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September 30, 2004

September 30, 2004

ENERGY

In the last 3 months, Guild Investment Management (GIM) has met with the CEOs and or CFOs of about 25 energy companies in Canada, Europe, Denver, New York and San Francisco, at individual meetings with company managements, and in groups at energy conferences. I returned last night from the latest conference and wanted to share our latest thoughts with you.

As you know, we have been enthusiastic about the opportunities in energy stocks for a couple of years. During that period, energy prices have moved to the $50 level, close to our target price of $55. Energy stocks have risen and we have participated in the group. However, we do not believe the underlying fundamentals of the energy price rise are at all exhausted. In our opinion, the fundamental reasons for their rise in price are just beginning to be recognized by the global investment markets.

We believe oil prices will average between $35 and $40 per barrel for the next several years. These prices are well below the current market price of $49, but are way above the levels being forecasted by the major oil companies in their economic models. Since most Wall Street analysts get their price expectations from the major oil companies, these analysts are also substantially too low in their estimates in asset value, earnings and cash flow of the oil and gas companies they follow.

Hence, the average institutional or public investor is operating with faulty data. Recently, the prominent energy investment bank Petrie Parkman and Co. outlined the following 10 reasons that oil prices are high. I have followed some of them with my comments.

TEN REASONS WHY OIL PRICES ARE HIGH

1. There is no excess supply.
Comment- Saudi Arabia’s recent increase of production of 2 million barrels per day completely removed the excess supply cushion.

2. Demand is understated (data is bad).
Comment- Demand data from India, China and Russia is very suspect and may even be intentionally understated to give the impression of low demand.

3. Supply is overstated (data is bad).

4. Insecurity premium (fear of supply disruptions due to war and terrorism).

5. Chinese demand is exploding.

6. Indian and Russian demand is growing.

7. OPEC has it together.
Comment- OPEC nations are more unified than in the recent past and not cheating on their quotas. Besides, how can they cheat on quotas that represent their full capacity?

8. We are in a new era.
Comment- Economically and politically, the world has changed.

9. The dollar devaluation of the last two years translates directly to higher oil prices.

10. One more we haven’t thought of yet.
Comment- There is always something that arises after the fact that adds to the list of reasons for a big bull market.

WHAT DOES ALL OF THIS MEAN TO US?

We like energy and continue to invest in it. We continue to see energy as a very special area for profits this year and next.

We think higher energy prices will have a negative impact on economic growth and that the U.S. and world economic growth rates will slow in 2005.

The U.S. budget trade and balance of payments deficits will both exacerbate our energy problem and simultaneously aggravate our deficits.

There are many statistics which continue to argue for long term increases in energy demand from China, India and Russia and the U.S. stock market has not accorded energy stocks the valuations that they will get before this rise is over.

For example, currently energy stocks make up about 9% of the S&P 500 in terms of their market price. Yet analysts are predicting that energy stocks will generate 40% of the S&P 500’s profits next year. This is quite an under-valuation and one that we believe will be corrected.

ENERGY STOCKS COME IN ALL SHAPES AND SIZES

We may invest in high yielding, fast growing, oil, natural gas, coal, energy services, energy transportation and energy finance companies.

OUTSIDE OF ENERGY, WE STILL VERY MUCH LIKE LOW P/E INDUSTRIAL AND SERVICE COMPANIES WITH HIGHLY VISIBLE GROWTH RATES.

DO WE STILL LIKE PRECIOUS METALS AND FOREIGN CURRENCY BONDS FOR THE LONG TERM.?

Yes. Definitely. The fundamentals for these assets continue to improve.