Tuesday, November 11, 2008

The Fall of 98'

10 short years ago the markets were gripped with the panic known as Long Term Capital Management. LTCM was a hedge fund that was the darling of the industry throughout the 90's. They were the brightest minds in the world in risk management and every major bank in the country was sending them billions of dollars to invest.

They were betting on risk spreads between bonds of different nations and after growing confident over the years they were leveraging their bets up to ridiculous levels. They would collect massive checks year after year as long as there was not some "event" that would shake the markets. Of course, that event came as it always does, in the form of Russia defaulting on its debt in the summer of 1998.

Long Term Capital Management was leveraged up so high that they turned to the Federal Reserve to bail them out because they represented systemic risk to the financial system. The Fed did just that, but the unwinding of their trades caused enormous shock waves through the credit markets, stock markets, and commodity markets.

Oil fell from $20 all the way down to $10 a barrel. The media cheered of the bursting of the oil bubble. To start the new year in 1999 the Economist magazine ran on it's cover that the price of oil was going to $5 and staying there for the foreseeable future. What was the reason? Demand Destruction.

Does any of this sound familiar?

Soon after the price of oil was announced to stay cheap forever, auto manufacturers created the wave of the future in SUV products that rolled off the assembly lines. Gas guzzlers if you will.

When the entire world was buying tech stocks in 1999, a small percentage of investors began buying oil companies due to the forced selling in the trading pits. They have done pretty well over the past ten years with those companies. The tech stocks? Well, we know that story.

I believe the next 5 years will have a similar story to the last ten. Oil touched $59 today. Unbelievable. Everyone is cheering for $20 oil, and cheap oil forever. The Demand Destruction has arrived. Or has it?

Worldwide demand is on pace to grow this year, and recent depletion studies are showing a 9.1% annual decline. SUV sales have risen sharply as buyers are picking them up at discounts hoping that oil will stay low. I'd rather buy oil stocks on discount, but time will tell who is making the right choice.

No comments:

Post a Comment