Altana Market Outlook – Feb 2015 by Lee Robinson
Profiting from the Oil fall
“Gold is the money of kings, silver is the money of the working class, barter is the money of peasants, but debt is the money of slaves” Anon
Many theories are espoused as to why the oil price is going lower and why it has fallen 50%. For example, too much supply, yes but that wouldn’t crush prices 50% so quickly given the rate of change of supply has not drastically moved. Too little demand, more likely given shipping, railcar transport rates have fallen dramatically to multi-year lows in many cases plus world slowdown that has hurt, but again would not explain the smooth, constant move from over $100 to under $50 a barrel. Manipulation from OPEC to hurt Russia? Possibly, but it seems unlikely given this could have happened during the winter of 2014 to cause greater Russian pain. We note that a large US oil firm, Schlumberger, has just bought control of a large Russian driller – Eurasia Drilling. Makes you think US-Russian relations are not as strained as the press would have you believe. As is true in 90% of cases, follow the money rationally and the answers can become clearer.
Where does following the money lead us? Over the last 5 years the Shale gas revolution has gone from potential to reality. This extra supply means OPEC cannot easily control and drive prices higher over time. However, this revolution was funded with debt. Think about it, an investment venture with commodity linked return whereby you make a killing if the oil market goes up or bust if falls below say $60-80 should always be funded with equity. However these companies have been funded with an ever increasing amount of debt over the last two plus years. According to the December Financial Times:
“Energy bonds now make up nearly 16 per cent of the $1.3 trillion junk bond market — more than three times their proportion 10 years ago,”
“Nearly 45 per cent of this year’s non-investment grade syndicated loans have been in oil and gas.”
I would recommend that all investors and students of history read ‘Confessions of an Economic Hitman’ by Perkins. Whether fact or fiction it explains how issuing debt at the right level can ultimately give you control of nations and key strategic assets.
So let us imagine we were advising OPEC on how to maximise future profits from higher oil prices. We would not have advised them to invest in Shale gas over five years ago when it was high risk but unproven technology. Now it is a proven competing technology what would we suggest? Perhaps pushing the oil price lower to drive these indebted companies out of business? However, driving the oil price down would only cause the assets to change hands. When OPEC eventually tries to raise prices back to above $100 the same competitors would still be present. So we would advise OPEC to buy these companies out of bankruptcy thus controlling an even greater global supply. For this to happen oil will have to trade low for a longer period of time say 9-15 months because at first the indebted slaves will sell more and more oil to provide cash flow to their creditors before entering Chapter 11 and restructuring.
How do you profit? When you see Middle East money, SWF and companies with strong ties to the region such as GE, Haliburton etc buying up these companies from bankruptcy we will be close to the point whereby OPEC lets oil prices rise much higher. At that point investors need to get very, very long oil futures and related investments. Worst case you have a hedge against your future energy consumption. Best case you profit from riding alongside a cartel.
As some of you know, my first job involved trading the Nikkei in 1991 which had daily moves up and down at the time that would seem frightening today. I traded interest rates in the boom of 93 and bust of 94, credit in many crises including Asia 97, LTCM 98 and 02-04 and the big one of 07-09. Using options and CDS some of these moves have been even larger relative to risk capital. I have seen many exciting moves in my trading career and as a keen reader of market history have read about many others. An oil price move of 50% in six months is big but not a stand out move. But I would point out the following as memorable:-The US stock market had six Hindenburg Omens in 6 of 8 trading days in December and between early Dec and January over 40% of trading days exhibited Hindenburg Omens. To my knowledge neither has happened before. A simple way to think about Hindenburg Omens is basically when over 2.2% of all stocks are making new highs and new lows on the same day which implies the underlying market is pulling in
separate directions. Remember that almost all stock market crashes have been preceded by confirmed Hindenberg Omens, although they can occur without a crash subsequently happening. They are rare events normally.
Silver moved from $16.5 to $14.5 back to $16.5 in one trading session in December. That is a 25% round trip in a commodity priced for thousands of years. The Ruble was even more volatile. One year ago it was at 32 to 1 $ yet in one day it moved from 58 to 80 back to 68 – a round trip of 32. Russia is a G8 nation with 140m people. Now of course we have the Swiss bank move and competitive devaluations in Turkey, Belarus and Kazakhstan. We expect the other former communist states to shortly follow leading to further euro weakness. Finally, the Baltic Dry is an index that is hard to manipulate, despite money printing it heads towards new lows and companies such as UPS complain about poor thanksgiving and Xmas sales despite a strong $ and low oil price.2015 is going to be a volatile year. Again we implore clients to think carefully about their currency and counterparty exposures.
November saw the launch of our new systematic ‘Directors Dealings’ strategy. There have been many academic papers written on why it makes sense to follow directors who know better than anyone about the health of their company. Nowadays technology is so powerful that executives at companies are aware of sales trends within their organizations in almost real time. The difficulty for anyone to mine for this information has always been to try and decipher what are the meaningful trades and what is just noise.
About a year ago we teamed up with behavioral scientist Godot Huard who built an impressive algorithm which filters US SEC ‘Form 4’ filings which every ‘insider’ (i.e. director, board member, significant shareholder etc.) needs to submit to the SEC website within 48 hours when they trade in their own company’s stock.
Using his behavioral technology background, we believe Godot has come up with a very credible product. His processes and algorithm focuses on the history of individual directors and if they have been opportunistic buyers of their own stock whether at their current company or a previous one. The algorithm also overlays a series of other factors, including price-to-book value of the company, activity of other directors in the same company, performance of the sector etc. to discover potentially profitable patterns.
What results is a powerful filtering tool which takes on average 150k filings per annum and filters out over 99% of them to leave us with approximately an average 550 buy signals. These buy signals we believe to be the most interesting from a potential profitability perspective.
The graph below shows the out-of-sample results for the algorithm (“ADDS” or Altana Directors Dealings System) from 2010-2013 measured against the S&P 500 and the Sabrient Insider Index (an index which uses the same unfiltered data as is, overlaid with some sentiment information).
Live performance since launch in November has been impressive with 3 months of outperformance versus the S&P. The strategy recorded +2.78% in November, +5.23% in December and -1.2% in January (versus SPX performance of +2.45%, -0.42% and -3.1% respectively for the same period)
A UCITS version of the strategy is ready for inward investment under our existing Altana UCITS umbrella.
If you wish to know more about the strategy please contact firstname.lastname@example.org.
This report is prepared by Altana Wealth Ltd (“Altana”) authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom. The investment products and services of Altana are only available to persons who are professional clients and eligible counterparties as defined in FCA’s rules. They are not available to retail clients. The distribution of this report may be restricted in certain jurisdictions and it is the responsibility of any person or persons in possession of this document to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. Past performance is not a guarantee of future results.