September 2005 Archives

I find it interesting how high oil prices are influencing international politics. As those of you who read my weblog periodically know, I have an interest in South America. Hugo Chavez of Venezuela is certainly changing the political landscape with his oil wealth.

David Luhnow and Jose De Cordoba of the Wall Street Journal wrote an article With Oil, Chavez Plays It Safe (subscription required).

To his critics, Venezuelan President Hugo Chavez comes across as a messianic radical, cozying up to anti-American figures like Iran's mullahs, blasting capitalism as the "road to hell" and threatening to stop shipping oil to the U.S., which relies on Venezuela for about 14% of its oil imports.

But when it comes to the country's economic centerpiece, the oil industry, the fiery leader is more pragmatic than most realize. He has squeezed more royalties and taxes out of foreign oil companies at a time when they can afford it because of high oil prices. And he is using that money, along with a windfall in exports from state-run oil giant Petroleos de Venezuela SA, to help fund his leftist agenda at home and to cultivate friends in the region.

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In the meantime, Mr. Chavez is using his oil billions to buy friends and influence nations, from the Caribbean basin to Patagonia. In the past year, Venezuela has emerged as a tropical version of the International Monetary Fund, offering cut-rate oil-supply deals and buying hundreds of millions of dollars of bonds from financially distressed countries such as Argentina and Ecuador. A grinning Mr. Chavez last week signed a pact for cut-rate oil shipments to Jamaica, telling reporters there: "Don't thank us. It is our call of conscience."

The article also discusses that most foreign oil companies are not pulling up stakes and leaving Venezuela after Chavez has extracted more economic rent through higher royalties and taxes. Instead, they are adapting the situation and moving forward. I suspect in truth those companies that choose to stay are cooling their jets while waiting for either a regime change or more confidence that the rules will remain in place. Oil companies have enough uncertainty with geology and geophysics, let alone having to deal with political risks as well. Exxon Mobil has pulled up stakes and decided to take Venezuela to an international court over some of the rule changes.

Andy Webb-Vidal in the Financial Times wrote an article Chavez set to extend government control over big banks (subscription required).

Venezuela is preparing to extend political control of private banks operating in the country as part of a drive to spread "revolutionary" government control over the economy of the world's fifth-largest oil exporter.

Venezuela's banking superintendent has privately told the heads of several of the banks that President Hugo Chavez wants to place two government representatives on the institutions' governing boards.

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Venezuelan banks are among the most profitable in Latin America, but they are also heavily exposed to government debt.

Public debt can account for as much as 60 per cent of a bank's assets.

The government is also the largest single depositor among many banks.

From this article, we learn that Venezuela is flush with cash and that Chavez is shaping the Venezuelan banking industry to support his platform.

I do not think most western governments pay much attention to South America in general and Venezuela in particular. But as Venezuela's influence in the Central and South American region grows, I anticipate Venezuela's profile will also grow. As long as oil prices continue to remain high, Hugo Chavez will be in the catbird seat.

There are interesting articles in this weekend's Barron's magazine for both bulls and bears alike. For the bulls, Michael Santoli wrote an article Lift Off, Already! Message to the Market (subscription required). In this article most of the Wall Street strategists comment that they are bullish and expect the market to rally five to ten percent in the last four months of the year. I found the energy comment interesting.

The energy story also is central to evaluating stocks' performance this year. So far in 2005, a portfolio that lacked energy stocks would have suffered mightily. Excluding its energy components, the S&P 500 is down nearly 10% since Jan. 1, a remarkable loss given energy stocks account for a mere 9% of the index's value.

Next for the bears, Sandra Ward interviewed Lee Mikles and Mark Miller, Mikles/Miller Management, for an article The Big Hook (subscription required). Their basic theme is that consumer are tapped out and that the recent negative savings rate confirms that consumers are tapped out. Consumers have enjoyed the rapid rise in housing prices with the consequent mortgage refinancing to support an unsustainable spending pattern.

