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  • Joe Cardello

Demand Will Resume and the World Needs Oil - April 28, 2020

Macro Thoughts

-  Potential for Midstream Energy Assets in the USA

-  International Equities with concentration in Crude Oil

  • I maintain the view that the US Economy is adapting to challenging conditions from Covid; demand destruction (while acute) will be a temporary phenomenon.

  • Global Governments and Central Banks will continue to provide support (particularly while focus is on virus, demand destruction, and declining prices). Any political resistance will have more to do with the substance of support and not the actual support itself.

  • Price disinflation is not deflation. Deflation occurs when spending decisions are delayed indefinitely because of expectations of lower prices in the future. I believe as prices fall, demand for goods and services will increase.

  • Central Banks will be increasingly confident they can further increase the flow of money to governments and the economy generally as prices decline during the demand destruction phase caused by the virus.

  • Official Government interest rates are being pushed to zero and below zero across the developed world and Central Banks are showing increased willingness to finance government spending.

  • Could this turn the concept of risk on its head? In my opinion, there is a potential risk that holding large amounts of cash will erode one’s wealth over the next few years.

  • Because the US Dollar is the world’s reserve currency, as official rates in the USA decline relative to foreign currency, the attraction of holding US Dollars could wane. Currently the dollar index (DXY) is within 5% of its highest level over the past 17 years. It may be an opportune time to increase investment weight to international equities and fixed inc.

  • High opportunity cost in holding precious metals because of (a) the expense of holding gold and silver, and (b) the current popularity in the short term of holding gold as an asset class. In the short term, I remain very underweight precious metals despite my long-held view that the asset class will provide protection from paper currency debasement due to global central bank policies.

  • Current Demand destruction and price declines have been particularly acute in energy prices. Supply restrictions have so far been far outpaced by the drop in demand for energy.

  • The world continues to rely on crude oil for energy and petrochemical products. As world aggregate demand recovers, I suspect demand will increase for energy sourced from very low-cost sources (crude oil) and decrease from high-cost sources (perhaps over a 2 to 5-year time horizon). The low prices will likely slow the move toward electrification of transport considerably.

  • Supply of crude will likely remain abundant, prices may continue to remain historically low, but demand (usage) is likely to increase over the next few years in the USA and globally.

  • In the USA, invest in assets that process, transport and store hydrocarbons (“midstream” assets) which normally are not as sensitive to the price of crude oil in the USA. Pipeline prices are set through contracts of normally 5 to 20 years with rates regulated by the government every 5 years.

  • Master Limited Partnerships have declined dramatically from January 2020 highs. The Alerian MLP index (leading gauge of energy MLP’s) declined form a high of 230 in January to 70 in March. The index has since recovered to the high 120’s. Considerable de-leveraging took place in MLP closed end funds. Outflows from these funds reduced risk allocation to this sector.

Why I am allocating to a diverse number of MLP’s, C-Corps and Midstream (energy pipeline and transport) assets in the USA:

  1. 12 Month Yield on the Alerian MLP index according to Bloomberg is over 16% as of April 28, 2020 (granted many of these distributions are being reduced).

  2. By one valuation measure: yields compared to both US 10-year Treasuries and BAA Corporates have rarely been this attractive.

  3. Switching to Crude Oil product in the USA is less likely than in Europe and Asia. Investing in a steadier stream of energy assets in the USA is more appealing.

Why I am allocating to International Equities with a concentration in Crude Oil:

  1. US Dollar is at historically high levels and US official and government rates are at historical low yields.

  2. Overall International equity markets have lagged the USA considerably, and dividend yields are more attractive.

  3. As global aggregate demand rebounds from the impact of the virus, Crude Oil will be a relatively inexpensive source of energy.

Some Charts to support: US Dollar Index (Bloomberg Chart 2003 to 2020)


US Generic Government 2 year yield index (Bloomberg Chart )







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