Macro Tsimmis

intelligently hedged investment

SELL iShares S&P Global Energy Sector Index Fund (IXC)

Posted by intelledgement on Wed, 10 Sep 08

OK, time to review those Econ 101 notes from freshman year. What happens when increasing demand occurs for a product with inelastic supply? If you said “the price rises” then go to the head of the class.

That’s what we said back in January 2007 when we recommended buying this ETF. But that was then, and this is now…and today’s question is, “What happens when dramatic demand destruction occurs for a product for which suppliers have pushed hard to increase production capacity?” And it’s not just that U.S. driving season gasoline consumption is down 4% as reported last week. That decline is largely tactical, driven by the rise in price per gallon. We are facing a strategic-level, international decline in energy consumption—and concomitant energy company valuation—due to the oncoming recession, which will certainly be wide and steep, and may be long-lasting. LOL the USA may be a lot less important than formerly, but when American consumers stop buying, the effects can still be felt in Paris, Beijing, and Brasilia.

Up to now, we have expected the markets to remain stable-to-bullish through the US presidential elections, but last weekend’s move by the federal government to take over Fannie Mae and Freddie Mac—in effect, undertaking potentially $1 trillion in obligations by guaranteeing those failed companies’ obligations—is a wake up call. Hey, we got trouble. Right here in River City. With a capital “T” and that rhymes with “D” and that stands for “debt.”

We have only the vaguest idea of the impact of the mountains of debt and dollars the government will be issuing over the coming weeks and months to counter the credit crisis that has the likes of Wachovia, Washington Mutual, and Lehman Brothers in the financial ICU (and the line for the emergency room is out the door and around the block)…but the effects on the dollar won’t be pleasant…to say nothing of inflation. And we really don’t know at what point folks begin to question the wisdom of continuing to fund the debt of the USA and the interest rate for treasuries begins to ramp up—in fact, we don’t really want to know—but unfortunately, it seems more and more likely that we are going to find out.

The market was euphoric about this Fannie/Freddie bailout on Monday, but we believe that Tuesday’s downturn was more apropos. No way did the Bush administration want to make this move prior to the election (or at all; they were no doubt hoping the spirit gum and baling wire would hold through to January so it can be the next guy’s problem). The fact that the pulled the trigger on an emergency-over-the-weekend basis tells us that things are a lot worse—and have degraded a lot faster—than they had thought.

Give that energy demand is largely a function of consumption, given that we now anticipate a swift and steep decline there, it is time to step aside here. When we do return—as we will; long term energy demand will continue to climb—we expect it to be at a lower price. Probably—unfortunately—much lower.


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