Tag Archives: International

Ideas for 2012: Look out, Helter Skelter!

Europe, Global Economy, On the cover

(Published in Cotizalia on 24th December 2011)

First of all, i wish you all a fantastic 2012, full of peace.

Like every year, I venture to give you my ideas for the year that is approaching.

My bet for 2012 is a combination of corporate bonds, anti-recession stocks  ​​and a very neutral strategy in commodities, covering with short positions in semi-state-owned companies and indexes in France, China and Brazil.

All my bets are relative, ie I do not expect the stock market to rise, in fact I see a fall potential of almost 20% in the Eurostoxx , so I expect a neutral strategy to deliver positive returns through the outperformance of longs versus shorts.

The reason why I look for long positions in Southern Europe, and particularly in Spain in 2012 is as follows. On the one hand, efforts to keep the corpse of the Euro will probably lead to the Germany and Eurozone countries to accept successive injections of liquidity by the ECB. That, as in 2011, creates the best short opportunities in the Eurostoxx as it is a transfer of wealth from Germany, Finland and the Netherlands to the south of Europe of nearly €150 billion, which added to the effect of a more aggressive policy to reduce debt by Monti in Italy and Rajoy in Spain could lead to the stocks in southern Europe to perform better than European indices. It is a gift from Northern Europe to the risk premium of Southern Europe stocks, and therefore lowers cost of capital.

Consensus of analysts still expects a growth in Europe of earnings per share of +10% a year 2012-2013 . This is falling gradually, and once adjusted for more realistic growth, the PE of the Eurostoxx, according to Kepler, is actually 11.2x 2012, not cheap. In a report with which I agree fully, and I’ve said before in this column, this investment bank believes that corporate earnings still have to be revised downward by 50% to reflect a realistic drop of 5-10% for 2012-2013.

Those who follow me regularly know that nobody can accuse me of being optimistic in my estimates, but Spain can be a surprise in the European market, but investors should be very selective because without subsidies or the debt expansion party, constructors, concessions, renewables, banks and other subsidized firms will continue to suffer a prolonged stock market Via Crucis . I would stick to the companies with strong LatAm and Emerging Market exposure and low gearing.

Dividend cuts in the rest of Europe are still to come. I expect a fall in the dividend yield of 4.6% of the Eurostoxx to a more reasonable 2.8%. Beware of German industrial companies, and the companies with unusually high expected dividend, which is likely to be cut.

I look for long positions also in the UK, where businesses are openly for sale, and mergers and acquisitions will likely accelerate in 2012. The benefit of the UK is to be an open market with its own currency, which has its own stimulus plan, and added to inflation makes it more attractive. British energy companies, except BP, remain at the top of my bets.

Avoid debt-dependent sectors and subsidies because the deleveraging process will continue in 2012 and will probably be much harder than in 2011. As an example, we have seen four solar companies go bankrupt in 2011, two consecutive profit warnings from Vestas in wind, and the list will continue. Putting money in these companies is not an investment, is a donation.

European banks have to seek capital for at least €115,000 million, and is not going to be easy. The risks of capital increases and dividend cuts are obvious.

Beware of “cheap for a reason” mega-caps and conglomerates. Do not bet on expansion of multiples when there has been none in 2009-2010 and 2011, years of expansion and growth thanks to the post-stimulus effect.
More Debt. More Debt.
No, unfortunately in 2012 I do not expect Europe to reduce debt as it should. Packaging more debt into the ECB balance sheet is simply masking reality. And the war of the conscious destruction of currencies by governments will continue … Let’s see who will be printing more and worse.France is the biggest problem, since it will probably have to rescue two of its banks with public money while industrial production falls by 0.5% and public debt reaches 110% of GDP. Countrywise, France, along with China, which is a huge bubble of debt, build up my bearish bets in 2012.

The bad news will continue to come from the OECD. The estimates of GDP growth in Europe and USA still seems too optimistic. With over $2 trillion cuts in public spending, $5.9 trillion debt to refinance only in Europe and elections in key countries like the United States and France, it will be hard to see the economy take off . I expect a GDP contraction of 0.5% in Europe and in Spain of 0.6%. In the U.S., estimates have been revised upwards after the latest macroeconomic data, regardless of the enormous amount of downward revisions of data from previous exercises we have seen. Very Orwellian, to review the past really helps to give good data today. Seeing all increase in jobs last week coming from couriers is not exactly exciting. I estimate real GDP growth of 1.5% in the U.S., entering a recession in the second half in a year of elections and sequestration of budget (almost the effect of a  “negative QE”).

