Will we face inflation; will we face deflation? What is going to be the result of the monetary printing press running full speed on and on?
We can find experts in both the deflationary and inflationary camps. Upon reading, they can both “sound” right. Personally, I think we are in uncharted territory.
Demand for gold and silver has been falling for the last few years. After reaching highs of above $1900/oz and almost $50/0z, respectively during 2011, gold and silver futures recently traded as low as less than 1150/oz for gold and below $15/oz on silver. Both metals have rebounded minimally to date.
Demand for crude oil saw oil priced at over $100/bl as recent as late summer of this year but today, as I write this post, it is well below $60/bl.
The precipitous fall in precious metals started before the outright collapse in oil. The oil and gas sector companies, and gold and silver miners have witnessed stock price collapses the likes of which most of us have never seen. Drilling companies in oil and gas are being decimated, stock-price-wise, as I write.
Many of these commodity companies are seeing their stocks trade at well, well, below their tangible equity per share. Are they buys, though?
A couple of things to consider from the risk analysis side if you are looking at such companies include:
-commodity companies very likely have less ability to differentiate themselves from each other than non-commodity companies, but are largely dictated by commodity prices; that is, while comparative company performance is useful, company managers can do very little about the commodity price constraints beyond using hedging contracts.
-most commodity company assets are of a “fixed asset” composition (i.e. property, plant and equipment). These assets are illiquid (for example, a drilling company’s drilling rigs) and the monetary value of the rigs can be greatly impacted by the underlying commodity price. (note, the discussion in my book, “Choose Stocks Wisely,” about my episodes with dry-bulk shippers in the latter part of Chapter 8).
Surely, the demand for oil and gold is not going to zero. However, there could very well be some serious consolidation among the ranks of energy companies and miners. Further, the companies with the most vulnerable balance sheets will be the first to go bankrupt, which is always the case, even if we are talking about the whole realm of stock market companies.
When demand rebounds, the strongest of these commodity companies will surely benefit. Stock prices of these sector-related companies are very, very low relative to where stock prices have been even recently. How low can they go? Whoever can answer that one can tell us where the commodity prices will bottom.
I know this; if I’m personally looking to buy any stocks in this arena, I’m definitely shopping for companies with strong liquidity and lesser debt relative to peers, giving me confidence in the ability to weather the storm and come out the other side smelling like a rose when the demand returns.
Excellent summary, thank you Paul.
From history we saw that oil prices can fall more than 60%, followed by a 100% increase over time. However all boils down to your point their earning are related to oil prices. When I talked to people in the industry the mentioned that it takes them up to 1 year cutting their supply significantly.
Thanks for the comment, Marcel. Some companies in the space (especially drillers) are already reflecting financial distress on their balance sheets. A year is a long time for those who are over-levered.