So the writing was on the wall. We discussed this last summer: keep a lot of cash and wait for the next big opportunity. What nobody could predict was the catalyst for the fall. In fact, we had a perfect storm brewing with 2 major catalysts. First, the COVID 19 outbreak: and the media has done a fine job in ensuring this particular outbreak will scare the crap out of any investor. Secondly: the Opec / Russia production increase. But perhaps this was more predictable...
Forget anything you may hear in the media about OPEC trying to gain market share. Crude is a commodity, not a brand name. Market share is gained or lost the moment one sells cheaper than one's competitor. What one needs to recognize is that oil is a political commodity. By not agreeing to production cuts, but rather to an increase when demand is plummeting at the height of a global pandemic, these two countries are achieving something quite different. It's irrational in economic terms, and when something doesn't make economic sense, one needs to question what's really going on.
This massive drop in the price of crude might hurt Russia in the short term, but it will give Russia much more leverage going forward. North American oil producers will suffer tremendously from this most recent price drop. Many of these shale producers are leveraged to the maximum. And with crude below $45, the marginal cost in the oil sands, production will stop. Europe will now be even more dependent upon Russian imports and the USA will begin to lose its strategic leverage in Europe. That's the intention anyway.
Now, as investors and traders, we have what could be one of the greatest opportunities of the century. Without making predictions about the stock market or the price of crude, let's consider how best to approach this. First of all, The oil price will likely remain low until it is no longer politically advantageous for Russia to keep producing. So one should pay close attention to political events that concern Europe, Russia and of course the USA.
Secondly, consider when the corona virus is likely to peak in the USA. If one considers how unprepared the USA was for this catastrophe, we can expect far more deaths in the USA than have occurred in China. The market may have recovered somewhat in the past few days, but the peak of this virus outbreak is expect in about 2 to 3 weeks. That could send the market back down to levels not seen since the financial crisis of 2008. This is not a prediction, just a caution. Certainly, there are bargains in the market, but I think people are being a bit naive thinking that the market will suddenly bounce back. It may retrace from here about 50% of its move down, but longer term, this event is going to affect the psyche of many people.
Be prepared for a very bumpy ride ahead. If the American government does things right - which is unlikely - we might see a recovery in the late summer. But if I were making a bet, I would say that there is more risk on the downside than opportunity on the upside between now and the end of summer. It is highly probably that the events of the past few weeks will put the world into a recession. If this happens, any rally in stocks should be considered an opportunity to sell.
If you are ready to venture into these murky turbulent waters, we suggest you look at some quality utilities that will continue to generate revenues. We would avoid banks for now because the risk vs reward ratio isn't attractive. With so many leveraged to the teeth on their mortgages and with so many bank loans in the oil patch, we would look elsewhere. Gold stocks and pharma stocks are two areas we like. Among the golds, we would suggest you look at the stocks which popped the most from the lows of this past week; companies with large and growing reserves in politically safe jurisdictions. We wouldn't look at the majors, but mid-tier companies and those companies involved in platinum and palladium. Impala, Gran Colombia, Osisko Mining and Osisko Royalties. Among the smaller companies, we like Balmoral, Victoria Gold, Great Bear, Midas Gold and Unigold. In the oil patch, we would consider Petrobras, but avoid any Canadian producers. They aren't coming back anytime soon if we have a recession. Good luck.
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