The problem of stimulus plans and injections of ECB debt in Europe is that it would strengthen the euro, and this makes it harder to recover the competitiveness of companies and European countries. This massive increase of ECB balance sheet to artificially lower CDS and help banks creates a real economy problem. The financial system and public debt eat all the financial resources available to the European economy, creating a “crowding out” effect on real economic growth, jobs and industries. When trying to resolve a problem of liquidity and solvency the true effect is that the European Union is squeezing the real economy out and not helping confidence or credibility in the system. I believe that the euro should go to $1.15 or even back to parity with the dollar.I do not think interventionists will allow it.
 
Emerging Markets
 
China is likely to remain the “Big Short” in 2012. Growth will continue to be manipulated, driven by a housing bubble that has already reached 12% of GDP and non-financial debt already exceeding 200% of GDP, and therefore destructive of value. With growth slowing, the country will pursue an expansionary monetary policy, accelerating debt to sustain a GDP growth above 6%. But this “growth” takes place through the further destruction of value seen in the economic environment, as returns collapse. In my analysis, 70% of Chinese listed companies generate returns below their cost of capital. It should be no surprise. Semi-state companies are usually large destructors of value, and in the MSCI China Index, 48% are semi-government owned. Conclusion: Short. Brazil and Russia will continue the same path, in which inflation and growth is expected to move in the same direction, generating very little value for investors, especially because of its excessive dependence on oil.
Avoid at all costs semi-state-owned entities in an environment of economic slowdown. They end up being the subsidisers of the economy and minority investors in them are simple charitable donors. That is why China, France and to a smaller extent Russia , where the percentage of semi-state companies is higher, is where the minority shareholder is most vulnerable when states seek to reduce inflation and contain costs.
Commodities
 

Unfortunately, consecutive years of printing money, lowering rates and injecting liquidity into the system means expensive commodities despite the expected fall in demand and increased supply.

I estimate growth in global oil demand of 0.7 million barrels a day compared with +1.2 million expected by  consensus and a small increase in production, generating a spare capacity of 5 million barrels/ day, leading to an estimated average of $90/barrel Brent excluding geopolitical pressures. The price premium for geopolitical risk if we see an increased pressure on Iran would move, as usual, between $8-10/barrel.

All indicators I have lead to estimate a stagnant demand for gas and electricity in the OECD, especially in Europe, which will highlight again the installed overcapacity environment.
In a  “La Nina” year, poor harvests and weather challenges would make a great opportunity to see increases in the price of corn and wheat of spectacular magnitude. My bets on commodities are kept in corn, wheat, oil and declining gas (Henry Hub), electricity (Germany and Nordpool) and especially CO2, where the path of death of this fake commodity, and manipulated as well, continues due to the massive selling pressure of debt filled countries, stagnant demand, refining shutdowns and emission free allowances needed to be sold. I see an unattractive environment for coal in 2012 , as China’s demand may not, in my opinion, offset the decline in India, which is spectacular. But my big bearish bet of 2012 is aluminium, where overcapacity is estimated to reach 30% while Chinese smelters continue to produce at lower costs.

Fixed Income

In a year in which states will be looking to refinance 5.9 billion in Europe and all companies have their sights on the bond market , the fixed income opportunities are not be missed because European companies have to refinance almost 1.1 billion in 2012 . No need to go to junk bonds, Single A  corporate bonds, (NOT banks) as in 2008, will be very attractive. Forget Sovereigns as oversupply will likely hurt any performance. As Bridgewater Founder, Ray Dalio said on Europe: “You’ve got insolvent banks supporting insolvent sovereigns and insolvent sovereigns supporting insolvent banks”
Remember in November 2008 flagship single A rated companies with good cash flows had to refinance at 250-350 basis points above the average (benchmark)? This generated one of the most attractive environments for investment in bonds. I think 2012 may again be a similar environment. The credit market will be monopolized by billions of sovereign debt issues and 1.1 billion of corporate debt to refinance, so it will likely be an attractive environment to buy single A corporate bonds at unusually attractive rates.
 In Summary

I see a year to gain much in the short term but very volatile, with a clear negative trend. I hope I’m wrong and in June I will write that all is well.

Volatility is good but does not hide a bearish environment, so I keep buying stocks ahead of Euro summits and stimulus packages and selling once announced. A market neutral strategy seems the most appropriate and of course, long only bets on “everything is already discounted” are the most dangerous.

