7:24 AM, 12 Sep 2008 Alan Kohler Oil killed Gordon Gekko TOP News Wall St week ahead: eyes on financials 2:37 PM Lehman fate in balance, emergency talks continue 11:27 AM Ike likely to cost insurers up to $US18bn 11:55 AM WA Libs and Nationals to form government 2:12 PM Local stocks seen higher 1:19 PM
The Spectators Bartholomeusz: KGB Interrogation: Trevor Rowe WEEKEND ECONOMIST: Down but not out RICH PICKINGS: Money talks PUNTING SPECTATOR: The business end TIME OUT: Design, duets and dim sum
Carlos Slim’s acquisition last night of another 6.4 per cent of the New York Times Co, taking his stake to 9.1 per cent, shows there are at least some buyers in this market.
When the dust settles and the bear retreats once more into hibernation, there will have been a massive shift in equity ownership of the world’s corporations.
Slim, the world’s second richest man (after Warren Buffett) and owner of Latin America’s largest mobile phone company, is a kind of sovereign wealth fund of his own. His spokesman says he’s just looking for bargains.
At this stage Warren Buffett is looking for safety. He stunned the market yesterday by pulling his bank deposit insurance firm, Kansas Bankers Surety, out of the business of insuring deposits above $100,000 – confining the business, therefore, to insuring deposits that are covered by the Federal Deposit Insurance Corporation – because he thinks there will be more bank failures.
The Oklahoman newspaper commented that in the debate between glass half empty and glass half full, Buffett is “glass cracked”.
But it won’t be rich individuals like Carlos Slim and Warren Buffett who end up owning the world. It will be oil producers.
Citi’s global equity strategist, Robert Buckland, published a fascinating study recently called The New Carry Trade.
In the credit boom, LBO funds raised cheap debt and bought cheap assets in the public equity markets; the new carry trade involves selling oil for $US100 per barrel and buying cheap assets on the public equity markets.
The average earnings purchasing power of oil on the global stockmarket since 1970 has been $US1.17 per barrel (that is, the MSCI world index earnings that can be bought with a barrel of oil).
It is now $US8, as the price of oil has gone up and corporate earnings are falling.
Buckland and his team comment that the credit crunch has radically changed the cost of capital across global financial markets.
Between 2002 and 2007 the cost of high yield debt fell 600 basis points, which outpaced valuations in the equity market. This offered a historic arbitrage opportunity: borrow at 7.5 per cent in the credit market and buy 10 per cent earnings in the equity market.
The private equity industry took the most advantage of this and LBO takeovers boomed.
The credit crunch has now changed all that. The cost of debt capital in the global high yield index has rocketed to 12 per cent, which is higher than the global earnings yield. A 300 basis point carry trade has switched to minus 100 basis points within 12 months.
Where is the new liquidity pool? Oil.
The pension fund herd, having galloped into the bond and credit markets and getting burned, have been galloping more recently into commodities instead. That, plus the demand from developing countries, has pushed the price of oil above $US100 a barrel and as we have seen this week, OPEC is trying to defend $US100 by cutting production.
Says Buckland: “We suspect that this has revealed an arbitrage opportunity that could reshape the global corporate sector just as dramatically as the great debt/equity arbitrage of 2003-07.”
In 1999 a barrel of oil would have bought just 40 cents of global earnings. Now that earnings are falling and that figure has gone up to $US8 of earnings, the price of oil would have to fall to $US20 a barrel to return the purchasing power of a barrel to its long-term average.
Just as the equity market looked cheap between 2003 and 2007 to anybody who could source capital from the debt markets, it now looks cheap to anybody who can source it from oil (or Latin American mobile phone contracts?).
“Move over private equity, here come the oil-financed sovereign wealth funds (SWFs). The figures are mind-boggling – at current prices, total world oil reserves ($135 trillion) could buy the S&P 500 index eleven times over. Just one year of production ($3.3 trillion) would buy the whole MSCI Emerging Market index.”
The other big liquidity pool is Asian central banks, which are now sitting on $US4 trillion of foreign exchange reserves, up from $US1 trillion in 2001.
Private equity has a surprisingly resilient pool of liquidity ($US323 billion) but the buying power of this money has contracted dramatically with the availability of debt.
No, the real financial power now lies with those who are sitting on oil and gas. In Australia we have seen incredible wealth being generated out of the coal seam methane reserves in Queensland’s Surat Basin, thanks in part to a rise in the price of LNG towards parity with oil.
The world’s oil-rich – including the Australian gas producers – could emerge from the bear market as the new masters of the universe.
It certainly won’t be Gordon Gekko and his mob on Wall Street.
