Book Notes: The Oil Factor
Notes on The Oil Factor: Protect Yourself - AND PROFIT – From the Coming Energy Crisis
Stephen Leeb and Donna Leeb, 2004
Read August-September 2006
Leeb writes an investment newsletter, and tries to predict trends. Here he predicts a near-term energy crisis, and suggests how to invest appropriately. I enjoyed the book; it’s easy to read and the writing style is congenial. His predictions are all plausible, but I don’t have enough of a finance or economics background to judge them well.
Synopsis
[All opinions are that of the authors.]
Chapter 2: Our Amazing Oil Indicator
Basically, the price of oil is a guide to how the market (in particular, the S&P 500) will perform. Sharp oil price increases are always correlated with recessions. Leeb’s rule of thumb: if oil prices have increased 80% over the last year, get out of the market, and stay there until the increase is reduced to 20%.
Chapter 3: The Geological Lowdown
Discussion of Hubbert’s Law, concluding that an oil will peak soon.
Chapter 4: Oil Prices: Up, Up, and Away
Predicts $100/barrel oil by 2010. This was a bolder prediction when the book was written than it is now.
Chapter 5: The Debt Burden.
Ordinarily, with rising oil prices, you would think the safe way to react would be to conserve, i.e. to consume less. However, this would shrink the economy. Given the current state of consumer debt (especially in the form of home mortgages), shrinking the economy is not likely to be an option the government will take. The only way out for our policymakers is to tolerate or even foster inflation.
Chapters 6 and 7: Moving Beyond Oil
Good overview of alternative energy.
Chapter 8: Government Spending
Government spending will be increasing, for the following reasons:
· defense, to protect oil supplies
· need to develop energy alternatives
· Medicare and Social Security for boomers
The point of all of this is that government spending generates inflation.
Chapter 9: The Case for Inflation
In the future, the Fed won’t be able to combat inflation by raising real (as opposed to nominal, inflation-adjusted) interest rates, because doing so would kill the real-estate market.
The productivity myth – productivity has been reported to have increased rapidly in the past decade, and that has been keeping inflation low. However, the productivity numbers can be misleading:
· prices have increased on many consumer items, but those items have gained more features. So the government hasn’t counted that as inflation, because you now get more for your money.
· example: a 2x increase in processor speed has been counted by the government as a doubling of productivity in the computer industry.
· finally, have our living standards really increased in the past 30 years, especially given the rise in dual-income families?
So the Leebs reject the theory that productivity gains will negate inflation.
Part II – Making Money
Chapter 10: The ABC’s of Inflation Investing.
Two rules for investing in inflationary periods:
· P/E ratios will be downgraded across the board, so only invest in companies whose earnings growth can compensate for that. In other words, in companies whose businesses are directly based on real assets.
· Abandon a policy of buy and hold, since you have to beware deflation.
Earnings growth has two components: real and inflationary. Inflationary growth is the effect of charging higher prices to reflect higher costs due to inflation, and has little investor value, since it’s common to all companies. Real growth (everything else) is what counts.
“Once inflation becomes entrenched, the economy becomes inherently less stable.” This is because you get into vicious cycle where companies raise prices because of higher costs, which requires other companies to raise prices, etc.
Chapter 11: Energy
What to buy: major oil companies, oil service companies, and independents; or energy funds. But get out of oil when oil prices rise sharply, since high oil prices lead to conservation and reduced demand.
Chapter 12: Gold
Suggests that gold is far undervalued, and that $2000 an ounce is not unreasonable.
Chapter 13: Alternative Energy
Suggested buys:
GE
Exelon (nuclear), EnCana and Petro-Canada (for oil sands), and Toyota (hybrids), and Utah Headwaters (clean coal). Silver and platinum.
Chapter 14: Defense
Suggested buys:
Northrop Grumman, Raytheon, CACI, General Dynamics, Lockheed Martin
Chapter 15: Berkshire Hathaway
Has Warren Buffett leading it, plus the authors like insurance -- especially as global warming heats up.
Chapter 16: Best of the rest
Small-cap stocks – performed well in the 1970’s, although volatility is high.
REIT’s –inflation will drive up real-estate prices.
Weight Watchers (obesity-awareness on the rise)
Tiffany’s
Intel (only when trading under 3x book value)
Stocks to shun – American/European car companies, airlines, S&P 500 index.
Chapter 17: Deflation Hedges
Cash
Bonds, especially zero-coupon bonds
Chapter 18: Putting it all together
A suggested portfolio:
Stephen Leeb and Donna Leeb, 2004
Read August-September 2006
Leeb writes an investment newsletter, and tries to predict trends. Here he predicts a near-term energy crisis, and suggests how to invest appropriately. I enjoyed the book; it’s easy to read and the writing style is congenial. His predictions are all plausible, but I don’t have enough of a finance or economics background to judge them well.