May I remind you of my traditional sentences. The market does not attack, it defends itself. And in 2012 the market will be attacked again and again by waves of intervention.

I always say this market is a good bet and a bad investment , make good use of that and there is much money to gain. And when you read strategic reports of banks, remember the three phrases to identify a good short position: a) fundamentals have not changed, b) it’s a good company and c) the dividend is still attractive.

Is CO2 dead?. Down 47% YTD, and Durban will do nothing for it

Global Economy, On the cover, Sin categoría

It’s the end of CO2 as we know it. And we said it here months ago. It was a fake commodity and a manipulated one by the way. The EU accounts for 16% of the CO2 emissions of the world but bears 100% of the cost. By manipulating demand and supply the EU forced up prices to €30/mt, and the scheme seemed to work nicely until the rules of demand and supply deflated the artificially created price. Of course the beginning was to assume an industrial and power demand growth that was wildly optimistic, but the most important part was that the EU issued emission permits and carbon-offsetting credits as if there was no tomorrow. No wonder that expensive carbon and widespread EUA grants have killed what seemed like a nice little niche of indirect tax to the economy. Unfortunately, it didn’t work.

Prices of CO2 emissions (EUAs) have slumped 47% ytd driven by oversupply and the Europe crisis, driving debt-ridden countries to dump their excess of EUAs in the market at any price as we mentioned here (http://energyandmoney.blogspot.com/2011/06/co2-collapses-20-in-two-days.html)

A record 1.5 billion tons of EU carbon permits were traded on the ICE Futures Europe exchange between July and September even as the price slump cut the value of the transactions. Trade in UN carbon credits was a record 348 million tons in the same period. Why? Permit holders are rushing to monetize their EUAs on the fear that the system will collapse under a recessionary environment where the EU will issue even more permits for countries while industrial demand and GDP fall.

And as carbon collapses, all those projects that were sanctioned globally, from CCS to other carbon neutralizing projects, are rushing to monetize before the scheme becomes barely economical. In fact, according to our estimates c56% of those projects will be loss-making at €7/mt CO2 price.

At the bottom of this disaster of CO2 permits lies the planning of the EU, which assumed that every country would follow suit and decide unilaterally to kill their competitiveness and increase the cost of its goods and services. It didn’t happen.

UBS says the European Union’s emissions trading scheme has cost the continent’s consumers $287 billion for “almost zero impact” on cutting carbon emissions, and has warned that the EU’s carbon pricing market is on the verge of a crash next year. In a recent report, UBS said that had the €210bn ($287bn) the European ETS had cost consumers been used in a targeted approach to replace the EU’s dirtiest power plants, emissions could have been reduced by 43% “instead of almost zero impact on the back of emissions trading” (courtesy http://indefenceofliberty.org).

Now the climate summit in Durban is going to put the last nail in the coffin of CO2 and the “green EU” over-subsidized and uncompetitive scheme. In the middle of a recession it is virtually impossible to see the US, which is seeing its economy thrive out of recession partially thanks to shale oil and gas, or China, which is seeing GDP growth weaken by the quarter, take anything but moderate measures to curb emissions. But entering a crazy scheme of CO2 pricing like the EU has done? No.

The Durban conference ran overtime throughout the weekend. The two most important outcomes were agreements to:

1. Extend Kyoto Protocol for 5 years from 2013 to 2017 after its first commitment period expires at the end of next year (but without Russian, Canada, Japan);

2. Reach a legally binding deal by 2015 to cut greenhouse-gas emissions, covering all major emitters including the US, China and India. This is the first time all major emitters have agreed to negotiate legally-binding emission cuts. The deal, however, is to be implemented by 2020. And there are NO penalties involved. So if a country doesn’t comply the deficit is passed to the next period.

Details for both of these agreements still need to be fleshed out, and a working group for reaching a 2015 legally binding deal should commence in the first half of 2012. The main result is that China, US and India have agreed in principal to sign a legally binding agreement to meet emissions targets from 2020 onwards. Until then, all emissions reductions remain voluntary. And by then… we will see. The deal looks to me worth the paper it is written on.

Canada has given notice at the Climate Change talks in Durban that it intends to withdrawal from the Kyoto protocol however it will work towards reaching new emissions targets. Canada’s PM said “to hit targets (the country) would have to take every single car off the road or else shut down every hospital and factory”.  Canada may save as much as $14 billion as a result of not having to buy offset credits starting in 2015 when Kyoto becomes legally enforceable. This is the first of 191 signatories to the Kyoto Protocol to annul its emissions reduction obligation.

