Today’s Outside the Box is special, because I’m about to give you a preview of things to come at Mauldin Economics. For months now I have been saying to my partners that we need to develop a service for the professionals who read me – the financial advisors, portfolio managers, family offices… you know who you are. And I’m excited to tell you that we are very close to making this service a reality. It will be called Mauldin Pro, and it will feature global macro and geopolitical research and analysis, portfolio recommendations, monthly interviews with some of the best talent in the business, and quarterly seminars to help you improve your game.
It will also feature a global macro analysis and investment letter that has created quite a buzz in the industry. Stray Reflections is written by Jawad Mian, a former portfolio manager who lives in the UAE. Born in Pakistan and educated in Canada, Jawad managed $250 million in proprietary funds before turning his attention to his real passion: writing about the macro themes that should be on every investor’s mind, and constructing a theme-based global macro investment portfolio. His audience includes some of the most-respected portfolio managers in the world.
He’ll bring his fantastic letter to Mauldin Pro in the coming weeks. If you are interested in learning more and you are a professional market participant, give us your email address, and we’ll contact you when the service is ready to go.
Regardless of who you are or how you make your living, you’ll enjoy this piece from Jawad, taken from the November edition of his Stray Reflections. It deals with his view on oil, which has been the focus of the market lately. Can we say Peak Demand?
Have a great week with your family and friends. Remember to take some time to catalog the probably long list of things you should be thankful for. High on my list will be you, whose gracious allocation of time and attention, two of the most valuable commodities in the world, makes my world even possible. I am truly grateful.
I finish this note after a long workout, trying to get ready for the Thursday marathon. The Beast has changed up the workout routine from lighter weights and many repetitions to “maxing out” the last few days. To my utter surprise, at the end of the workout I bench-pressed 205 pounds, 10 more than my previous max (which was 10 years ago). Who knew that 65 was such a good age for working out?
John Mauldin, Editor
Outside the Box [email protected]
Stray Reflections (November 2014)
By Jawad Mian
Investment Observations
The precipitous decline in the price of oil is perhaps one of the most bearish macro developments this year. We believe we are entering a “new oil normal,” where oil prices stay lower for longer. While we highlighted the risk of a near-term decline in the oil price in our July newsletter, we failed to adjust our portfolio sufficiently to reflect such a scenario. This month we identify the major implications of our revised energy thesis.
The reason oil prices started sliding in June can be explained by record growth in US production, sputtering demand from Europe and China, and an unwind of the Middle East geopolitical risk premium. The world oil market, which consumes 92 million barrels a day, currently has one million barrels more than it needs. US pumped 8.97 million barrels a day by the end of October (the highest since 1985) thanks partly to increases in shale-oil output which accounts for 5 million barrels per day. Libya’s production has recovered from 200,000 barrels a day in April to 900,000 barrels a day, while war hasn’t stopped production in Iraq and output there has risen to an all-time high level of 3.3 million barrels per day. The IMF, meanwhile, has cut its projection for global growth in 2014 for the third time this year to 3.3%. Next year, it still expects growth to pick up again, but only slightly.
Everyone believes that the oil-price decline is temporary. It is assumed that once oil prices plummet, the process is much more likely to be self-stabilizing than destabilizing. As the theory goes, once demand drops, price follows, and leveraged high-cost producers shut production. Eventually, supply falls to match demand and price stabilizes. When demand recovers, so does price, and marginal production returns to meet rising demand. Prices then stabilize at a higher level as supply and demand become more balanced. It has been well-said that: “In theory, there is no difference between theory and practice. But, in practice, there is.” For the classic model to hold true in oil’s case, the market must correctly anticipate the equilibrating role of price in the presence of supply/demand imbalances.
By 2020, we see oil demand realistically rising to no more than 96 million barrels a day. North American oil consumption has been in a structural decline, whereas the European economy is expected to remain lacklustre. Risks to the Chinese economy are tilted to the downside and we find no reason to anticipate a positive growth surprise. This limits the potential for growth in oil demand and leads us to believe global oil prices will struggle to rebound to their previous levels. The International Energy Agency says we could soon hit “peak oil demand”, due to cheaper fuel alternatives, environmental concerns, and improving oil efficiency.
The oil market will remain well supplied, even at lower prices. We believe incremental oil demand through 2020 can be met with rising output in Libya, Iraq and Iran. We expect production in Libya to return to the level prior to the civil war, adding at least 600,000 barrels a day to world supply. Big investments in Iraq’s oil industry should pay-off too with production rising an extra 1.5-2 million barrels a day over the next five years. We also believe the American-Iranian détente is serious, and that sooner or later both parties will agree to terms and reach a definitive agreement. This will eventually lead to more oil supply coming to the market from Iran, further depressing prices in the “new oil normal”. Iranian oil production has fallen from 4 million barrels a day in 2008 to 2.8 million today, which we would expect to fully recover once international relations normalize. In sum, we see the potential for supply to increase by nearly 4 million barrels a day at the lowest marginal cost, which should be enough to offset output cuts from marginal players in a sluggish world economy.
