When we contemplate the market’s assessment of commodities versus stocks, we find the former, which includes oil and gas, to be at the lowest valuation point in at least 50 years. Does this mean that the commodity market it being disrupted? Peak valuation points occurred in 1973-74, 1990 and 2008. Each peak was associated with spikes in oil prices caused by geopolitical events such as the Arab Oil Embargo, the First Gulf War and the Global Financial Crisis, which happened as oil prices traded in excess of $100 per barrel. Likewise, each low has been associated with low oil prices – either absolute lows, or lows below more recent oil price ranges.
With respect to the low points in the valuation of commodities versus stocks, the prior two lows were marked by excess stock market speculation about super-growth stock future earnings. The 1998-99 Dot.com Bubble, which saw companies brought public with barely any revenues and no earnings, but lots of “eyeballs” on web sites or clicks on shopping sites, happened to also be associated with oil prices falling to $11 per barrel as the Asian currency crisis unfolded and a brief global recession occurred. The 1970-73 low was marked by the market bubble created by the Nifty-Fifty growth stocks, as price-to-earnings ratios for these 50 super-growth companies soared to ratios in excess of 50 times next year estimates for earnings per share. Of course, two energy service companies – Schlumberger Ltd. (SLB-NYSE) and Halliburton Companies, Inc. (HAL-NYSE) – were part of this Nifty-Fifty stock group. Crude oil prices at that point were in the $3 per barrel range, and there was a battle brewing between the seven largest global oil companies that ruled the international oil business and the Organization of Petroleum Exporting Countries over the value of a barrel of oil for tax and royalty calculations. That tax battle lit the fuse that exploded after the Yom Kippur War involving Israel and Egypt in 1973, leading to the Arab Oil Embargo and the explosion in global oil prices.
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This ratio has been doing the rounds of pundit commentary for the last couple of years because commodities are trading at a such a record low level relative to stocks. Jeff Gundlach in particular has been predicting a resurgence in commodity prices because of their relative discount to stocks and one of the reasons private equity has been so interested in the energy space is because of the relative discount to equities on offer, coupled with the prolific production profiles (and early payback) of unconventional wells.