As I have mentioned in other articles in my blog I am cautious, though not pessimistic, in my outlook. One of the largest dangers for an investor, in my view, is becoming too anchored to your own beliefs and not being adept or agile enough to change when circumstances change. Compounding that danger is that a negative outlook always appears to be more rigorous, more factual. Bears can always point to cracks in the system and why things are failing. Always. Bulls always require a bit of faith looking out to the future. The current trajectory of positive news must continue. The fact is, more often than not the future is positive and the economy continues to grow and expand. Thus our challenge is to weigh the arguments for a decline or stagnant economic outlook against the arguments for a positive economic outlook.

I think now is a particularly challenging environment because there are many crosscurrents. There are strong cases to be made for either a bullish or bearish outlook. It should be an interesting fall season.

Neal E. Boudette wrote an interesting article GM, Toyota Differ On Future Direction Of Gasoline Prices (subscription required).

The recent spike in wholesale gasoline prices to $2.60 to $2.70 "is abnormal relative to demand, relative to supply. It's being driven by the fact that we've taken 10% of our refining capacity off the market for the short term."

GM believes "the market in total is smarter than any of us individually and if you look at the market in total it expects prices to come back down rather significantly by year end," Mr. Ballew said.

In contrast to GM, a top executive from Toyota Motor Corp. said the Japanese car maker expects gas prices to rise.

"The cost of oil is going to continue to increase," Jim Press, president and chief operating officer of Toyota's U.S. sales unit. "In the long term and the short term."

Mr. Press said this view is based on the fact that demand for oil is rising and even before Hurricane Katrina U.S. refineries were operating at full capacity. "As we look forward, the fact is our country doesn't have the cushion in refining capability," Mr. Press said.

I know that they both cannot be right. It will be interesting to see how gas prices play out over the next several months.

As an aside, there have been several negative articles on GM recently as well as a few positive articles, including one well written Barron's article Can GM Break Through? (subscription required). In this article Richard Rescigno interviewed Mark LaNeve, chief North American marketer, General Motors.

I find the GM story interesting because I believe the company is in a very difficult position, even though it is doing well with regard to quality as indicated by the J.D. Power awards. Unfortunately for GM, I think its legacy costs and its product line that emphasizes gas guzzling SUVs and Hummers will prove difficult in this environment. Taking the opposite view is Kirk Kerkorian, an 87 year old billionaire who recently purchased a huge stake in GM. Obviously given his age, Kerkorian is not looking to be a buy-and-hold, long-time, passive investor.

So I am curious how this story will eventually play itself out. I have written several short articles on GM, where I have indicated my bearish outlook. For those interested, you can use the search feature to see my prior articles regarding GM.

I remain short GM stock.

There have been several articles recently discussing the shape of the yield curve. In today's Wall Street Journal Online, Agnes T. Crane wrote Yield Curve Could Give Fed Pause (subscription required).

For many in the bond market, the signal from the shifting shape of the Treasury yield curve couldn't be clearer: The economy will slow, and the Federal Reserve will stop raising interest rates sooner than previously thought.

Whether the message is right is debatable. But investors are having a harder time ignoring the potential economic downside of $70-a-barrel oil prices and destruction wrought by Hurricane Katrina. A more than 14-point drop in the August Chicago purchasing-managers index, which measures area manufacturing activity, didn't help alleviate concerns.

Tuesday, yields of two- and three-year Treasury notes essentially changed places periodically, in which the longer of the maturities yielded less than the two-year note.

Yet the benchmark yield curve, which measures the distance between the two- and 10-year note, has moved further away in the past two trading sessions from such an inversion. The benchmark 10-year currently yields 0.19 percentage point more than its shorter-term counterpart. Monday, it yielded only 0.11 percentage point more.

As I have stated several times in my weblog, I am cautious in my outlook. High energy prices and Katrina will damp the economy. Sure some specific sectors will benefit because of Katrina, but the economy as a whole will not—just as the oil sector benefits because of high energy prices but the economy as a whole does not. The yield curve also appears to be indicating caution. Thus, I am inclined to think that the Fed will not continue to raise rates as previously thought.

If the Fed does stop its planned increases, will stock markets rebound on the lower than expected rates?