David Fuller and Eoin Treacy's Free (Abbreviated)
Comment of the Day

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Click HERE to see the most recent free Subscriber's Comment from 19 September, 2014

December 19 2014

Commentary by David Fuller

Oil Production and Climate Change

My thanks to a relative for this interesting and detailed report by James W Murray, School of Oceanography, University of Washington.  Because it consists mostly of graphics, here is the briefest opening:

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”

Mark Twain

There are many, many things that the public and policymakers know for sure about energy that just ain't so.

"We like to think that the reason we enjoy our high standards of living is because we have been so clever at figuring out how to use the world's available resources. But we should not dismiss the possibility that there may also have been a nontrivial contribution of simply having been quite lucky to have found an incredibly valuable raw material that for a century and a half or so was relatively easy to obtain."

- James D. Hamilton (Dept. of Economics, UCSD)

Oil Production has beenon a plateau since 2005

David Fuller's view

Many thanks for this interesting and informative report.  I have been reading, trying to learn from, and commenting on energy reports for over 45 years.  Most have proved to be quite inaccurate, in terms of long-term forecasts, largely because their authors did not fully appreciate the march of technology.  Many also had biases, across the widest range, from green alarmists to industrial deniers.  Moreover, if what we know about energy production and technology had remained unchanged from the '60s or '70s, we would be living in a much more economically depressed and energy challenged environment today.  I think you could say the same about what we know today, relative to what will happen during the rest of our lives and well beyond.

Of course Climate Change is extremely important and worrying, and we are but one of its major causes, if we consider the long-term history of our planet.  Coal is currently the cheapest energy source, widely available and the biggest pollutant.  Fortunately, the use of coal is being phased out by many countries, not least in China, for health reasons. 

Greens and political alarmists such as Al Gore persuaded Germany to invest fortunes in inefficient wind mills and early solar projects.  As a consequence, in addition to some of the world's highest energy costs, Germany is burning more coal today because the renewables need back-up coal-fired plants to offset frequent, sudden shortfalls when the wind is not blowing or the sun is not shining.   

France closed all its nuclear power stations following Japan's Fukushima nuclear disaster in March 2011, caused by a massive earthquake and tidal wave.  Today, France burns more coal for the same reasons as Germany, and both countries have considerably weaker economies.  These mistakes have been repeated across much of Europe and the UK.

The report above, interesting though it is, has biases and inaccuracies, such as the sweeping generalisations in points 3 & 4 below:

3. They are environmentally damaging because the fracking fluid is highly toxic and much of it escapes during the blowback process and sometimes water wells are contaminated.

4. Because each well has low flow and depletes quickly, massive numbers of wells must be drilled creating significant infrastructure damage to roads and bridges. Currently no state or municipal authorities are capturing anything close to the total cost of the infrastructure damage from the shale operators which means taxpayers are gong to be left paying those bills.

 This item continues in the Subscribers’ Area, where the report is also posted.

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December 19 2014

Commentary by David Fuller

Berkshire Energy Fined for Eagle Death at Wyoming Wind Farms

Here is the opening of this distressing report from Bloomberg:

PacifiCorp, one of the utilities owned by Berkshire Hathaway Inc. (BRK/A)’s energy unit, agreed to pay $2.5 million to settle charges that its wind facilities in Wyoming killed eagles and other birds.

The deaths near the Seven Mile Hill and Glenrock/Rolling Hills wind farms violated the Migratory Bird Treaty Act, according to a statement today from the utility. PacifiCorp said it will pay $400,000 in fines, $200,000 in restitution to the Wyoming Game and Fish Department and $1.9 million to the National Fish and Wildlife Foundation to help protect golden eagles near the facilities.

David Fuller's view

Good.  I hope they continue fining nice Warren Buffett and other owners of wind farms which remain cuisenaires for birds, and also drive people mad who have the misfortune to live nearby.   

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December 19 2014

Commentary by David Fuller

Obama Vows U.S. Response to North Korean Hacking Attack on Sony

Here is the opening of this topical article from Bloomberg:

President Barack Obama said the U.S. will respond to North Korea’s cyber-assault on Sony Pictures Entertainment “in a place and time and manner that we choose,” adding that he thought the studio made a mistake by canceling the release of a movie linked to the attack.