This week Goldman Sachs published a note on CO2, “Carbon: Political and fundamental upside risks outweigh downside”. Goldman expects a policy intervention to support prices but agrees with me that fundamentals of supply and demand are atrocious. Not easy or feasible to see aggressive policy to support CO2 prices from dying when Europe has to deal with more pressing issues. An upcoming recession, massive austerity packages, and a monstrous debt burden that needs to be sorted out.

Despite the collapse of CO2 the immediate risks are:- Risk that carbon prices remain depressed due to weak economy and selling pressure as new permits are auctioned. A balance in the supply-demand is not expected until 2017. This could put CO2 easily at €3/mt before it even rebounds, and that is if (and only if) demand for power generation recovers above 2007 levels in Europe, something I do not see happening easily.

co2 chart 1

– Not even political intervention will help. Two amendments to the structure of Phase III are currently discussed:

  1. The first is the option to remove or “set aside” a number of permits from the system (restricting supply).
  2. The second is to increase the 2020 target by reducing the cap (consistent with a step up in the EU’s emissions reduction target from the current 20%). Shortage would still only happen if Europe has been able to recover the path to growth, and even then it would happen at best in 2017.
– What if the EU simply kills the Cap and Trade scheme and introduces of a carbon price floor? . The UK floor was set at £16/tonne in 2013 (€19), more than double current market price. This would effectively bust the scheme, making the new permits worthless and accelerating the sell-off between 2012 and 2014, particularly as the redemption would not be guaranteed by any solvent entity.

These interventions could be explained by budget deficits and government need for money. Sure, only a problem. GDP and competitiveness collapses and EU loses even further in industrial demand. From 2000 to 2010 CO2 impact on GDP in the Eurozone has meant an annual loss of GDP of 0.5% net of the fiscal profit of CO2 in taxes. Even more, in Spain and countries where the cost of CO2 has been internalized by companies, it has meant a loss of competitiveness of c10% (2004-2010).

Here are the effect of carbon permits:

co2 chart 3

In summary, the mistake of creating a  Cap and Trade scheme instead of a straightforward carbon tax has made the EUAs collapse as oversupply first, and the likelihood of the zero value of the permits of carbon-offsetting projects second have proven that the Cap part was based on ridiculous assumptions of industrial demand. And now there is oversupply already from permits that are issued (let alone the new ones to come) until 2017. Then there is the Trade part, which created a Boom and Bust cycle that is impossible to unwind now that financial investors, companies with free permits and projects are all on fire-sale. And if the EU was going to buy the excess credits… at what price would it do it?  with what money with all countries struggling with debt? who takes the counterparty risk?. I still think we see CO2 get to €3-5/mt. The world need a new framework that is still growth friendly and allows companies to respond with more certainty and stability, carbon pricing is inefficient, ineffective and hopefully on the way out.

Update:

The Euro Council, Parliament and Commission on Energy Efficiency discussions were meant to begin on March 26th but have been pushed back to Apr 11th as countries were not ready to start talks. Chairman of the environment committee says issue of a CO2 floor will certainly not be resolved this year.

OPEC Meeting Ahead: Concerns About Oversupply?

Global Economy, On the cover, Sin categoría,

(December 2nd 2011)The December OPEC meeting in Vienna is coming and the picture of the oil market is mixed at best:

1) China PMI below 50 for the first time since Feb 2009. Global manufacturing PMIs remain weak as the table below shows, particularly in Europe.
2) Bearish US DOE weekly with high inventory build and very low implied demand. The EIA’s monthly revised oil demand numbers for September came in at 18.8m bpd, which was down from 19.05m bpd. It was also down 0.7m bpd y-o-y.
3) OPEC production in November: came in at 30.35m bpd, up 390,000 bpd from October, according to Bloomberg. The increase was led by Libya (155k bpd), Saudi Arabia (65k bpd) and Iraq (50 k bpd).

pmi global

Earlier this month we had additional evidence that the slowdown in activity is seriously reaching emerging markets now. India’s industrial output declined 5.1% y/y in October, the first decline since June 2009, with a 6.0% y/y fall in manufacturing, and with capital goods output down 25.5% y/y.

