The Double Case for Shorting Middle East ETFs

by: Rakesh Saxena December 01, 2008 | about stocks: AFK / GAF / GULF / MES / PMNA    

Rakesh Saxena

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Following the OPEC meeting this weekend, Saudi oil minister Ali al-Naimi asserted that $75 a barrel represented a “fair price” which incorporated the cost of investment required to prove up more oil from undeveloped oilfields. But, quite noticeably, OPEC was unable to identify today’s demand-supply equation. In fact, the problem today is not finding more oil; there are dozens and dozens of proven energy resources waiting to be tapped. The problem is to figure out how much oil is the world buying on a daily basis today, and how much it is expected to buy through a recession-ridden 2009.

The problem is aggravated by a number of other factors. Primarily, “best estimates” apart, nobody really knows how much oil is produced and sold every day since the energy cartel (and Russia) have never subjected their petrochemical complexes to independent, verifiable international-standard audits. Then there is the issue of “rogue” producers, like Iran and Venezuela, who must keep selling oil regardless of OPEC-dictated prices and quotas, simply to support national budgets and political commitments. Finally, consumption figures from the highly-favoured economies (e.g. China, India, Turkey and South Korea) are dubious, at best; and, in any event, emerging market demand for oil and gas as a whole is, to a sizable extent, determined by the quantum of domestic subsidies.

Quite naturally, in an environment where much-needed precision is at a premium, and where all near-term indicators from the global economy are suggesting a sharp reduction in demand, oil should be headed towards $40 (and lower) well before OPEC’s $75 target becomes a reality. The case for shorting Middle East-based Exchange-traded funds (AFK, GAF, GULF, MES, PMNA) within a medium-term horizon is compelling, particularly in view of the remoteness of the possibility of Iran creating havoc in the Straits of Hormuz, through which roughly 25% of the world’s daily oil shipments are navigated.

If anything, Iran will sell as much oil as it can. Though Iran’s breakeven point for selling oil (to balance its budget) is $100 a barrel, according to a Merrill Lynch report, the Islamist regime today is more interested in hard currency balances to import food and, disturbingly, to continue upgrades to its military establishment. Venezuela is expected to follow Iran’s lead as a rogue oil exporter, if only to meet massive domestic social welfare commitments, and political obligations to sell oil at discounted prices to Latin American nations (Argentina, Cuba and Nicaragua, amongst others) sympathetic to the ideals of Hugo Chavez’s Bolivarian revolution.

The dual case for lower oil, i.e. falling demand and diminished conflict risk, leads to the logical conclusion that virtually all the economies of the Middle East (Israel is excluded in this analysis) are due for a sharp and painful contraction in the first few months of next year.

This writer is looking for a steep decline in Middle East ETFs as a fresh batch of economic data from the US, Europe and Asia is available through and just after the holidays. Already, credit default swap spreads for Middle East sovereign and corporate risk have been widening in recent weeks. There are hardly any entities willing to provide political risk insurance rates, for covering business uncertainties, beyond a 1-year period.

Remember that much of the televised activity in the bustling bazaars and marketplaces of the Gulf is driven by consumer demand, in the smuggling and semi-legal trading segments, from the highly populated countries of Iran, Pakistan and India. The same countries are also the source of huge dollar deposits, generated from inside their underground economies, with Gulf banks and money changers. Where that “hot” money will go in the event of an economic contraction is still an open question.

Disclosure: Author holds a short position in GULF

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This article has 3 comments:

  •  
    Dec 01 03:10 AM
    Good idea, I dont fully agree with the premise for the Short, but I would expect a medium term decline. The best trades are the ones you dont need to think twice about, which this is, BUT do you really believe you can take any meaningful short position when the highest volume on any of those ETF's in the past 3 months being GAF with an average of 50k shares. It seems you're following the MENA regional markets, with that you'd know that you can't short as per any of the exchanges. Obviously there are ways around this, but these ETF's dont provide you with a key factor in any trade, LIQUIDITY

    The best ideas are actually actionable......
    Reply | Link to Comment
  •  
    Dec 02 01:57 AM
    Is there an inverse (bear mareket) ETF for this?
    Reply | Link to Comment
  •  
    Dec 02 10:09 AM
    completely disagree with your analysis. Middle east stock markets have already got hit very hard, down 60-70%. The average P/E is only at about 6-8, whereas China (after its huge crash) is still at around 15. Therefore their valuation levels are currently fully reflective of whats going on. Furthermore, you forget that GCC economies have excess liquidity (as compared to the rest of the world's economies) and are investing heavily in their economies - therefore domestic growth will continue. Other, than oil which is a commodity, they dont rely on the rest of the world to maintain their economies - whereas China and India are much reliant on their exports. Last word on oil: maybe demand has recently slight dipped, but medium to long term, demand will continuously increase whereas as proven supply is pretty much fixed. There is only one direction for oil, and that's up. I would say that this is anything but a "no brainer, dont think twice" short.
    Reply | Link to Comment
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