Arabia hopes to rake in more than $25 billion by selling a 1.5% stake in Aramco. However, that's a big comedown from the $100 billion that the kingdom previously hoped to bring in through its IPO.

Aramco was slated to start its global road show last week. Management was due to visit big institutional investors in money centers around the world to sell them on buying shares in the offering.

But the company just scrapped the plan, calling off meetings with investors outside of Saudi Arabia. As the Financial Times reported recently...

Saudi Arabian officials have told bankers they are unhappy with the level of foreign demand for Saudi Aramco... [there is a] gulf in demand between domestic investors and foreign institutions in the run-up to the much-delayed initial public offering.

The problem is, that gap isn't small...

Foreign investors indicated they might be interested in buying shares at prices that would put Aramco's value in a range between $1.2 trillion and $1.5 trillion, the Financial Times reported.

That would position it in the neighborhood of electronics giant Apple (AAPL), whose $1.2 trillion market cap makes it the largest U.S.-listed company. By comparison, the venerable oil major ExxonMobil (XOM) sports a market cap of only about $300 billion.

But that wasn't good enough for the Saudis...

Local investors in Saudi Arabia – where Aramco will be listed on December 4 – were more generous. Over the weekend, the company announced a price range for the shares that would value the company between $1.6 trillion and $1.7 trillion. As Kim explained in an e-mail to us...

That difference in opinion isn't surprising.

Domestic investors – Saudi fund managers, state-controlled funds, or other pools of capital linked to the government – are under pressure to support the IPO. The government is "encouraging" them to bid at higher levels. Saudi citizens are being offered interest-free loans to invest, and bonus shares for holding past six months – and religious leaders are urging their flock to participate.

Most big Saudi investors understand when the government "encourages" you to do something... you'd better do it.

He pointed out how Saudi Crown Prince Mohammed bin Salman had journalist Jamal Khashoggi murdered in October 2018 at the kingdom's consulate in Istanbul.

Khashoggi, a U.S.-based journalist who had criticized the regime in columns for the Washington Post, was strangled and his body was cut into pieces. The Saudi government soon charged 11 agents – including members of the crown prince's security detail – for what it has called a "rogue operation." Turkish intelligence officials and the U.S. CIA have both said they have evidence that bin Salman ordered the hit.

(Just two days ago, the Saudi government arrested a number of local writers and bloggers who are critical of the kingdom in what the Financial Times called "a fresh crackdown on dissent.")

Regardless of how much blood you think is on bin Salman's hands... the point is, this is how the kingdom keeps people in line. And as Kim noted...

So if you're sitting on a mountain of money in Riyadh or Jeddah, and bin Salman suggests that you should buy shares of Aramco at the offering, it's probably a good idea to write a check with a lot of zeros to do just that.

Bin Salman is also corralling other investors in the Persian Gulf region... Abu Dhabi state-backed funds are likely to invest $1.5 billion in the offering as a show of support to Saudi Arabia, according to the Financial Times.

Foreign investors, though, are under no such pressure...

Big Western institutional investors – pension, mutual, and hedge funds – have a lot of good reasons to be cautious. As Kim pointed out...

For starters, it's never a good sign when insiders want to sell... and Saudi Arabia is the ultimate oil industry insider. It has the world's second-biggest oil reserves after Venezuela... It's the second-biggest oil producer (after the U.S.)... and it's the largest oil exporter. It's the most important member of the OPEC oil cartel.

If Saudi Arabia is selling shares of Aramco to the public, it could be the sign of a long-term top in oil prices.

Then, of course, the Khashoggi scandal reminds everyone that the government of Saudi Arabia is as brutal as any strongman regime in the world.

The biggest problem with giving your money to the Saudi government – which will remain the 98.5% majority shareholder of Aramco – is that you can't trust it. From Kim...

You have to think long and hard before investing in a country where you can't rely on basic legal protections or recourse if something goes wrong.

Of course, higher risk can be acceptable if the investment promises a better return...

Given Aramco's elevated level of risk, foreign investors should expect a higher return. And in an IPO, your chances of a higher return are a lot better if you buy into a company's shares at a lower price.