In his first extensive public comments on a hacking attack the U.S. Justice Department today said was carried out by the North Korean government, Obama said companies shouldn’t be intimidated.

“We cannot have a society in which some dictator in some place can start imposing censorship here in the United States,” Obama told reporters in Washingtontoday.

The cyber-attack on Sony computers exposed Hollywood secrets, destroyed company data and caused the studio to cancel release of “The Interview,” a comedy about a fictional assassination of North Korean leader Kim Jong Un. The hackers rendered thousands of computers inoperable and forced Sony to take its entire computer network offline.

David Fuller's view

Good for Obama.  Eoin first mentioned this earlier in the week and I would also like to see the film, in protest at this cyber attack and in support of Sony.  Cyber terrorism is a growing threat for us all, with considerable consequences.  I have seen estimates that this one may have cost Sony $200 million.

See also: Sony’s Lynton Blames Theatres for Cancelling ‘The Interview’.

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December 19 2014

Commentary by David Fuller

Iain Little: Global Thematic Investors

Here is a brief sample from Iain’s latest Fund Manager’s Diary:

The market has focused its laser gaze on negatives. Q: How much oil-related corporate debt is there? (A: about 15% of US recent issuance occasioned by the fracking capex boom,; a lot, but hardly a disaster) Q: How will Mr Putin react? (A: ask Mrs Putin; like Mr Putin, an unknowable unknown.) Q: Where are the bankruptcies? (A: it depends on how long resources languish at these levels, but there will be casualties; there always are) Q: Is oil's weakness a symptom of a wider economic malaise (A: maybe, but one detects the hand of swing-producer Saudi Arabia, rattled by US fracking, seeking to embarrass both the fracking and renewable energy communities; it only adds to general merriment in Riyadh if political scores-Russia, Iran, Venezuela come to mind- can be settled at the same time)

David Fuller's view

If you would like to meet Iain Little, a fellow subscriber to this service for decades, you can do so and hear his views, particularly on the important subject of Investment Trusts (closed-end funds) at the next Markets Now meeting in London on 12th January – see details below.  

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December 19 2014

Commentary by David Fuller

You Are Not Disabled. You Eat Junk

Here is the opening of this topical article from Bloomberg:

The decision by Europe's highest court that obesity can be a disability will only make a bad problem worse. Too many people in rich countries are already overweight. Giving them legal grounds to feel righteous about their condition, regardless of its causes, will almost certainly expand their ranks.

The case brought to the European Court of Justice involved Danish child-minder Karsten Kaltoft, fired by the municipality of Billund in 2010 after 15 years of service. The town attributed the firing to redundancy, but Kaltoft, who is 5'8'' tall and weighs 352 pounds, claimed his employer got rid of him because he was overweight: his weight was mentioned in the conversations that preceded his dismissal. The court was asked to decide whether that would have violated a 14-year-old European Union directive banning discrimination against people with disabilities. 

The matter turned on whether obesity qualifies as a disability. It's not expressly described as such in any Danish or European statutes. But the Court ultimately sided with an opinion filed by Advocate General Niilo Jaaskinen. He argued:

In cases where the condition of obesity has reached a degree that it, in interaction with attitudinal and environmental barriers, as mentioned in the UN Convention, plainly hinders full participation in professional life on an equal footing with other employees due to the physical and/or psychological limitations that it entails, then it can be considered to be a disability.

In other words, if one gets to be so overweight that it hampers one's work, the employer should find ways to accommodate the obese worker, rather than seek to replace him or her. That might mean buying her an extra large chair or even installing an elevator so she doesn't have to use the stairs to get to her workplace. It doesn't matter, Jaaskinen wrote, "whether the person concerned became obese due to simple excessive energy intake, in relation to energy expended, or whether it can be explained by reference to a psychological or metabolic problem, or as a side-effect of medication." Even if the disability is self-inflicted, Jaaskinen (and the Court) determined that discriminating on that basis shouldn't be permitted. 

