The world’s largest economy is vulnerable on so many fronts. In the US, social emphasis is being placed on protecting ourselves against terrorists and the threats of nuclear and chemical attack. But perhaps an equally serious peril is being ignored: our dependence on Middle Eastern oil, for example.
A shrinking dollar, growing federal debt, increasing trade gap, record-high consumer debt, mortgage bubble, rising oil prices, inflation, flat productivity, falling wages…the US — responsible for 98% of global GDP growth in the 10 years to 2002, according to Stephen Roach at Morgan Stanley – faces many problems, all part of the same trend translating to financial vulnerability.
But this economic sword of Damocles points the way to how everyone can change their investing mode, not only to avoid US-exposed losses but also to maximise their investment profits.
If you accept the suggestion that big changes are going to be coming in these arenas, how can you reposition assets without also increasing market risks? Most investors are not going to sell their equity positions and go short on US stocks, or sell options or futures contracts. It simply isn’t within their profile to do so.
The trick is to find ways to take advantage of the coming changes in smart ways – and there are several.
The way you choose to change strategies should depend on your investing experience and knowledge, risk tolerance, and personal preferences. In seeking ways to reposition your portfolio, there are two major markets UK investors will want to keep in mind either to avoid long positions or seek ways to work against the falling dollar trend: oil and gold.
The price of oil went over $50 per barrel more than once in 2004, and by 2005 it seemed inevitable that the price was going to continue upward. Remember, only three years before, barrel prices were down at the $20 range. The rise in prices was not as surprising as how quickly it occurred. The problem is not just the Organisation of Petroleum Exporting Countries (OPEC)’s holding back on production, although that certainly plays a part in the big picture. A civil war in Nigeria, the fifth-largest US supplier, has directly affected US imports as well. Add to that the four hurricanes in 2004, which cut back about 11.3 million barrels of production in the Gulf of Mexico.
We are also facing growing demand for oil from China. Its oil imports were up 40% in 2004, and that growing demand is also driving up prices paid in Europe and the United States. Chinese industry demand for oil is experiencing the highest growth curve in the world today. The Chinese population adds to the problem in that the automobile has become desirable and affordable.
During a two month period in the summer of 2003, for example, private automobile ownership in Beijing rose by 200,000 cars. Chinese demand has been climbing steadily over the past 14 years.
When oil consumption in China is projected forward only a few years, it is apparent that consumption is going to outpace any hopes of production’s keeping up. We can safely assume based on the trend in both industrial and consumer use that China is going to be the major oil consumer in coming years. So there is no logical reason to expect oil prices to drop. Rising prices affect one-third of all US companies in some way. They create a double-whammy on corporate profits. First, they drive up operating costs, and second, higher prices lead to reduced consumer spending.
So it isn’t just oil; it’s the whole economy and any industry using petrochemicals. These include construction, manufacturing, clothing, carpeting, and a vast number of other industries. Increased demand affects oil prices as much as weather patterns, political problems, and of course the threat of terrorism.
And there is little the United States or Britain can do to fix the problem. In 2005, Congress approved oil drilling in the Arctic National Wildlife Refuge (ANWR) in Alaska. But even this won’t produce a drop of oil for at least 10 years. Additional drilling is not going to address the deeper problem.
At current consumption rates, there is only enough oil remaining to meet current need levels for another 30 years. The relationship between oil discovery and production also looks quite dismal. What can investors do to position their portfolios?
Stocks in companies involved in oil drilling and exploration, as well as those supplying drilling ventures, will continue to be solid investment opportunities in the future. New demand for oil rigs and drilling will push profits and stock prices higher. With OPEC already producing at 95% capacity, it is hollow to blame their policies for shortages.
The truth is, reserves are dwindling as demand grows. Evaluate the oil production and drilling industry. Look for stocks that will benefit as oil prices rise. For mutual fund investors, seek out energy and commodity funds. For the more advanced investor who is comfortable with options, consider buying long-term calls in oil- related sectors with the greatest growth potential. Consider the four major sub-sectors within the larger energy sector of the market: coal, oil and gas (integrated), oil and gas operations, and oil well services and equipment.
Of course, looking for energy-related mutual funds and ETFs is also a wise move. With prices rising, oil and gas companies and their products will become more in demand in the future.
The ultimate dollar hedge investment will always be gold. Investing in gold through ownership of the metal itself, mutual funds, or gold mining stock provides the most direct counter to the dollar. As the dollar falls, gold will inevitably rise.
For now, we emphasise the high probability of gold’s future. The real potential for profits in the coming years and decades is not going to be found in the traditional blue-chip American industry or UK engineering company. They are financial dinosaurs that can no longer compete in the world market. The future growth is going to be seen in gold.
The world economy may remain off the gold standard, but ultimately the tangible value of gold as the basis for real value—whether acknowledged by central banks or not— will never change. Historically, this has always been the case, and it always will be.
In other words, we are on a ‘gold standard’ in spite of the popularity of fiat monetary systems. So besides knowing where to position your capital to maximise returns when the dollar falls, also think about strategies that sell the dollar to produce profits.
By Addison WiggiFor The Daily Reckoning
Addison Wiggin is the editorial director and publisher of The Daily Reckoning. To get more from Addison and a host of other daily contributors, check out the free daily email, The Daily Reckoning.
This essay was taken from Addison’s newly-released book, ‘The Demise of the Dollar…and Why It’s Great for Your Investments’. It has just hit the New York Times bestseller list. You can buy your copy here for £8.49.
https://books.global-investor.com/books/22296.htm?ginPtrCode=21664