Market Insights & Analysis from Kramer Capital Research

Black Swan or Black Gold: Are Oil Stocks Signaling a Market Crash?

Energy was supposed to be the hot spot this year, with earnings in the sector rebounding as much as 30 percent on the back of strong oil prices. Instead, profits cratered, and the stocks don’t look great either.

When you live on petroleum sales, you suffer when oil reverses. And since the global economy runs on fossil fuel, investors get nervous about a recession when demand for oil declines.

I’m not one of those nervous investors. Despite all the tension and turmoil of the last few months, I don’t see the world economy going over any cliffs in the near term.

But even if this is not the “black swan” that foreshadows a broader crash, there’s still a reason crude oil is down 30 percent from its October peak. This is simply how energy markets work.

Updating Risk about China’s Economy and the Coronavirus

Start by bracketing the assumption that there’s an essential link between declining oil prices and decelerating economic activity.

Yes, oil is the fuel that drives everything from factories to farming. There’s a strong correlation between the rate at which we burn that fuel and the speed at which the economic world spins.

However, oil is still a commodity subject to market logic. When supply rises faster than demand, prices go down.

Demand is still edging up in some places like the United States and surging in places like China. However, global supply has risen faster.

It is really that simple. More oil to burn gives consumers a break. Sooner or later, they’ll burn the excess and prices will rise again, but getting to that equilibrium point will take time.

Right now, China is the big player on the demand side. The country has quarantined 50 million people, which takes just enough fire out of the world’s aviation and auto markets to temporarily depress consumption by 2 percent.

But even with that hiccup, the country is still tracking 17 percent higher consumption this year. That’s over 2 million barrels of oil a day, enough to absorb all OPEC spare production capacity and more.

When China comes back, petroleum prices will surge. In the meantime, other consumers are happy to stockpile fuel here. India is rapidly becoming a key energy importer and around the world barrels that would have once gone to China are being diverted to other destinations.

That’s not a recession signal. But until producers pull back, petroleum will remain under pressure.

Are Supply Disruptions a Thing of the Past?

The mood in the energy market reminds me more of 2014 than 2008. In both years, oil prices went over a cliff, but only one downswing was a sign of a global recession on the horizon.

Onshore shale has transformed the risk landscape. The days of having to cope with a major disruption in countries like Nigeria, Venezuela or the Middle East are over.

Look at the market’s reaction to the drone attacks on Saudi processing plants or the more recent missile exchanges with Iran. Traders who were caught short had to move fast to cover their positions, but the overall price trend still pointed up.

It is hard to get really nervous about a coup breaking out in Texas to knock oil wells offline for days, weeks or years. While there will always be hot spots, global energy risk has declined.

That’s a great thing. And if U.S. producers can make $60 a barrel work, they’ll do well for long-term shareholders.

After all, all the drillers have to do is drill the holes and then pump black gold out of the ground. The right geology is truly a license to print money.

The stocks are always a slightly different story. We want to buy companies that have better futures ahead of them, which means either coming in early or waiting for a big dip to reset valuations.

In the former scenario, I’ve been talking to a few start-ups for potential inclusion in my new IPO service.

The others make their way to Value Authority, where we’ve done well with Big Energy at moments like this.

Either way, 2014 wasn’t a bad year for my subscribers at all. We just didn’t invest in a sector that was obviously deteriorating. Wait for the falling knife to hit the floor.

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Cannabis Corner: No More Commodity Models

Aurora Cannabis Corp. (NYSE:ACB) remains a drag on sentiment throughout the cannabis industry after reporting a $1 billion loss. While this is not the closing bell for the company, it is a wake-up call.

The commodity sales model is simply broken. Too many opportunistic growers have flooded the market with low-quality plant product and gotten Canadian consumers habituated to the cheapest buzz possible.

That’s a bad business because until the giants can consolidate enough of the small suppliers and enforce discipline, everyone is in a race to the bottom. And that’s where ACB and its peers are now.

These companies need to entice consumers with higher-end merchandise and price points to match. People have talked for years about recombinant strains and tailored edible products. They just haven’t gotten any traction.

Part of the problem is that Canada was slow in approving sales of anything beyond basic “Cannabis 1.0” plant material and extracts. There just wasn’t an outlet for innovation or added value.

And in the meantime, consumers got used to fixed prices. Maybe they weren’t euphoric about the experience, but it was legal and met their needs.

Unfortunately, ACB says Cannabis 2.0 buying patterns are volatile. Consumer tastes are fickle. There’s no breakout hit yet, and until someone finds the lucky formula, new product development will be expensive.

Someone will find that formula. Until then, it looks like the 1.0 market has matured. ACB is one of the top players in the industry and its revenue growth has stalled.

When the giants stall, smaller competitors can seize market momentum with differentiated products that stand out from the status quo.

I’m watching those companies as the key to the next wave of investable cannabis stocks. But unless ACB or one of its big rivals step up fast, I’m writing them off for the time being.

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