The easiest way to value a company is comparing its price (market cap) with its earnings, better known as the "P/E ratio."

According to Kim, Aramco generated profits of $111 billion in 2018. That makes it the most profitable company in the world. It's nearly twice the net income of Apple... more than three times that of Alphabet (GOOGL)... and five times what ExxonMobil earns.

So at a total market cap of $1.65 trillion (the middle of Aramco's announced range), the company would go public at a 2018 P/E ratio of about 15.

That compares with a 2018 P/E ratio for ExxonMobil of around 14. Rivals BP (BP) and Royal Dutch Shell (RDS-B) are valued at 2018 P/E multiples of 13 times and 11 times, respectively. As a result, in his e-mail to us, Kim wondered...

Does Aramco deserve to be valued at the same level as – or higher than – these globally diversified energy companies with a track record going back decades of treating investors fairly, in a market that enjoys rule of law? I don't think so.

According to Kim, a better comparison for Aramco is Gazprom...

The Russian government owns a majority stake in Gazprom, the world's largest natural gas company. And as Kim explained in his e-mail...

I've followed Gazprom since the mid-1990s, when I was an energy analyst in Moscow. It is one of the most corrupt companies in the world, and it's unbelievably inefficient.

Twenty-eight years since the end of the Soviet Union, it's still run like a ministry of the USSR. Largely because of this – and the limited chances that small investors have to actually claim what is their fair stake of the riches of company – shares of Gazprom trade at a P/E ratio of around 4 today.

So should Aramco shares trade at a P/E of 4, like Gazprom, or 14, like BP or ExxonMobil? We know what bin Salman thinks – and what domestic investors in Saudi Arabia will be pressured to buy at.

If we're generous and say that Aramco should be at a valuation twice that of Gazprom, it would suggest a total market capitalization of around $800 billion to $900 billion.

That's a lot... but it's a whole lot less than what it looks like will happen.

Many IPOs wind up being bad investments. Aramco probably will be, too...

Bin Salman isn't getting what he originally wanted for Aramco. And with the scaled-back targeted valuation level and scrapping of a big effort to draw in international investors, the company is floating its shares only on Saudi Arabia's Tadawul stock exchange.

It has been a pretty hard lesson for the kingdom about how markets work so far. And that lesson probably won't get any easier. As Kim concluded in his e-mail...

IPOs tend to substantially underperform the market as a whole – and any sustained effort by the Saudi government to support Aramco shares could wind up being very expensive.

But it's probably a matter of time before bin Salman tries again to entice international investors to buy Aramco... maybe through a secondary offering in New York or London. The Saudi government's thirst for capital is enormous... and it will want to try to repair its wounded pride.

In the bigger picture, I think Aramco's problem is... oil. When the most plugged-in oil investor in the world starts to sell – whatever the reason – it means it has better ideas for its capital. And if you're an investor in oil, that's a big cause for pause.

If you're putting money to work in the oil sector today, be warned.

New 52-week highs (as of 11/26/19): CBRE Group (CBRE), Quest Diagnostics (DGX), Disney (DIS), DocuSign (DOCU), New Oriental Education & Technology (EDU), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), Intuitive Surgical (ISRG), iShares U.S. Home Construction Fund (ITB), iShares Russell 2000 Fund (IWM), JPMorgan Chase (JPM), Masco (MAS), Microsoft (MSFT), NetEase (NTES), Invesco S&P 500 BuyWrite Fund (PBP), Flutter Entertainment (PDYPY), ALPS Medical Breakthroughs Fund (SBIO), ProShares Ultra S&P 500 Fund (SSO), Silvercorp Metals (SVM), ProShares Ultra Financials Fund (UYG), and Vanguard S&P 500 Fund (VOO).

A quiet mailbag today... We hope you and yours have a great Thanksgiving holiday. As usual, you can send your comments and questions to feedback@stansberryresearch.com. We can't provide individual investment advice, but we do read every note.

Regards,

Carli Flippen
Baltimore, Maryland
November 27, 2019