The market’s dynamic beast

The market’s dynamic beast

The Brent crude benchmark went over US$81 in trade overnight. That’s the highest price since 2014.

For basically all of 2018, I’ve reported on why I expected oil to keep pushing higher.

The rally may not be done yet, either.

However, you’re in luck.

Oil stocks, despite the strength in the US futures market, have not really taken off in a big way here in Australia.

That means you still have time to surf this wave.

The mainstream media is focusing on the Iranian sanctions. These are taking a lot of barrels off the market.

The 3% surge in oil last night came from OPEC suggesting they would not increase production to ease the price at their latest meeting over the weekend.

Analysts at JP Morgan suggest Brent could go to US$90 a barrel before Christmas.

We can’t know how long the good times will last here. The oil market is a dynamic beast.

But for now, this surge is pouring cash into the relevant producing stocks, and will likely shift investor interest into the explorers.

There are lots of ways to play this.

One is to consider oil juniors. These are the type of stocks I cover over at Small Cap Alpha.

However, they are usually exploring and spending a lot of money on drilling. That means they come with other risks besides the pure oil price.

You have to decide how much risk you want to embrace.

If you just want to ride the oil price, you need to consider a company producing now, and check its hedging policy.

A lot of oil producers sell forward their production, meaning they lock in a guaranteed price.

That means future moves — up or down — in the oil price don’t matter for those specific barrels.

Often, an oil company will lock in a price for some of its production – say 50% – and leave the other half exposed to the market swings.

Usually they’re trying to cover their basic costs or making sure they can pay their debts.

But not all of them. One of the oil stocks on my Small Cap Alpha buy list has no hedging in place at all.

That means every dollar rise in the oil benchmark is another dollar in their bank account.

But you can look at the bigger stocks, too, or even the market in general.

BHP Billiton Ltd [ASX:BHP] is one example of why.

Watch October for oil

Of course, BHP is not a pure oil and gas stock.

But 18% of its earnings came from its petroleum division in its last annual performance.

If oil keeps rising, it’s just more free cash flow for BHP to either pay out to shareholders, invest in more production, or use to lower its debt ratio.

And because BHP makes up such a large weighting in the index, it can help keep pushing the market higher.

I think the Aussie market is going to keep going higher over this year, and next.

If that’s to happen, in my mind, it’s almost certainly going to come from the natural resource sector.

This is the one area of the market that can get a big, unexpected lift to earnings if commodity prices keep trending up.

October is the month to watch on this front.

That’s when analysts are likely to upgrade their iron ore and coal assumptions they use to estimate BHP’s future earnings.

These are likely going to go up, based on the current market, and likely take BHP’s valuation with them.

The latest move in oil, if sustained, could give BHP a third leg-up.

The copper price is springing back to life, too.

In fact, it’s possible all four of BHP’s key pillars will begin firing at the same time.

And yet, the mainstream media keep battering us over the head with the idea that global trade is at great risk.

Maybe it is, but most of the iron ore, coal and oil imported into China are not sent to the US. They are used in Chinese construction based around internal demand.

So, it’s not so clear-cut that US tariffs will knock down the commodity markets.

But it’s this fear that’s suppressing BHP’s stock price more than the actual reality right now.

That’s not to say it can’t all change tomorrow.

But it’s an example of how short-term fears can create compelling long-term buying opportunities.

Then you have to calculate your risk going forward. The world never stops turning.

Like I said at the start, there are always opportunities in the market.


Callum Newman Signature

Callum Newman,
Editor, The Daily Reckoning Australia