We’re shorting XOM, the chart of which is pictured above — its out-of-line overperformance easy to see. Stocks do not overperform, as a rule, over a very long period of time.

Steve Forbes says oil prices will drop in mere months to $30-40 per barrel, and we are paying attention, despite the naysayers. He may be wrong, but many fundamentals support him:

(1) the Saudis don’t want oil at this price for their long term interests; (2) China, the massive marginal consumer of oil, has an export-led economy which has grown by 9% per annum over the last 20 years, but it is hard to see where double-digit growth is coming from now; (3) (key item) China has, in our view, not reached Walt Rostow’s take-off point of self-sustaining internal growth — the collapse of China’s steel industry, the low 15% value added in Chinese manufacturing, the corruption of its banking system, and the massive unproductivity of capital investment in China (eg, $5 to get $1 in sales) are evidence of this — therefore, any significant slowdown of external demand will have substantial reprecussions in domestic Chinese consumption patterns; (4) China’s 40% increase in oil imports over the last few years is therefore unsustainable; (5) Americans are rich, but $65 oil is killing the swing consumers of oil in many countries around the world; and (6) our old colleague, Barton Biggs, predicted a China hiccup three years ago the same way he predicted Japan’s market meltdown three years before it happened — and Barton is almost never wrong about big picture appraisals like this.

Two items are key in our analysis. The first is incontrovertible, that every poorer country in the world is getting slaughtered by high oil prices. Could this result in a 2-3% reduction in world oil demand? We think so. The second factor is China, the pivotal source of most of the increased demand for oil over the last two years, and where we posit that export-led growth may slow considerably, at least for a little while. Of course China, with its commitment to a minimum 7% growth to maintain internal stability, its $600+ billion in forex reserves and an economy which may be more internally self-sustaining than we give it credit for, can do much to enhance domestic demand, but it has no incentive to influence that demand so that it fattens the coffers of Arab sheikhs, unless it is critical to the growth strategy for China.

We may be right or we may be wrong about the factors influencing changes in price for oil. But this remains a constant: commodities, particularly those with inelastic supply curves, suffer wild increases — and decreases — in price, when market conditions change swiftly.

Wall Street is great at many things. One thing it is not good at is forecasting discontinuities. In August 1987, some traders bought puts on elements in the roaring bull market of the time. In October, the market plunged 508 points in a single day, making them wildly rich, and proving, as the Great Crash did, that the market often fails to predict major, discontinuous, changes of direction. Wall Street currently is not forecasting anything other than up, up, up in the price of oil (which, incidentally, we last experienced in stocks on CNBC in early 2000 when the NASDAQ was 5000 — as oppsed to 40% of that today). We may be wrong, but this oil market smells fishy to us, and we’re going to put our money where our mouth is.

This entry was posted on Sunday, September 11th, 2005 at 9:23 pm and is filed under China, General, business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.