Let's Talk Dirty

If you ask the average investor and judging by the positioning in most portfolios, Apple stock is a buy and Exxon Mobile is a sell. I've got news for you. Since last November, that bet is offside big-time. Like 50% big time. That's a ton of lost alpha that is now starting to register with investors. They are now talking dirty. Dirty oil.

Despite all the talk of the green revolution, global oil markets have acted well, in advance of the OPEC+ meeting this week. With the tailwind of a reawakening global economy, oil demand is quickly rising back to pre-pandemic levels and excess inventories are dropping quickly. Recent ESG ( environmental, social, and governance) driven shareholder and legal movements have suddenly put the publicly traded major oil producers on the back foot. They are, more than ever, making decisions based on environmental considerations, rather than growth at any cost as was the mantra of the previous regimes. Exxon has reduced cap-ex dramatically, increasing its capital return to shareholders at the expense of growth.

That's a conundrum for the vast majority of investors desperate to 'beat' an increasingly choppy and rotational market. Switching significantly into a sector that only represents 2.5% of the benchmark is treated as an afterthought by most managers. The 'sector' that once dominated the investment landscape a generation ago, is dismissed as a dinosaur by many a new and newly-woke investor. Exxon's removal from the Dow last year marked the bottom. It is now one of the best performers this year, benefitting from the insatiable quest for income in a zero-rate world. It still yields 100 bps over the junk bond market, with a fortress balance sheet, and is likely to increase its dividend for years to come.

So dirty oil is having its revenge. Who cares? Not many, judging by the fund flows into the sector ETF, "XLE", which have been muted. But the real implication isn't for investors, but politicians. The systematic dismantling of the existing oil production paradigm is playing into the 'dirty' hands of the most unstable and repressive regimes extant. OPEC, led by the ruthless Saudi Prince Mohammed bin Salman, and Russia's dictator for life Vladimir Putin. Now Iran is set to join the production fray courtesy of a now less hawkish West, led by the U.S. Democrats anxious for a return to a less fractious global discourse. The forces of ESG are playing into the hands of extremists, with decidedly repressive social and governance constructs. They don't give a rats ass about shareholders, judges, or teenage environmentalists.

The unintended side effects of the well-meaning, but politically naive, climate change movement are likely to continue. Hard assets, so far, have outperformed for mainly fundamental reasons. The demand for 'stuff' has rebounded nicely from last year's global time-out. For all commodities, the supply response now inelastic, being distorted by the externalities of climate change policies. It will be increasingly hard to build a mine, drill a well, lay a pipeline, or disturb a habitat. While as laudable a goal is saving the planet - it will increasingly shape the price we pay for building the green future.

More than most, the fundamentals of oil are changing for non-economic reasons. I have said in this blog that there is plenty of $60 oil. While that may be true from a geologic and economic view, I have increasing concern that geopolitics will dominate the price direction over the next few years. As we transition, there will be many speed bumps along the road to a carbon-free future from the dirty energy past. I'm now seeing a very large one this year. It's now time to talk dirty - oil that is.

Risk Model: 2/5 - Risk Off

Investors are displaying curious recalcitrance that belies the steadiness of the upward market. Low volumes imply that they have cashed out or headed for the sidelines. Only the VXV and Copper/Gold are in the 'risk-on' mode. In addition to the RSI and 200DMA measures, the AAII survey (below) is in the 'off' position. Only in relation to the recent strong recovery following last year's collapse does it look bad. Historically, at 1.38, it is in the middle of a wide trading range and looks more sanguine than the signal line dictates as it is holding a rising trendline.

The 'sell in May' crowd did little damage recently to a market buoyed by strong earnings and ample liquidity. That liquidity looks more than enough to fuel a melt-up rally into the summer months, with left-behind value leading the charge. XOM is as 'value' as it gets.

Copper/Gold is worth a mention. Strike activity and political unrest in Chile are keeping the normal seasonal factors at bay. China so far has been unsuccessful at 'talking down' commodity prices, unlike their knee-capping of Bitcoin. Copper is also in the throes of a 'green' theme investment fad, and like oil, is highly sensitive to ESG supply constraints over the longer term. Gold caught a 'Boomer Bitcoin' bid but has yet to follow through to new highs. Unlike oil, copper is seen as a solution in the decarbonization drive for a global climate solution. Longer-term I prefer it to oil as a hard asset but oil has some catching up to do to reach the downtrend line. (chart below). As long as Gold rises more gradually than Copper, the model will stay happy.