Long Oil - Your Money March 4th 2022

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After a very volatile week, some indices are knocking on the door of a bear market (a drop of 20%) thanks to some big corrections in high flying tech stocks. In contrast, the TSX is about 400 points away from another record high, so why the dichotomy? The US Nasdaq index and to some extent the S&P 500 both have outsized exposure to technology stocks whereas in Canada, financials dominate the index (33%) followed by Energy (15%) and Materials (12%.) No surprise the carnage taking place in Europe has created ripples through everything from corn, to fertilizer oil and gas,  wheat and iron ore (in no particular order.) And sadly, during times of duress, commodities in particular tend to trade on rumours rather than facts which only serves to magnify the price swings leaving financial carnage in its path. That in turn works its way into other asset classes like stocks and bonds.

If we look at the worst performing stocks in Canada this week its easy to see why Magna has tumbled 17% this week (they have idled a parts plant in Russia) but Marinrea, another auto parts player, does not operate there and yet its down 15% this week. Or the Canadian banks. Over the past ten days, the big six have reported billions in profits yet their stock prices have either moved sideways or have traded lower. Some cite falling bond yields as investors bail out of stocks and into US bonds, while other contend a negative economic shockwave will develop as a consequence of Russian financial sanctions. Last time I checked they don’t have a lot of Russian exposure.

More to the point, one just must look at the oil price curve. The April contract is $115 a barrel, while the July contract is $103 and December closed at $93. That tells me the smart money believes the current price spike is only temporary and make somewhat logical sense. The cure for high oil prices is…high oil prices. According to the EIA, drilling companies are now drilling wells with laterals extending 15,000 feet and 25% of the pads each have nine wells. My understanding is it takes them about three weeks to do this. So imagine a pad of concrete the size of a school gymnasium that instead of one well, has nine, each with a huge horizontal section spreading out 2 miles.

We know the last downturn in energy prices caused a huge shockwave in the energy patch. “Drill, baby drill” gave way to “drill only if you can afford to do it without borrowing money from a bank”. Based on my experience, with oil over $85, its only a matter of time before “drill baby drill” will ring from one end of Texas to the other. I can almost hear the exploration engineers opening up the filing cabinets and dusting off their pet projects that got shelved when crude sank five years ago. If nothing else, at these prices, Alberta will be booming in no time.

Turning to gold, base metals iron ore and even potash, there is no question we are in a state of high anxiety. Cleveland Cliffs has spiked from $16 at the end of January to $26 today. Their iron ore mines and steel mills are running at full capacity as the US prepares for a nearly unprecedented infrastructure boom courtesy of the US Government and their Build Back America philosophy. However, there is no shortage of iron ore in the world just ask the team over at Labrador Iron Ore Company. The stock hit a record high $50.45 last June and then spent the next six months gradually sliding back down to a respectable $36 by Christmas. Today it hit $50, up 10% this week and 33% this year. Plus it pays a monster dividend. Has it gotten ahead of itself? In the short run maybe not. Who can say how the next few weeks will unfold, but longer term, the perceived supply squeeze will likely  give way to more rationale pricing.

Bottom line, keep calm, take a long view and separate fact from fiction. Furthermore, there is a volatility index called the “VIX”  otherwise known as the fear gauge and its at 33 versus a normal 12. That tells me we are in for some more turbulence next week.

Our hearts go out to the people in Ukraine.

Stay safe and Happy trading.

Cheers Steve

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Steve Bokor

Steve Bokor

Portfolio Manager