Investors are running for the exit... Another sign of a bottom?... What you need to know about shale-oil drillers... How this game of 'chicken' will end... Why we recommend silver... An important note on 'junk' silver...
If the herd of investors running for the exit is any indication, we may be close to a bottom in commodities and emerging markets...
We discussed several signs of a potential bottom in commodities in yesterday's Digest. Today, we have another...
On Tuesday, Bank of America Merrill Lynch published its monthly fund manager survey. Polling more than 200 fund managers, the survey found hedge funds are "bailing" on commodities, emerging markets, and energy stocks at a record pace.
An article on financial-news website MarketWatch noted this could be a sign of "capitulation"...
Capitulation is defined as the moment when everyone who wants to exit a particular asset class is already out, creating bargains. Prices should then bounce off those lows.
Record underweights in all three asset classes could turn into a "late-summer pain trade" and give way to a rally, said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research, in a news release.
"Fears on Greece have been replaced by fears of a Chinese recession/[emerging market] debt crisis. This has manifested in capitulation"... both globally and in Europe, said Hartnett.
We also checked in with our friend Jason Goepfert – who runs the fantastic SentimenTrader website – to see what his research has to say...
In a report earlier this week, Jason confirmed the negative sentiment, noting "more extremes are being registered in commodities, commodity currencies, and emerging markets in general as sentiment has morphed from hope, to resignation, to outright pessimism at this point."
While the details are reserved for his paid subscribers, his proprietary sentiment indicators have recently registered "excessive" pessimism for several individual commodities (including gold, silver, copper, and even oil), the broad CRB commodities index, and emerging markets, as represented by the iShares MSCI Emerging Markets Fund (EEM).
Extremely negative sentiment measures like these usually lead to at least short-term rallies, and are often good long-term buying opportunities.
As we mentioned yesterday, no one can consistently call the bottom in a market. But we're seeing more and more signs a significant bottom could be approaching here.
You likely noticed oil was included in the list above. And that's not surprising...
Supply and demand (along with inflation and currency debasement) are the long-term drivers of commodity prices. But commodities are also subject to investor emotion like any other market.
The dramatic decline and extreme pessimism in oil suggest a rally is likely in the short term.
But as regular Digest readers know, we believe prices are ultimately headed lower. A sustained recovery is unlikely until production begins to decline... and that isn't happening.
Yesterday, we discussed why Saudi Arabia and OPEC are still increasing production. Today, we're taking a closer look at the shale-oil drillers here in the U.S... and why they're still pumping, too.
The answer, in a word, is debt.
Porter predicted today's problems long before they became headline news. As he explained in the March 13 Digest...
The shale-oil industry is in jeopardy because a lot of the capital used was raised via debt offerings.
Since 2007, total debt in the U.S. exploration and production sector has gone from $125 billion to almost $300 billion. And much of this debt is destined to default.
The mainstream media started to pick up the story this summer. From an article in Bloomberg in late June...
The debt that fueled the U.S. shale boom now threatens to be its undoing.
Drillers are devoting more revenue than ever to interest payments. In one example, Continental Resources Inc., the company credited with making North Dakota's Bakken Shale one of the biggest oil-producing regions in the world, spent almost as much as ExxonMobil Corp., a company 20 times its size.
The burden is becoming heavier after oil prices fell 43 percent in the past year... "The question is, how long do they have that they can get away with this," said Thomas Watters, an oil and gas credit analyst at Standard & Poor's in New York. The companies with the lowest credit ratings "are in survival mode," he said.
And things have only been getting worse...
Many commodities producers use futures contracts as a way to "hedge" against falling prices.
If you're not familiar, a futures contract is just an agreement between two parties to buy or sell a commodity for an agreed-upon price at a specific date in the future. By locking in a purchase or sales price in the future, companies can reduce their exposure to higher or lower prices.
Many shale producers have been benefiting from futures contracts made before prices collapsed last year. The contracts guaranteed they could sell their oil for prices as high as $85-$95 per barrel.
But these hedges are beginning to expire... just as oil prices are headed lower again.
This means many companies will suddenly be making much less money for each barrel of oil sold. They'll have no choice but to produce more oil at lower prices, or they'll go under.
Barring an unexpected recovery in oil prices, many are likely to be doomed no matter how much oil they try to produce. But don't be surprised to see them continue to produce as much oil as possible until they are.
