The Best Investment For 2021
Oil stocks. These assets in our opinion hold the best investment opportunity for the first half of 2021 and possibly beyond. The current environment reminds me of just before the 2018 bull market in gold I was sounding the alarm on.
First, we need to understand what I mean by the best "investment opportunity". A great investment opportunity is when: The downside is protected and the upside hasn't been priced into the market yet.
When someone truly finds these great investment opportunities- they ought to have to fight the urge to not go all in. Simultaneously, when the asset goes down, they can't help but buy more.
These are the moments when an experienced investor starts franticly looking all around wondering why nobody else can't see the elephant in the room. Ultimately, you know you have to act fast because the clock is ticking. It's always just a matter of time until the market "prices in" what the reality always should have been.
Let me be clear, I'm not saying that oil stocks will outperform every other asset in 2021. I'm saying oil stocks present the most opportunity for a lot of upside while protecting the downside. If you aren't protecting the downside then you aren't investing- you are gambling. Certainly a bitcoin investor can return 300% this year. They also could lose every penny in 72 hours. There is no way to be aggressive with a large sum of money in that environment.
THE OIL STOCK UPSIDE THESIS
First, let's start with a SCRATH THE SURFACE view of the situation. Right before the Covid-19 oil crash the price of WTI crude oil was $53/barrel.
As you can see in the above chart our current oil price of $53/barrel matches the price of oil before the Covid-19 crash.
The above picture is a snapshot of the Vanguard Energy Index. This is a basket of various oil companies. The index is currently 25% lower then it was when oil was trading at the same $53/barrel level in March. To be clear, I am not advocating to purchase the VDE index. I am simply using the index as a tool to show the price discrepancy in the market in relation to the commodity price and stocks in that space. Furthermore I believe it is important to cherry pick which oil companies an investor selects due to each countries regulations, balance sheets, etc.
Nonetheless, it is clear that oil stocks aren't trading at expensive multiples compared to historic valuations. In fact, the VDE index was trading at a P/E ratio (Price to earnings ratio... this is a valuation metric) of 15 in March 2020. This itself isn't an expensive valuation. Currently the S&P 500 index finds itself trading around a P/E ratio of 22.
If someone could almost guarantee you a 25% return for the year then you would be a fool not to take it. However, I do believe there will even a stronger return then 25%.
PROTECTING THE DOWNSIDE
In these circumstances the downside protection is also mixed with a case for the upside. Below is a chart of the US Dollar Index measured against other major currencies. As you can see we have fallen 13% since the first quarter of 2020. Our weakening dollar will continue to boost the price of oil. Our downside is also protected by the federal reserve stating they won't raise interest rates (this strengthens our dollar) until 2022 at the earliest. Additionally, there doesn't seem to be any near end in site of future stimulus bills coming down the pipeline further weakening the US dollar.
US OIL BANKRUPTCIES SOAKING UP SUPPLY
The United States oil industry is seeing a large consolidation process taking place as well. As we all know when there is less competition their is higher prices.
The fracking industry that flooded the world with oil under President Trump is getting crushed. In 2020 alone 40 oil producing and exploration companies have filed for bankruptcy. This bankruptcy wave to date is responsible for $54B in defaults. The largest bankruptcy was an $11.8B default via Chesapeake Energy (I was among the few that shorted Chesapeake Energy in 2020). These losses certainly won't be too motivating for future investments in the US oil industry. We can also expect the Biden administration to be quite a difficult environment for US oil companies to operate in. The weak oil companies that didn't succumb to bankruptcies will continued to be gobbled up by the stronger producers- resulting in less competition. It's safe to say the oil bath the U.S. gave the world will be taking a pause and higher prices are around the corner.
SAUDI ARABIA AND RUSSIA RELIANCE ON HIGHER OIL PRICES
The IMF estimates that Saudi Arabia needs oil to be at $80/barrel to balance their budget. Russia needs oil to be at $40/barrel to balance their budget. After seeing a dismal 2020 with oil prices well below $40/barrel both countries will be looking for higher oil prices in 2021 and beyond. Evidence of this can be seen in Saudi Arabia's latest oil cut of 1M barrel's per day throughout February and March of 2021. Now that the U.S. has less of a strangle hold on the oil supply- look for OPEC nations and Russia to manipulate the price higher to make up for past losses.
GET READY FOR A POST COVID WORLD WITH HEALTHIER OIL PRODUCERS
Just as the Spanish Influenza didn't last forever- The Covid-19 crisis won't either. The Spanish Influenza lasted 18 months just after world war 1. The Covid-19 epidemic seems to be on the same timeline now that we have vaccines hitting the market. The combination of vaccines and summer weather will finally put an end to this crisis. Post Spanish Influenza we saw the roaring 1920's. We expect to see the same frenzy around the world ready to finally take those postponed vacations. The oil market will try and accommodate the demand resulting in higher prices.
In terms of "healthier" oil producers I am talking about balance sheets. The oil producers that are making it through the crisis did so by the skin of their teeth. Throughout 2020 they were forced make drastic cost cutting measures. These cost saving measures even allowed many oil producers to stop losing money when oil hit $40/barrel. Now that oil is above $50/barrel we could see healthier bottom lines then before the crisis even began.
The combination of undervalued oil companies compared to pre Covid-19 levels, production cuts as demand begins to increase, and a weakening US dollar all contribute to oil stocks being our favorite investment for at least the first half of 2021.
John Lawrence is an investment advisor and the owner/founder of J.A. Lawrence Wealth Management, LLC.
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