In the meantime, geopolitical concerns surrounding Syria and Iran, added to the inflationary pressures of the constant reduction of interest rates in Europe and Australia more recently, have kept oil prices at a very strong level, with Brent at $109.6 at the close of this post.

To me, one of the most interesting trends is that heavy oil continues to re-rate and that Tapis (Asia) remains at a healthy premium to Brent, proving that Asian demand remains solid despite the relative weakening in the recent data.

In this environment, another interesting trend is shown by the significant increase in the break-even price required by producers to balance their budget. At $80/bbl, Saudi Arabia’s commitments to invest in social peace and support the MENA stability is starting to prove costly. But still very comfortable versus the market price. Otherwise, Russia’s $110/bbl is a reflection of the strong investment commitments of the country, which are likely to slow down in the next years, so the headline number of break-even price might be overstated in the mid-term.

Break_even_oil_price

Considering this, it is not hard to understand why the OPEC World Outlook Reference Case oil price assumption has been increased from last year. It is assumed that, in nominal terms, prices stay in the range of $85–95/b for this decade, compared to $75–85/b in last year’s expectation.

At the same time, global refining capacity is soaring and excess capacity is likely to reach 10mmbpd. This will have a significant impact on refining margins and, as such, high oil prices might be cushioned for the final price paid by the consumer by lower refining margins.

OPEC Refining Capacity

While Russian production stays afloat at 10.3mbpd and OPEC supply stands firmly above 30mmbpd (remember OPEC quotas are 24mmbpd) I continue to think that demand growth estimates are exaggerated, and not consistent with a slowdown in global GDP growth, so until I see a strengthening of the two main demand centers, China and US, I fail to see how emerging markets will offset the decline in OECD demand to reach a total of 92mmbpd demand in 2014. I think we stay pretty much flat at 88mmbpd for a few years.  Worth analyzing Chinese implied oil demand. In November it was 9.5 mm bpd, but this excludes inventory adjustments which are not published, driven by strong diesel demand which comes from regional shortages as a result of refinery maintenance and turnarounds. Crude imports were 5.52 mm bopd, +8.5% y/y but starting to show a slowdown from previous years.

OPEC supply demand

In this context, even if we assume that oil demand rises to 92mmbpd, spare OPEC crude oil capacity is set to reach around 8 mb/d over the medium-term, and in the high case of demand around 4 mmbpd in 2011. Even if I assume no OPEC production growth, spare capacity at OPEC countries is unlikely to go below 3mmbpd, which according to my estimates is pretty much a super-tight market.

OPEC capex spend

Obviously, the big question mark in this picture is how will capex be affected by any weakness in oil prices.

The table below shows the OPEC annual upstream capex required to reach the capacity additions assumed in their base case. Interestingly, this annual capex is unlikely to be affected by a global downturn in the case it happens given it’s such a small proportion of the total global capex including downstream and midstream. So prices would have to dramatically fall below the $80/bbl level to curtail the spending.

So spending is not the issue. The issue is execution and a stable framework that allows this capacity to be added on time and on budget. This is much more difficult than spending and drilling.OPEC Capex Spend II

I think it is safe to assume that we will likely be negatively surprised by capacity additions in the system, probably assuming that around 75% of that capacity is actually added as expected. This, in any case, doesn’t impact the base case of OPEC spare capacity moving between 4 and 8mmbpd in the next five years.

So what is the OPEC meeting going to approve?. Very unlikely to see a production cut given the very high oil prices, even with pressure from Venezuela and acting president Iran to do so. It is more likely that OPEC alerts to a risk of oversupply mid-term, tries to enforce the current quotas, as every country is producing above quotas except Saudi Arabia, and extends the decision to cut or to take action on quotas to a meeting where they can assess the true impact of the Euro and debt crisis on global demand. OPEC could offer an increase in quotas that sets the limit at the current level, so basically making no impact to global supply, just recognizing the real volumes. The risk is that countries will continue to “cheat” on the new quotas, but geo-political concerns might prevent that from impacting prices.
opec quotas

Iran’s role as president of OPEC here is critical, in the middle of the aggressive rhetoric with Israel. If Iran is perceived as anti-West in its proposals to OPEC the moderate side, led by Saudi Arabia, are likely to continue to act as buffers of the oil market. If Iran leads the meeting in a conciliatory and open way, the conclusions will likely be more firmly implemented. The last OPEC meeting gave the impression of countries “against” each other in some instances. This one could be the opportunity for a constructive approach that sends a positive message to consumers and producers alike.

OPEC_production