Oil Prices: Hyperinflation Trades Unwind

Oil Prices: Hyperinflation Trades Unwind

Oil Prices: Hyperinflation Trades Unwind by Todd Sullivan, ValuePlays

“Davidson” submits:

Investors have a history of over investing in trends. Too often a trend is enhanced by investor activity which draws more investors in believing profits are ‘guaranteed’ when nothing could be further from reality. In 2010-2012 we had multiple stories of investors fearing hyperinflation as well as the onset of ‘peak oil’. This resulted in investors leasing and even building storage for oil on which they could trade derivatives in a drive to gain from future expectations.  See the Brent Oil Price history and WSJ story about using tankers for oil storage.

Building storage capacity and filling it was self-supporting till ‘peak oil’ failed to materialize, but the 1970’s evidence on government over-spending leading to high inflation remained in the system. Few investors saw the EOG Analyst Presentation April 7, 2010 in which Mark Papa said,

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“…with the announcements we’re making today, we think it will be pretty clear that we’re the industry first mover in additional big horizontal shale oil plays. The last notation on this slide is one that I personally believe – I believe that horizontal oil from unconventional rock is going to be a North American industry game changer. I believe it is that significant. It certainly will be a game changer for EOG, but it will be a game changer for the whole industry.”

Since Papa’s 2010 presentation, the US has witnessed events unfold as he outlined. Nonetheless, the hyperinflation trade persisted till May 2014 when the signs became clear that some were exiting positions as their expectations had not come to pass and the US$ began to rise. A rising US$ flies in the face of hyperinflation!! Since May 2014 oil and other hyperinflation positions have come under pressure forcing Brent prices to fall to ~$90bbl. Certainly some of this was accelerated by Russia’s invasion of Ukraine which resulted in strong capital flows to the US, but we have witnessed in recent years strong capital flows to US assets from the Mid-East, So. America and China as foreign buyers deposited wealth in Western Democracies.  I think it is fair to think of Democracy and the strength of our property rights as responsible for foreign investors coming to US and other Western style countries.

Today, I think we have just witnessed the unwinding of the ‘hyperinflation trade’. This has brought oil out of storage and into the marketplace so that it appears we are ‘flooded’ with oil. It is not possible for an extra 3mil bbls/day of US oil (United States Oil Fund LP (ETF) (NYSEARCA:USO)) to ‘flood’ the globe with oil when usage is ~91mil bbl/day http://www.eia.gov/oiaf/aeo/tablebrowser/#release=IEO2014&subject=0-IEO2014&table=5-IEO2014&region=0-0&cases=Reference-2014_03_21

The panic selling we are seeing today is in my opinion coming from the reversal of the ‘hyperinflation trade’ and it will end at some point.

If anything, lower energy prices are likely to prove somewhat stimulating for global recovery and growth and this will lift demand.

I would treat the current selling panic as an opportunity to buy the great companies at cheap prices.

Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a RealMoney.com contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.
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