Agora Financial’s Rude Awakening

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· Just another momentous day in the global financial markets is all,
· Mayer on the “New Silk Road” and how you can cash in on it,
· The cost of neglect: a look at America’s oil infrastructure and more…

Eric Fry, reporting from Laguna Beach, California…

Another momentous day arrived in the global financial markets yesterday. The Dow Jones Industrial Average fell to a fresh five-year low, while Japan’s Nikkei Index fell to a fresh 26-year low. Most of the rest of the world’s stock markets also tumbled to new multi-year lows. Many of the year-to-date declines look like misprints: London’s FTSE Index is down 53%, Hong Kong’s Hang Seng Index is down 60%, Russia’s RTS Index is down 76%.

Down 76% is more than just a bad year; it’s a disaster. “That’s not going to happen here!” we tell ourselves, as we cross our fingers, knock on wood and light a candle to Saint Martin of Tours. “The U.S. is not an emerging market, after all.”

More than likely, the beleaguered Dow Jones Industrials’ 38% loss, year-to-date, will not “do a Russia” and double to 76%…at least not immediately. But the line between “developed markets” and “emerging markets” has become very blurred. Nearly every stock market in the world has become a “submerging market.”

When will this global financial trauma come to an end? Probably not for many years. At least that’s our guess. But we would also guess that some stocks are worth buying right now, even of the overall market continues to decline for many months or years to come. In the column below, Chris Mayer nominates a couple of stocks that might buck the market’s downward trend…

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Down, But Not Out
By Chris Mayer

Like a boxer who has a habit of dropping his hands, America finally caught one on the chin. The U.S. economy is flat on its back, and the financial markets are leaning down into its face yelling out a 10-count. But the U.S. economy isn’t “out for the count” yet. It will struggle back to its feet. But if the economy hopes to stay on its feet, it will have to devise new tactics. The old, sloppy tactics of credit-financed consumption won’t work anymore.

The biggest change in the American economy over the last few decades has been the transition from making things to making loans. We Americans abandoned the manufacturing industries that once powered our economy and devoted ourselves to merely financial activities. We became experts in “financial origami.” Precisely when and why this happened will be something for historians to debate. But sometime in the 1990s, the percentage of corporate profits from finance surpassed that from manufacturing.

The gap between the two has only grown wider ever since. Before the recent credit crisis hit, profits from financial firms made up nearly half of total corporate profits in the U.S. Only 10% came from the manufacturing sector! As recently as the mid-1960s, these percentages were the other way around.

Eventually America’s over-reliance of financial gimmickry, rather than traditional commerce, left our economy exposed to a serious shock. The shock has arrived. But every crisis brings opportunity. In the current crisis one, investors will go back to investing in simpler, more durable things (at least until forgetfulness kicks in). The focus will shift to things we need, rather than things we want. For instance, investing in a company that supplies grains to hungry people looks like a better bet than investing in one that sells mortgages to people who can’t afford them.

To a smaller degree, we had a similar crisis in the 1970s, Kevin Phillips tells us in his new book, Bad Money. Mortgage debt doubled from 1960-70. Then the stock market crashed, losing 36% of its value from 1969-70. Hedge funds blew up. The top 28 funds lost 70% of their assets, and about 100 brokerage and financial firms disappeared – by either acquisition or outright failure. Seems a lot like the headlines of the present day, does it not?

The 1970s also had two major oil price spikes. The first in 1973-74 and the second in 1979-80. We’ve already had one oil spike now, if a second one arrives in the next few years, it could push prices through $200 a barrel.

That’s because the global oil industry has not been re-investing very actively in developing new production. America’s neglect of “making things” is very evident in the oil business. Phillips says the U.S. has a “dated, ghost-of-glories past petroleum infrastructure.” He writes that the major oil companies “are wealthy, but aging behemoths, hard-pressed to maintain production levels, despite large exploration outlays, and no longer enjoying access to overseas oil fields they once commanded.”

Exxon Mobil, once the largest oil company in the world, now ranks 25th by booked oil reserves. The top 10 are all state-owned national oil companies (NOCs). The top 13 NOCs own four-fifths of the world’s known oil reserves. They don’t share them cheaply.

A look at where we get our oil is not encouraging. Most of these sources of supply are not particularly reliable. As Phillips opines (the table below comes from his book): “Of the eight principal 2007 suppliers of petroleum to the United States as of August, only one, Canada, could be called secure and reliable.” Mexico seems secure, but exports have been falling since 2004, as Mexican production has fallen. It could become an insignificant source of oil by 2012.

And we are not alone in competing for these oil reserves. China became a net oil exporter in 1993, and its appetite grows every year. It is now the world’s second largest consumer of oil, behind only the U.S. China actually imports more oil from Saudi Arabia than the U.S. This partnership is not surprising, given the dynamics of the New Silk Road.

The “New Silk Road” is a term I use for the boom in trade between countries from the Middle East to China. In matters of energy, you see a lot of deals inked on the New Silk Road. Saudi Arabia and China get together regularly like newfound pals. Sinopec, a Chinese oil company, recently got the OK to explore the Saudis’ Empty Quarter for oil and gas. Saudi Aramco, the big oil company, put $750 million toward a huge plant in China.

Just as interesting to me is what I like to call the “New Burma Road” – after the road of World War II fame that linked China and India via Burma. The New Burma Road identifies the booming trade between India and China. As Phillips writes, “China has already made a six-lane highway out of its portion of the road from Chinese Kunming to India’s state of Assam… The demographics of a Sino-Indian entente would make it especially momentous.”

Yeah, I’d say so, given the strengthened ties between more than 2 billion people.

As you know, there is an awful lot going on in the world today, and it’s all far more complex than I can get into here. But this is where we are, in brief: The U.S. economy faces a crisis in its biggest sector – finance. The neglect of making things is finally taking its toll, a fact most apparent in the oil and gas world, but also apparent in infrastructure across the spectrum. And the world is less U.S.-centric than it has been in a long time. We see this, too, in the oil and gas sector and in the flurry of deal making along the New Silk Road (and its “momentous” segment, the New Burma Road.)

The implication of this post-finance U.S. economy is a theme we’ll explore more in this letter. As an early conclusion, though, I believe the spread between finance and manufacturing has reached millennial extremes, like a rubber band at its limits. Now begins the snap back.

Now begins the time to invest in companies that make things. Many of these companies operate in the oil services industry, and many of them are EXTREMELY cheap right now. T-3 Energy Services (Nasdaq: TTES. $16.53) and Contango Oil & Gas (NYSE: MCF. $38.50) illustrate the point. Both are “old economy” companies that provide essential products. Both are selling for less than six times earnings. I’ll provide complete details in tomorrow’s Rude Awakening.

[Joel's Note: In the meantime, you can catch up with all Chris’ recommendations in his Mayer’s Special Services portfolio right here .

We’re seeing the Asian markets bounce quite dramatically as this morning’s Rude rolls off the virtual press (Hong Kong’s Hang Seng leapt 14%!), so we’ll have details about all that in tomorrow’s edition too.

In the meantime, all the best in the markets today.

Until next time…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com