No one can say when this game of "chicken" between OPEC and the U.S. will end. But an article this morning from Bloomberg could offer a clue...
In this war, the chicken-out price isn't what's needed to meet budget requirements, which ranges between $40 a barrel in Kuwait and $125 a barrel in Venezuela. It isn't the cost of drilling, pipeline laying and other overhead expenses, either.
No, it's the marginal cost of getting the oil out of the ground once the wells are drilled, the pipelines laid and the overhead covered. It's the price at which cash flow for an additional barrel drops to zero. In Texas's Permian Basin and in the Persian Gulf, the marginal cost is $10 to $20 a barrel, and even lower for some Saudi oil fields.
As long as prices exceed marginal cost, more (not less) production is encouraged to make up for lost revenue. Some producers will raise output even at prices below marginal costs.
In other words, so long as prices are above $10-$20 per barrel, producers in OPEC and here in the U.S. are likely to keep pumping.
Unless Saudi Arabia says "uncle," prices could go lower for much longer than almost anyone expects. And as we discussed yesterday, even that may not be enough to quickly reverse the trend at this point.
We continue to believe oil could fall as low as $30 per barrel... or lower. And while that's still a "contrarian" view, more folks are beginning to wake up to the possibility. From an article in the Wall Street Journal...
Most analysts still expect prices to bottom out soon and trudge toward $70 a barrel by the end of next year. But some are eyeing a list of further threats this fall, with the end of the summer vacation driving season and as refineries in the U.S., Europe, and Asia go into regular maintenance.
Carsten Fritsch, senior commodity analyst at Commerzbank AG, said that the coming maintenance season and worries over Chinese growth could easily push WTI into the $30 range in the coming months.
Andrew Lipow, president of Houston-based consultancy Lipow Oil Associates, said that the pressure on oil will continue until next March as inventories build up with the maintenance season. Mr. Lipow has a price target of $32 to $34 a barrel for WTI in the next six months.
Citi's "bear case" sees WTI dropping to the lower $30s per barrel later this year and staying there for much of 2016.
The bottom line is, it's still far too early to buy the shares of most oil producers today. Traders will likely have an opportunity to profit from rallies along the way... but the big trend is still down.
Finally, we have some important news for anyone buying silver today...
Longtime readers know we recommend everyone have a portion of their savings in physical gold. But we recommend owning some physical silver, too. Porter reminded readers why in his recent book America 2020...
Why are we so bullish on silver? History.
No other investment asset loves a monetary crisis like silver does. I would urge (even beg) you to read the May 2006 issue of Stansberry's Investment Advisory. It explains in great detail the reasons why silver prices tend to soar during a monetary crisis. It also explains the three phases of a monetary crisis. Back then, I explained why we were on the cusp of entering the second phase of a monetary crisis, which I defined this way...
Phase II happens as the government begins to take actions to halt rising prices through force. The government will not cut its own spending, which is the primary driver of inflation... It will not begin to address the unsustainable nature of entitlement spending, or the current value of its long-tail obligations...
Instead of addressing the genuine causes of inflation in the United States, the government will begin to tax, regulate, and even imprison what it labels the culprits. These efforts will only exacerbate and accelerate the rise in prices... Once Phase II begins, more and more people have tangible evidence that something has gone badly wrong with the economy. They begin to hoard. Rich people hoard gold and silver.
As Porter explained, things have only gotten worse since then...
After I wrote those words, the annual government deficit has soared from less than $300 billion to around $500 billion annually. The U.S. government continues to foster a soak-the-rich, tax-and-regulate regime, in which a dozen or more states have enacted steeply progressive "millionaire" taxes. Obama has personally lobbied the American people for more taxes on the "rich" – all of which have been used to justify more government spending and ever-larger government deficits.
Meanwhile, the inflation and the joblessness these policies cause have led to a return to "misery index"' conditions in the United States and more social unrest. I wish I could tell you the worst was over and our leaders will soon come to their senses and return our country to sound economic policies. But that will not happen. Instead, the political dynamic in our country – where criminals run wild on the streets (and in the halls of Congress) while the government continues to print money to pay its debts – will soon lead to what I call a "Phase III" monetary crisis.