Synopsis
[All opinions are that of the authors.]
Chapter 2: Our Amazing Oil Indicator
Basically, the price of oil is a guide to how the market (in particular, the S&P 500) will perform. Sharp oil price increases are always correlated with recessions. Leeb’s rule of thumb: if oil prices have increased 80% over the last year, get out of the market, and stay there until the increase is reduced to 20%.
Chapter 3: The Geological Lowdown
Discussion of Hubbert’s Law, concluding that an oil will peak soon.
Chapter 4: Oil Prices: Up, Up, and Away
Predicts $100/barrel oil by 2010. This was a bolder prediction when the book was written than it is now.
Chapter 5: The Debt Burden.
Ordinarily, with rising oil prices, you would think the safe way to react would be to conserve, i.e. to consume less. However, this would shrink the economy. Given the current state of consumer debt (especially in the form of home mortgages), shrinking the economy is not likely to be an option the government will take. The only way out for our policymakers is to tolerate or even foster inflation.
Chapters 6 and 7: Moving Beyond Oil
Good overview of alternative energy.
Chapter 8: Government Spending
Government spending will be increasing, for the following reasons:
· defense, to protect oil supplies
· need to develop energy alternatives
· Medicare and Social Security for boomers
The point of all of this is that government spending generates inflation.
Chapter 9: The Case for Inflation
In the future, the Fed won’t be able to combat inflation by raising real (as opposed to nominal, inflation-adjusted) interest rates, because doing so would kill the real-estate market.
The productivity myth – productivity has been reported to have increased rapidly in the past decade, and that has been keeping inflation low. However, the productivity numbers can be misleading:
· prices have increased on many consumer items, but those items have gained more features. So the government hasn’t counted that as inflation, because you now get more for your money.
· example: a 2x increase in processor speed has been counted by the government as a doubling of productivity in the computer industry.
· finally, have our living standards really increased in the past 30 years, especially given the rise in dual-income families?
So the Leebs reject the theory that productivity gains will negate inflation.
Part II – Making Money
Chapter 10: The ABC’s of Inflation Investing.
Two rules for investing in inflationary periods:
· P/E ratios will be downgraded across the board, so only invest in companies whose earnings growth can compensate for that. In other words, in companies whose businesses are directly based on real assets.
· Abandon a policy of buy and hold, since you have to beware deflation.
Earnings growth has two components: real and inflationary. Inflationary growth is the effect of charging higher prices to reflect higher costs due to inflation, and has little investor value, since it’s common to all companies. Real growth (everything else) is what counts.
“Once inflation becomes entrenched, the economy becomes inherently less stable.” This is because you get into vicious cycle where companies raise prices because of higher costs, which requires other companies to raise prices, etc.
Chapter 11: Energy
What to buy: major oil companies, oil service companies, and independents; or energy funds. But get out of oil when oil prices rise sharply, since high oil prices lead to conservation and reduced demand.
Chapter 12: Gold
Suggests that gold is far undervalued, and that $2000 an ounce is not unreasonable.
Chapter 13: Alternative Energy
Suggested buys:
GE
Exelon (nuclear), EnCana and Petro-Canada (for oil sands), and Toyota (hybrids), and Utah Headwaters (clean coal). Silver and platinum.
Chapter 14: Defense
Suggested buys:
Northrop Grumman, Raytheon, CACI, General Dynamics, Lockheed Martin
Chapter 15: Berkshire Hathaway
Has Warren Buffett leading it, plus the authors like insurance -- especially as global warming heats up.
Chapter 16: Best of the rest
Small-cap stocks – performed well in the 1970’s, although volatility is high.
REIT’s –inflation will drive up real-estate prices.
Weight Watchers (obesity-awareness on the rise)
Tiffany’s
Intel (only when trading under 3x book value)
Stocks to shun – American/European car companies, airlines, S&P 500 index.
Chapter 17: Deflation Hedges
Cash
Bonds, especially zero-coupon bonds
Chapter 18: Putting it all together
A suggested portfolio:
| annual oil price increase under 20% | > 80% | |
| energy | 23% | 10% |
| gold | 15% | 10% |
| alternative energy | 20% | 5% |
| defense | 8% | 5% |
| berkshire hathaway | 15% | 15% |
| misc | 14% | 5% |
| deflation | 5% | 50% |
posted by Jim at
9:30 PM
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