Taal selectie

Sell in may and go away

A Welcome Truce

Pascal Blackburne & Luc Synaeghel 2019-07-01

Tension ahead of late June G20 summit in Osaka was high. Would this gathering of world leaders put the final nail in the coffin of multilateralism or instead succeed in rekindling discussions towards a US-China trade agreement – not to mention global cooperation on the climate front?

The Group of Twenty (G20) was founded in 1999 but began its practice of convening at summits only 11 years ago, in the wake of the Great Financial Crisis. Somewhat ironically given the ongoing trade dispute, creating the G20 was a means for the US to sponsor the emergence of China as a global power, by letting it have a seat at the table (unlike in the G7 or G8 forums). The aim of the inaugural G20 summit, in October 2008, was to coordinate efforts to save the financial system and avoid global economic depression. As the years moved on, the G20 broadened its perspective, notably become a driving force of the Paris Climate Agreement.

Needless to say, the Trump Presidency has left little of this cooperative spirit alive. His “America First” policy has indeed driven the US into a lonely spot, with the list of countries alienated by tariffs and sanctions getting longer by the day. To some extent, the fact that this G20 summit actually took place was reassuring, even though bilateral meetings overshadowed multilateral discussions. And, of course, the good news was that further tariffs on Chinese goods have been postponed, Huawei has regained access to US components, and negotiations towards a trade agreement will resume – helped perhaps by China’s considerable purchase of US soybeans.

Misunderstandings have clearly been rife on both sides of the ongoing dispute. Of particular note, in our view, is the fact that the US vastly underestimates China’s internal growth potential. Outside of the very large cities, the Chinese population is only just starting to gain access to consumer goods, via smartphones, Alibaba’s digital marketplace and the logistical network that it is busy rolling out for deliveries. Cars are another example: did you know that China currently boasts ca. 80 domestic manufacturers, some of whom with very advanced electrical technology?

Ultimately, we continue to expect an agreement to be reached, probably going into the 2020 US Presidential election. The trade dispute has taken its toll on global growth, but on that of the US too – which is why President Trump so wants a weaker dollar (each new round of US tariffs has been countered by yuan depreciation) and is pressuring the Fed to cut rates soon. We thus intend to reduce portfolio dollar exposure, also taking advantage of falling costs for currency hedging.

On a different subject, but one that likewise made recent headlines, let us venture some thoughts on Facebook’s forthcoming Libra currency. Regulators appear circumspect (despite having allegedly been consulted up-front) and for good reason. Beyond facilitating cross-border financial transactions, is there an intention to actually create money? Put differently, will the consortium running Libra hold reserves that match the amount in circulation, or only a fraction thereof? In the latter case, users would have no assurance of being able to exchange their Libra back into the underlying basket of currencies – nor will they be able to use them to pay taxes which, as it were, is the only true definition of a currency.

Our Positive Case for Oil

Alongside persistent US-China tensions, the US-Iran situation has heated up over the past weeks – culminating on the night of June 20 when President Trump made a last-minute decision to call-off a military attack on Iran (initially conceived as retaliation for the downing of a US Navy drone). While we give little credit to the official humanitarian justifications provided for the U-turn, we can only speculate on what really happened during that “historical” night: Russian intervention, recognition that the Iranian defence system was too strong?

Whatever the true story, the fact remains that oil prices benefitted from renewed Middle Eastern geopolitical risks, with the WTI surging to the USD 60 mark before falling back more recently to USD 57. Make no mistake, though, this upmove is also justified by tight physical market conditions, particularly since the OPEC+ coalition just decided to prolong its production cuts for a further 9 months.

Oil speculators meanwhile continue to focus on – volatile and useless – weekly US stocks figures. These logically expanded during the recent period of refinery maintenance, in preparation for the shift from producing mainly heating oil to that of gasoline for the summer driving season, and also because of the time lag between full enforcement of Iranian sanctions and the arrival of the last tanker loads to the US shores.

Frankly speaking, the influence of such short-term oriented players is problematic, oil probably being the commodity with the largest share of speculative trading. It argues for continued volatility, even within an upward-oriented oil price trend. Note for instance that the largest East coast refinery (in Philadelphia) blew up a few days ago: the resultant increase in US crude oil stocks is bound to – temporarily – push down oil prices, even though it should come as no surprise.

Still, we reiterate our positive call on US shale producers. Their share prices have tracked oil prices on the downside, but not (so far) on the upside. As such, they are trading at bargain valuations (average expected 2019 EV/EBITDA of 4.5x and 35% discount to net asset value). Indeed, they have become so cheap that larger oil companies are getting into action. Continental Resources, for instance, one of the bigger shale oil producers, announced that it will use USD 1 billion of its free cash flow to buy back a portion of its own shares. And, a couple of months ago, oil major Chevron made a bid on Anadarko, also one of the larger shale oil producers, at a premium to market cap of roughly 35%, followed by an even higher bid by Occidental Petroleum (at a premium exceeding 50%).

We expect further such corporate activity and remain convinced that oil will trade (much) higher in the second half of this year, buoyed also by larger demand from the global shipping sector, where an engine shift towards low sulphur fuel oil or marine diesel oil will soon be mandatory. The major risk to our optimistic scenario would be a very serious slowdown in world growth, or even recession, due to further escalation in the trade war – hence the welcome G20 truce.

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