The big trade of this year positions oneself for the upcoming US recession. In speculating and investing if one can get the main concept right everything else falls into place. Various trades will branch off from this theme. The trade is not priced into the market at all since we are betting against the accepted narrative. We can use various proxies to play the trade, as just about anything economically sensitive may qualify. Base metal producers, car companies, sub prime financiers, retail establishments, the list goes on. The main vehicle I have chosen to execute the trade is the oil price. I have chosen this because both fundamentals and technicals indicate to me it is over priced and due for a fall. It trades deep and has a record of falling under distressed economic conditions.
“All that we see or seem is but a dream within a dream”- Edger Allan Poe
That’s what we have lived over the past 8 years, an economic mirage. A historic FED fueled reflation rally, that was just a dream. Central banks led by Phd academics applied their unproven pet theories of substituting credit conjured from thin air in place of accumulated savings to stimulate demand. We are now going to see if their theories worked. Von Mises explained in “Human Action” that a credit-fueled boom ends in one of two ways:
“Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever growing orgy of speculation, which, as in all other cases of unlimited inflation ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis.”
That is where we are right now, at the beginning of the credit restriction, the crisis will then follow. Its time to take the trade before its begins to be priced into the market. The oil market is rife with false understandings that should soon be exposed. Chief among them is that OPEC is in control. A belief in an OPEC put reminds me of the belief in the central bank put which existed in 2008. That dream was soon blown away. The false idea that producers will simply shut down production once they reach their all in costs is simply wrong. Sovereigns and independents have bills to pay, the costs of infrastructure can be written off.
Diego Parrilla has written a wonderful book “The energy world is flat”where he describes forces converging on the energy markets which ultimately work towards lower prices. These forces have converged to put crude oil on the defensive. Substitution, regional convergence, lower transportation costs have essentially made Oil into strictly a transportation fuel. Oil once the source of power generation is no more. Oil now competes at a disadvantage with virtually most other energy sources.
Consumers have defended themselves in various ways and geopolitics no longer add much of a premium into price with ample storage capacity and diverse supplies. Peak oil turns out was a very linear static view of the world. It ignored the dynamism of the market. These are forces that will exert a downward pressure on prices for years to come and when a faltering economy runs headlong into the largest spec long position of any commodity in history prices will drop.
Distressed producers and investors.
Reversion to the mean is a statistical certainty. The only question is what duration do we use to determine it? If one is to look at the oil price spanning the entire modern era (post WWII) the mean price, in today’s dollars, would be around $35. So its not hard to imagine a dip below the mean during a mean reversion cycle.
Capturing that move below $35 is what this trade is all about. As I said earlier what makes this the Big Trade is not the percentage move, but in getting the theme right and using that theme in your other investments.