Jim McDonald says "dollar-strength victims" may well continue to suffer in 2016
Two investment experts yesterday argued the case for overweighting energy stocks in the medium term, though next year might be too early to expect such a strategy to pay off.
Over the next five years, the price of oil will head back towards the $100-a-barrel mark, said James McDonald, chief investment strategist at US financial services group Northern Trust. He told AsianInvestor’s annual institutional investment forum in Singapore that natural resources would reward equity investors who took a medium-term view.
Alan Chua, global equities portfolio manager at Franklin Templeton, agreed that energy stocks are a buy. In aggregate, their price-to-book valuations are trading at the steepest discount to the MSCI All Country World Index since the early 1990s.
“I don’t know when oil prices start to rise or when supply and demand come into balance, but the fact that you are paying a 40% discount to global equities makes us say: be overweight in energy,” Chua said.
Brent crude oil priced at $44.38/barrel yesterday (December 1), having stood at $110/barrel as recently as August 2014, before collapsing.
McDonald declined to guess where the price was headed in 2016, given its volatility, but he argued that the medium-term trend was clear. Each year oil fields deplete by 4% if no new supply is brought online, so if demand for oil grows about 1% per annum, each year 5% of supply must be added – that’s 30% compounded over five years.
Will there be such a demand, at a time when Saudi Arabia has opted to fight for market share rather than support the price, and when so many economies are mired in slow or decelerating growth? The sector has underperformed in the past year, partly because of the strong dollar, in which natural resources are priced, thereby making them more expensive for countries other than the US.
McDonald says yes: global economic growth may not be stellar but it exists, and the US Federal Reserve will be cautious about raising interest rates by too much too quickly, lest it make the US dollar too strong.
Chua agreed that demand was more robust than it appeared. China’s overall economy may be slowing, but its consumption of fuel, including diesel and petroleum, would still grow by double-digit figures this year, he said.
Chua argued that not only was demand likely to increase, but that supply was “dangerously low”. Oil companies have been cutting spending across the board, from discovery to drilling to refining. Spare capacity relative to demand was 15% in the 1970s and 1980s; today it is only 3%.
“That’s not a lot of spare capacity, especially if demand grows and supply comes off,” Chua said. The last time spare capacity was tighter was in 2005, when the price of oil spiked amid talk by the likes of Goldman Sachs of “peak oil”.
The world will remain dependent on crude, said Chua, as alternative energy sources remain a “minuscule” (1%) part of global consumption. US shale gas producers, which can open and shut wells relatively swiftly and have been the main growth in supply over the past decade, have reduced drilling activity. US oil supply peaked in April. These wells have rapid depletion rates. Reduced drilling and depletion will see US supply decline further.
The short-run outlook for investors is different, however. Those price increases may be forecast for the medium term, but investors looking at next year should not expect instant gratification from energy stocks.
McDonald said the outlook for 2016 would continue to penalise what he called “dollar-strength victims”, including natural resources. Energy stocks are cheap, but for them to pay off for investors, a few other big-picture trends need to take place, starting with getting through the coming US interest-rate hikes.
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