David Fuller's view

So people who eat too much junk food are not responsible for their own weight?

With rare exceptions in developed countries, of course they are.  You are what you eat.  We are responsible for our actions. 

Temptation is another matter and so is corporate responsibility.  I approve of the pressure governments, the medical profession, health industries and responsible individuals put on firms to provide healthier meals and accurately list all ingredients, not least including sugars, fats and preservatives.  This is sound commercial good sense, judging from the queues I encounter in Waitrose and Marks & Spencer food stores.     

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December 19 2014

Commentary by David Fuller

The Markets Now

Monday January 12th, 5:30pm to 8:30pm, at East India Club, 16 St. James Square,London, SW1Y 4LH

David Fuller's view

Here is the new brochure.  I am looking forward to this opening session for 2015.  There are certainly plenty of opportunities in the markets, in addition to some inevitable risks which we all hope to avoid.  We have an interesting new guest speaker - Charles Elliott - who will talk about the exciting field of technology in which we all have an interest.  Our November session at the East India Club was a sell-out, attracting plenty of knowledgeable delegates who contributed to a lively session.  I expect the same in January and suggest that you book early for the better rate and to ensure seats for yourself and any guests.  If you have the time, do join us for a drink and further chats at the Club’s cash bar after 8:30pm.

Good news - Bruce Albrecht will also be able to give a short presentation at this seminar.

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December 19 2014

Commentary by Eoin Treacy

Stress Testing EM FX

Thanks to a subscriber for this heavyweight report which may be of interest to subscribers. Here is a section: 

We expect this uphill battle to extend into 2015 as the main forces that drove EMFX in 2014 are still in place. However, we believe that these headwinds are poised to ease as the year unfolds, since we believe that: 1) the upside for the USD into 2015 is about one-third of what we saw in 4Q14 (and possibly concentrated in 1Q15); 2) oil prices have already approached the bottom of our expected range; 3) the political calendar will be considerably lighter; 4) policy uncertainty has reduced; and 5) EM growth will likely pick up some steam over the next year. On aggregate, we forecast EMFX spot slightly stronger in 2015. This, plus the usual contribution from carry, as the chart below shows, should eventually benefit portfolio flows.

Central banks: Not to the rescue. As one important byproduct of the recent fall in commodities, investors will still face mostly dovish central banks. In addition to reduced inflationary pressures (mostly outside LatAm), central banks see EM currencies as their main line of defense against external and domestic shocks. This – in addition to policy divergence and differences in exposure to oil – have underpinned our preference for INR, IDR, TRY vs. BRL, RUB – and to a lesser extent ZAR (where downgrade risks will linger) – among the high-yielders.

Although we believe that the dovishness of central banks is to a large extent priced among the lowyielders in EMEA, it will likely continue to weigh on Asia FX. With the JPY, food and energy prices down, we expect the need to preserve value to drive policy in SGD, KRW, and THB. We also see BNM shifting its line of MYR defense to 3.50, while PHP remains vulnerable to perceptions that monetary policy is falling “behind the curve”. In LatAm, the room for easing monetary policy is a lot less given high inflation and the region’s FX exposure to commodities, but we believe that further easing will keep CLP undervalued in the first part of 2015, at least.

Eoin Treacy's view

A link to the full report is posted in the Subscriber's Area.

The Dollar’s rally this year not only against the Yen but a host of emerging and developed market currencies has been both outsized and counter to the trend that has prevailed for the better part of a decade. Commodity prices, electoral cycles and central bank actions have all been major factors but the relative strength of the US economy is perhaps the most notable factor of all. 

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December 19 2014

Commentary by Eoin Treacy

Email of the day on Hong Kong REITs

I emailed several weeks ago to ask that you include Prosperity REIT (808:HK) in the Chart Library, but I gave you the wrong ticker, so could you please add this again. And do you think you could review the Hong Kong REIT market at some point as well? It might prove interesting for us all. Thanks so much, and happy holidays.

