When does an investor “make money?” There are at least two ways to look at this question. As my mother has said, and truly, you only make money when you sell. In other words, it’s nice to watch your portfolio gain value but you have not really made a profit until you close a position out.
That’s true for a given holding, but not for a portfolio. Unless the proceeds of a given sale are kept in cash or moved to a different class of investment - like real estate or commodities for example - ultimate success has not been achieved by selling a position for a gain. Stock positions that have been closed out are simply tax events with possible cash consequences to the portfolio come April.
The real deal is total investment value and ROI at the point when you decide to liquidate the entire portfolio. Therefore the current portfolio valuation is a limited measure of success but it is the best one can have. Simply totting up the gains and losses from past holdings that have been sold is not as meaningful.
The implication of this is that an investor truly earns her rewards when she makes decisions that lead to a higher total portfolio value down the road when the portfolio is ultimately liquidated. If you sell oil stock A at a profit and re-invest in oil stock B or any stock B, you have not really “made money.”
We are now in a period when an energy investor will earn her keep. Oil and gas has pulled back appreciably as I (along with most observers) have been expecting and they may well pull back further and/or remain in a lower trading range for a while. Energy stocks have fallen even more than the commodities and they failed to rise as rapidly as the oil and gas price so for in 2008. So as we watch the value of our portfolios decline faster than an old oil field, the instinct is to sell to protect profits or avoid future losses.
This might be the right instinct if your investment horizon is short term. But if everything that I have posted on this site has any meaning, the price of oil and gas and therefore most likely the value of equities dependent on the oil and gas price will be much higher within a few years at the latest than at the moment.
So an investor makes money “now” by not selling at the new lower level. The way we do it is to hold on. And on. And on.
The current oil price pullback can go anywhere and last for any length of time. But a reasonable risk assessment, I think, is that it could turn back around at any time and is not likely to last for more than 18 months. During the current pullback it would be unsurprising for oil to go into the low 120’s; not a shock if it tested $110, a bit of a surprise if it goes back to test $100, and a big surprise to me if that test were not successful.
In December, 2007 I expected oil prices in 2008 to range between $85 - $115. We have clearly overshot. So it is likely that the overly exuberant recent run up in energy prices will do the job they are intended for - reduce demand and increase supply.
Demand reduction takes time to occur as does supply enhancement. Ironically, oil supply increases might not come until some time after the oil price starts declining when some producers that may have been hoarding production begin to think they must sell it before the oil price falls further. In other words, when there is a reduction in the hoarding mentality.
It would not be surprising to see an oil price retrenchment occur in waves. Oil might well make a series of lower lows and lower highs. It might take us through the better part of 2009 to work this recent excess out of the market. After all, as we know from the megaprojects analysis the near term - 2008 and 2009 - is likely to be a period of relatively strong oil production compared with recent years and any periods of time after, say, 2010.
On the other hand, the adequacy of oil production to match demand is increasingly likely to fail after the start of 2010 and to become increasingly inadequate each year after that for perhaps up to a decade. So I would not expect this pullback in the price of oil to last much beyond 2009.
One way to play the game if one thinks we are at the early stages of temporary weakness or at least stability in oil and gas prices is to shift from more speculative to more stable oil production companies and to emphasize those with high dividend payout’s. Recently I have added to my position in Canadian Oil Sands Trust (COSWF), the premier oil sands player that pays a dividend now over 8%. At the same time I have pulled back from some more gassy names and smaller more speculative oil positions.
Another strategy for dealing with a temporary decline or stabilization in the price of oil and gas is to emphasize the service and drilling companies. They have been taken down recently with other energy plays, but their earnings, which are forecast to grow at healthy double digit rates, are not really sensitive to the price of oil as long as it stays above, say, $90. Eventually the market is likely to take note of that.
It is not clear to me that a period of somewhat weaker oil prices would be horrible for the EIS portfolio. After all, the EIS portfolio of companies that produce oil and gas or help other companies do so will be reporting extremely strong earning gains during the next two years at any oil price above $100. Analysts’ earnings projections for such stocks are based on oil and gas prices generally in the $80 - $100 range.
Furthermore, if oil and gas prices decline for an extended period the global economy will get a huge boost. That will tend to restore higher economic growth rates and therefore boost oil and gas demand, thus setting the stage for an even more rapid resumption of the upward sloping energy price chart.
In fact, if this scenario of much lower energy prices leading to more rapid growth were to play out, we might come to a point in the next year or two when we could face both a rising economy and the start of the final long term decline in oil production. That combination would probably set oil on its longest and strongest price escalation of all time, a period that I expect will last for up to ten years.
But that may be then and here we are now. Now, if you are a trader you do the opposite of holding. If Mr. Market is telling you that Energy Correction Time is here, a trader will sell and stay out until Mr. Market seems to have changed his mind. So you have to know if you are a trader or an investor. Both can make money (although only one will be taxed at the long term capital gains rate that can be one third of the ordinary rate.)
I am an investor. What makes one an investor, particularly a Tsunami Investor, is conviction. You must truly have conviction that over the longer term the part of the economy in which you are investing will become much more valuable. If you do, you keep your investments. And when Mr. Market convinces you that the correction is over, you may add to them.
A trader might argue that a Tsunami Investor [TI] is inherently arrogant. It is true that the TI is, in a sense, saying that she knows more than the market knows, which seems like a form of arrogance. On the other hand, as Mr. Buffet has explained, in the short term the market is a popularity gauge. In the long term it is a value scale.
I don’t say that one approach is better than another. I just think it’s a lot harder to be a trader than an investor because an investor has so much better data to work with. Lead times in oil and gas production are long, adding a great measure of predictability. Trends in economic growth rates are long. China and India are not going to turn down on a dime. The oil exporting countries are not going to stop growing rapidly unless the price of oil tanks, in which case the rest of the world will grow much more rapidly thus adding to oil demand elsewhere.
Therefore, I argue that it is appropriate to be a Tsunami Investor in energy at this historical juncture. Of course a long term buy and hold approach can become spectacularly wrong if you overstay the trend. But we are hardly at that point now.
Yes, the energy Tsunami will be ameliorated by new technologies that produce cheaper renewable electricity and new transportation technologies that power up with electricity, not petroleum. Or maybe new liquid fuels based on cellulosic ethanol or algae will reduce pressure on oil and gas prices.
But those things will not be proven out quickly and they certainly will not be implemented rapidly. They are not like new chip technologies that can change a market almost overnight. They will take many years to have impacts.
Meanwhile the inexorable depletion of oil fields and growing lack of new fields to take their place is already set pretty much in stone. The power of the trends toward stable and then declining oil production on the one hand and rising growth in oil demand from developing countries on the other is too strong to be stopped within the next 5 - 10 years regardless of technological changes that are likely to come.
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This article has 3 comments:
- Ernie Montague
- 174 Comments
Jul 21 12:44 PM- investor88
- 595 Comments
Jul 22 10:02 AM- investor88
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Jul 22 01:29 PMMore by Jim Kingsdale