In a Phase III crisis, people flee from the currency at all costs. Civil society falls apart. Cash savings are destroyed and other forms of savings that depend on a stable currency – like insurance policies – are wiped out, too. Worst of all, the monetary crisis makes it impossible for people to save or invest in America. Our standard of living and our stature in the world collapse.
That's what's going to happen. I can't tell you exactly when. But the sure way to know how bad things are getting is to watch the Treasury markets. As long as the world continues to buy our bonds, we're safe. But a moment will arrive when investors simply refuse to own our government's debt at almost any price. If you don't take steps right now to protect yourself, you will be wiped out when that moment arrives.
Over the years, many Stansberry Research analysts have recommended so-called "junk" silver as one of the best ways to own physical silver. The reason is simple. Here's how our colleague Dr. David "Doc" Eifrig explained it...
The Coinage Act of 1965 removed most of the silver from U.S. coins. Half dollars changed from 90% silver to 40% silver... And other coins were 75% copper and 25% nickel. Then in 1970, Congress pulled the remaining silver from the coins.
Coins dated before 1965 are known as "junk silver." They get tagged as "junk" because they have no value to collectors. They circulated widely in pockets and purses and show a lot of wear. By one estimate, more than 13 billion of these coins are spread around the country. But what's bad for collectors is great for us as investors...
Because they don't have collectible value, these coins can be purchased at just a few percentage points above the spot price for an ounce of silver. That's significant since collectible and uncirculated silver coins often have premiums of 25%-50% or more than the spot price. So junk silver gives us an immediate 25%-30% discount to other types of silver coins.
As Doc said, the reason we recommend buying junk silver is because it's typically much cheaper per ounce than silver coins and bullion.
But before you buy junk silver, there's something you need to know...
Regular readers may remember Rich Checkan of Asset Strategies International. His firm is one of two precious metals dealers we frequently recommend to subscribers. (The other is Van Simmons of David Hall Rare Coins.)
Rich just alerted us to an unusual development in the junk silver market.
In short, due to increased demand, premiums – the amount you'll pay above the current or "spot" price of silver – are much higher than usual. Delivery times are much longer, too.
For example, Rich says premiums for junk silver averaged about 4%-6% over the spot price over the past 10-plus years. In the past few years, that has slowly increased to 10%-15%, which was still cheaper than other forms of silver.
But recently, premiums have jumped to 25%-35% over spot for junk silver (which is even higher than the 15%-20% premiums you'll pay on most one-ounce silver bullion coins). And Rich says delivery times are north of eight weeks today.
Incredibly, he says folks are paying these high premiums for junk silver, despite his recommendations to consider cheaper alternatives.
If you're looking to buy more physical silver, Rich says 100-ounce bars of silver bullion are a much better value. Most dealers are offering them at just 5%-10% over spot today.
If you'd like more information, Rich and his colleagues at Asset Strategies International would be happy to talk with you. As always, we receive no compensation for recommending their services... they've just always treated our customers well. You can reach them at 1-800-831-0007 or by e-mail at contactus@assetstrategies.com.
New 52-week highs (as of 8/19/15): American Financial Group (AFG), Expeditors International (EXPD), UBS ETRACS Monthly Reset 2xLeveraged ISE Exclusively Homebuilders Fund (HOML), iShares U.S. Home Construction Fund (ITB), McDonald's (MCD), Constellation Brands (STZ), short position in Viacom (VIAB), and SPDR S&P Homebuilders Fund (XHB).
Two compliments for Porter in today's mailbag. Send your thoughts – good and bad – to feedback@stansberryresearch.com.
"Porter, I have sent the occasional feedback in regarding your postings, usually only when I think you are off base. e.g. some of your over ratings of how the various publications did against known benchmarks and some big calls you made on stocks that absolutely can't miss like Boston Scientific a few years ago. However... your call on the price of oil going further down that virtually no one else predicted is spot on. Now if you had only recommended some puts on various oil stocks or ETFs we could have made a lot of money. Like many great analysts that I have read (it is a short list) their/your macro views are much better than your individual stock picks." – Paid-up subscriber Howard
"[The August 14] Digest is one of Porter's very best, from a long line of very best editions and destined to become an all-time classic. Many of today's topics have been covered before in S&A publications but this one tied them all together to illustrate the pattern that is clearly emerging. Well done Porter!" – Paid-up subscriber James Pyke
Regards,
Justin Brill
Baltimore, Maryland
August 20, 2015
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