and Will Contribute to the Development of Alternative Energy Sources
by Chris Ciovacco
March 21, 2006
Kurt Cobb’s
(view article) position that Peak Oil investing doesn’t really matter in the long run represents a defeatist’s position. There are at least two significant reasons for individuals, institutions, corporations, and governments to invest using the concept of Peak Oil as a guide:
R&D: Capital invested in alternative energy companies, as well as traditional oil companies, drives the stock prices of those companies higher. As the stock prices of these companies rise, so does their financial strength and ability to increase research and development activities that are critical to reducing the severity of the impact of Peak Oil. The act of investing in energy stocks, or physical oil via options contracts, indirectly draws attention (people will notice when gas is at $5.00 a gallon) to the problems associated with Peak Oil. As oil prices rise, so will the profile of Peak Oil.
Life goes on: Even in the worst-case scenarios, such as a severe global recession, people will still have to exist, eat, and provide shelter for themselves and their family. Obviously, access to additional financial resources would be helpful in any time of economic downturn or crisis.
In the event that you agree with these positions, how does an individual or institution allocate their investment capital to (a) create a profitable portfolio, and (b) encourage more research and development of alternative energy sources?
Before we can attempt to answer that question, it is important to understand some basic concepts that may shape the investing landscape in the event of a global energy shortage.
Inflation: Rising energy prices push the prices of all goods and services higher. Energy is consumed to produce all goods (even food). As the cost of inputs increase, so do prices on the shelves. Even services providers, such as consultants, will incur higher costs in travel, office supplies, etc.
Economic weakness: High energy costs and rising inflation will hurt economic activity globally. Enough said.
Monetary policy: When economic times get tough, central bankers (like our Federal Reserve or FED) lower interest rates and print more money in an effort to stimulate economic activity (see policies post 9/11). These “easy credit” policies are also inflationary. We have all seen easy monetary policy contribute to rising stock, real estate, and now commodity prices. After the deflationary disaster in Japan from 1990 to the present, global central bankers will use all weapons in their arsenal to fight deflation, which in turn may result in inflation. Between high energy prices and easy monetary policy, we may see hyper inflation sometime in the next 10 years. For those in the deflationary camp, recent central bank policies and the writings of Ben Bernanke point toward inflation first, possibly followed by deflation.
Weak U.S. dollar: The U.S. dollar has not been backed by gold since Nixon closed the gold window in 1971. The U.S. dollar is backed by the full faith and credit of the U.S. government. The dollar is simply an IOU. Between the trade deficit, budget deficits, Social Security, Medicare, and high consumer debt, the full faith and credit of the U.S. government is becoming more questionable each year. If our FED combats weak economic conditions by lowering interest rates and printing more money, this will only contribute to the increasing lack of confidence in holding U.S. debt and U.S. dollar denominated assets (stocks, bonds, real estate, etc.)
Higher interest rates: Inflation, excessive money printing, economic weakness, and high levels of debt, will put upward pressure on interest rates.
Listed above is a small sample of issues to consider when building a portfolio for Peak Oil. Next, let’s discuss some asset classes and how you may want to approach them in the environment outlined above.
U.S. stocks: The average stock will most likely drop. You may want to consider finding a manager who can purchase “insurance” against falling stock prices. This is done via options contracts. If things get really bad, you may want to have a manager who has experience selling stocks short. Be very careful shorting stocks. As of this writing, I would not advocate that the average Joe go short. You do have to be rich to access these investment strategies. They are available to even modest investors. On the other hand, in an easy credit and inflationary environment, stocks may surprise on the upside especially in the early stages of a new FED easing cycle. I would be careful becoming wedded to either the bullish or bearish case for stocks in the next few years. Let the market be your guide and you won’t stray too far.
Foreign stocks: As a way to combat possible future weakness in the U.S. dollar, it does make sense to consider moving some of your stock investments outside the United States. This is something that you may want to consider right now. It may help your returns in the early stages of a downturn, but ultimately, Peak Oil will not be good for global stocks. Hedging with options will most likely become important here as well.
U.S. bonds: As interest rates rise, bond funds can be a very unattractive place to be. If you own bond funds, use funds that hold bonds with shorter maturities. Avoid bond funds that invest in long maturity bonds in a rising interest rate environment. A small portion of inflation protected bonds (know as TIPS) may be a good idea.
Global bonds: If the U.S. dollar does continue to weaken vs. other currencies, you can get a “double return” in select foreign bonds. For example, if I own Brazilian bonds and Brazil’s currency appreciates vs. the U.S. dollar, I get my interest payment and I also get a 2nd gain when the interest is converted back to U.S. dollars. Keep your maturities medium to short.
Gold & silver: Since no major world currency is backed by gold or silver, gold and silver remain the world’s only true currencies. Owning physical gold, physical silver, or stocks in precious metals companies can help you combat a falling U.S. dollar and rising inflation. These are the primary reasons why precious metals have seen increased buying interest in recent years. People are getting nervous about the vulnerability of the U.S. dollar. With the new gold ETFs (exchange traded funds), owning an investment backed by physical gold is easier than ever.
Energy & energy stocks: As stated above, investments in this area will improve the probability that alternative energy sources can be developed which may be able to lessen the blow of Peak Oil. Unfortunately, unless something miraculous happens, it is unlikely that any alternative energy source can be brought to market in time to improve our situation in the next few years. However, capital invested in alternative and traditional energy, will improve the somewhat slim chances of a miracle. Regardless of how fast new technologies can be brought to market, energy investments will help shorten that window. Ultimately, we need to find alternatives.
Other commodities: Oil is not the only natural resource that is facing a possible supply and demand problem. Due to still inflated U.S. stock valuations, rising inflation, and a weakening U.S. dollar, diversifying a portion of your assets into physical commodities and commodity related stocks could help reduce your correlation to movements in stock and bond prices.
Real estate: While there is no question that U.S. residential real estate is expensive vs. historical norms, real estate does perform well in an inflationary environment. Like all the asset classes discussed here, diversification is very important. Since most of us own real estate in the U.S. in the form of our homes, placing a small portion of your assets in global real estate has some merits on several fronts. This can be accomplished via stocks, or even in a small number of mutual funds.
In closing, I am far from an expert on Peak Oil. While I have been a professional investor for over a dozen years, I also realize the importance of keeping an open mind in our ever changing world. Our current investment strategy is diversified across several different asset classes and remains flexible based on what actually happens in the coming years. Investors should be developing an investment game plan that works in today’s world while having a contingency plan in which to migrate to as the investment landscape inevitably changes in the coming years. Getting help, in the form of a money manger or via mutual funds, may be crucial to navigating successfully in the coming years.
© 2006 Chris Ciovacco
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Chris Ciovacco, CIO
Ciovacco Capital Management, LLC
Atlanta, GA USA
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