We were early.
It's this simple: Either the commodity is right or the stocks are right.
If the futures can foretell, well, the future, the shares are trading too high.
It may be because equity traders are slower to react than commodity traders, it may be that shareholders believe they are looking past the valley of despair to the broad sunlit uplands or it may be that the world is nuts and there is no connection between current prices, future prices, discounted cash flows or a hundred other things that can be measured.
On the other hand it may be the shares are correct and that the price declines we've seen in oil and gasoline are already raising demand but I doubt it.
The ETF representing the energy behemoths of the S&P 500, the Energy Select Sector SPDR ETF (XLE) is trading around 20% too high based on current oil prices, not to mention where the futures might drop to in the first half of 2015. The more speculative SPDR S&P Oil & Gas Exploration & Production ETF (XOP) could drop 25%.
XLE $78.71 Down 0.45 (0.57%)
XOP $47.41 Down 0.45 (0.94%)
Brent $56.31 down $1.02
WTI $52.59 down 68 cents.
Equity holders have barely gotten past the shock of the declines much less the 5 stages of grief that Kübler-Ross posits. We could be looking at waterfall cascades as realization sets in.
From Mohamed A. El-Erian at Bloomberg View:
This Era of Low-Cost Oil Is Different
Having seen numerous fluctuations in the energy markets over the years, many analysts and policy makers have a natural tendency to “look through” the latest drop in oil prices -- that is, to treat the impact as transient rather than as signaling long-term changes.
I suspect that view would be a mistake this time around. The world is experiencing much more than a temporary dip in oil prices. Because of a change in the supply model, this is a fundamental shift that will likely have long-lasting effects.
Through the years, markets have been conditioned to expect OPEC members to cut their production in response to a sharp drop in prices. Saudi Arabia played the role of the “swing producer.” As the biggest producer, it was willing and able to absorb a disproportionately large part of the output cut in order to stabilize prices and provide the basis for a rebound.
It did so directly by adhering to its lowered individual output ceiling, and indirectly by turning a blind eye when other OPEC members cheated by exceeding their ceilings to generate higher earnings. In the few periods when Saudi Arabia didn't initially play this role, such as in the late 1990s, oil prices collapsed to levels that threatened the commercial viability of even the lower-cost OPEC producers.
Yet in serving as the swing producer through the years, Saudi Arabia learned an important lesson: It isn’t easy to regain market share. This difficulty is greatly amplified now that significant non-traditional energy supplies, including shale, are hitting the market.
That simple calculation is behind Saudi Arabia’s insistence on not reducing production this time. Without such action by the No. 1 producer, and with no one else either able or willing to be the swing producer, OPEC is no longer in a position to lower its production even though oil prices have collapsed by about 50 percent since June.
This change in the production model means it is up to natural market forces to restore pricing power to the oil markets. Low prices will lead to the gradual shutdown of what are now unprofitable oil fields and alternative energy supplies, and they will discourage investment in new capacity. At the same time, they will encourage higher demand for oil....MORE