Eoin Treacy's view

Thank you for this question which highlights a high yield sector in Hong Kong, which is benefitting from the potential for additional flow of funds from the mainland. We have added the correct ticker for Prosperity REIT to the Chart Library. 

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December 19 2014

Commentary by Eoin Treacy

Year-Ahead Outlook 2015

Thanks to a subscriber for this report from Deutsche Bank focusing on the credit markets. Here is a section:

 

Historically, it has been the case that lower oil provided a net benefit to the US and EU economies, both of which were large net importers of energy. This remains the case in EU today, however we wonder to what extent this relationship might have changed for the US in recent years. Just looking at energy companies in our IG and HY indexes, we are seeing their cumulative capital expenditures since Jan 2010 at $4.7 trillion, with $1.15trln coming in the last four quarters alone. The latter figure translates into 6.5% of the total US GDP, not an immaterial figure. We realize that not all of this capex went into US shale plays, however it is just as important to acknowledge that not all US shale players are captured by our IG/HY index data. What part of this capex budget gets cut next year is subject to uncertainty, however even a relatively modest cut of 10% could translate into a noticeable 65bp impact on broader GDP figures.

What makes this issue even more consequential to the US economy, is that the negative impact of lower oil is unlikely to remain confined just to the Energy sector alone. Some of the more obvious casualties will include capital goods and materials sectors, where suppliers of drilling equipment, pipes, storage containers, machinery, cement, water, and chemicals used in shale production are all likely to experience a negative impact. Now, readers should be careful to avoid double-counting the same dollars here, as a dollar of capex by oil producer is 80 cents of inventory sold from its suppliers; only incremental value-added is captured by the GDP. Add to this list railroads, where volumes exploded in recent years as large quantities of oil were ferried by rail cars.

All these are relatively obvious casualties of a pullback in energy producers’ budgets. Perhaps somewhat less straightforward would be utilities – we wonder how much electricity was used to power all this new shale-related manufacturing, production, transportation, and refining activity? Taking one more step towards less directly impacted sectors, we think about financials, and not even in a sense of direct loan exposures to cash-flow challenged producers. Energy producers have raised $550bn in new debt across USD IG, HY, and leveraged loan markets since early 2010 (Figure 3). Lower capex budgets would imply lower need (and ability!) to borrow, thus squeezing a revenue source for investment banks.

And now to the least obvious, or perhaps even counterintuitive, candidates: think about consumer discretionary sectors, such as retail, autos, real estate, and gaming. States with the strongest employment growth in the US in the last few years were all states heavily involved in shale development – average unemployment rate in Dakotas, Nebraska, Utah, Colorado, Iowa, Montana, Oklahoma, Wyoming, and Texas is 4.1%, compared to a national aggregate of 5.8%. Average unemployment rate in oil-producing states today is lower than the national aggregate was at any point in time in the last twelve years.

While we still believe that lower oil prices would provide a net benefit to consumer discretionary areas, we think that historical parallels between energy prices and their positive net effects could be challenged in this episode given significant changes to structural characteristics of the US economy. Just as we believe consensus has consistently underestimated positive externalities of the US energy revolution in the past few years, it is positioning itself to underestimate the other side of this development now. 

Eoin Treacy's view

A link to the full report is posted in the Subscriber's Area.

The stock market appears to be currently focused on the benign economic scenario that has allowed the Fed to signal short-term interest rates may increase in 2015. With unemployment back to trend and early signs of wage increases, along with recovering economic growth, the Fed has good reason to want to use this environment as an opportunity to replenish its arsenal of policy tools. Consumers will find that they have extra money in their pocket every time they fill up at the pump or pay of heating oil and these benefits will pass on to energy consuming sectors as well. 

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December 19 2014

Commentary by Eoin Treacy

Email of the day on DXJ divergence with the Nikkei 225

Do you know why DXJ is down over 8% today when the Nikkei was up 389 points?

Eoin Treacy's view

The Wisdomtree Japan Hedged Equity Fund (DXJ) paid short and long-term capital distributions today, which has affected the fund’s price but not the overall trend or ability to reflect the hedged performance of the Japanese market. 

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