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The Energy Sector and US Markets

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    January 12, 2014

    Investors may be underestimating the power of America’s oil and natural gas industry evolution.The US is producing more oil today than ever. It has abundant natural gas and growing production. Quantities of natural gas and oil are likely to increase for many years. Nearly all of this production is currently consumed domestically.

    Still ahead is the time when energy is exported in the form of liquefied natural gas, oil, and refined products. Right now, exports are very limited by US statutory restrictions.  Once our political leadership gets their rear ends in motion, this energy growth will accelerate. While America waits for fiddling politicians, domestic energy growth will accelerate on its own momentum. All this reenergizing of America’s economy takes place in spite of political leaders, not because of them.

    What does this resurgence in domestic energy production mean? Vincent Reinhart, Chief US Economist for Morgan Stanley, commented on this during his interview with Tom Keene on Bloomberg TV. Vince talked about how powerful the energy component is as it relates to accelerating US growth. The Financial Times analyzed the wage-income impact in the energy sector some time ago. The numbers only get better. Employment in the energy patch generates higher-income jobs. There are multiplier effects as each one of those jobs is created. Those incomes go into households that develop spending patterns on durable goods, automobiles, housing improvement, credit improvement, and so forth. The US energy renaissance is powerful.

    In the general global financial arena, producing more of our energy domestically means we will send less money each month to adversaries abroad in order to buy their oil. It also means that the collective global domiciles of dollars are receiving less money flow from us. The trade data and current account flows continue to reflect that trend. Those global holders of dollars have fewer and fewer incoming marginal dollars to recycle back into the US. Remember, this is a closed system. If a country has a current account deficit, it also has a capital account surplus. If a dollar is sent abroad to buy oil, that dollar gets recycled and re-deposited in flows into the US. Trade and current account deficits and capital account surpluses are a zero-sum game. Send fewer dollars out, and fewer dollars are available abroad to come back searching a domicile.

    Consequently, foreign-flow pressures for higher US interest rates are diminished. Foreign flows seek placement of dollars in an environment in which the dollar gradually improves. That trend is bullish for US bonds and stocks because they are denominated in US dollars. It is also bullish for real estate and about everything else — except for the tulip-bubbled Bitcoin.

    This is how the energy renaissance should be played. Take the books on “peak oil” and throw them in the trash. Peak oil is decades, maybe centuries away. Since US oil is now expanding by volume, not by price, you have to look at energy-related investments through a different lens. In the old days, investors sought rising prices and scarcity in quantity. So you selected stocks and investments related to them in ways in which you could play this combination of quantity limit and higher price. In the new days, you want to play rising quantity, not accelerating price pressure. So, you have to look at your investment selection methodology differently.

    At Cumberland, we are favoring the beneficiaries of rising quantity in the US energy patch. That means that the transportation sector, which is a big user of energy, benefits because it does not have to face the previously assumed constantly rising energy price pressure. There are ETFs designed to capture that sector, and in our view they should be owned and overweighted, which is what we do. We own and have owned IYT.

    In the materials sector, ETFs which favor the chemical and industrial companies also benefit from this renaissance of energy in the US. Those who use energy-related products as feedstock benefit. Those who build out the business of natural gas and oil refineries, pipelines, and transportation in the US will benefit. Overweighting those sectors that are beneficiaries can be accomplished in the ETF arena. XLB and XLI and the specialty ETFs in those sectors offer these possibilities. Cumberland owns both XLB and XLI in managed accounts.

    The US energy renaissance is on a sure path for years to come. Pun purposely intended, it cannot be derailed. It has too much momentum. It is too broadly spread around the country and now has a constituency in Washington, DC, defending it.

    As my good friend Loren Scott, Professor Emeritus of Louisiana State University, quipped in his speeches, “All the energy in the US was in four states: Texas, Louisiana, Alabama, and Mississippi; and the dipsticks were in Washington.” In the new days, the dipsticks are still in Washington, but the constituency to defend and improve the US energy sector now includes Congressional delegations from North Dakota, Pennsylvania, and elsewhere.

    The way to play the energy sectors is through the beneficiaries of relatively stable, nominal prices in energy and falling real prices in energy as additional quantities of natural gas, oil, and all their derivatives make their way pervasively through the US economy and gradually around the world.

    At Cumberland, we like the ETFs that benefit. We seek the municipal bond credits in the regions that benefit from improving credit. For certain clients, we use a specialized technique in which we deploy funds in Master Limited Partnerships that are selected to benefit from energy quantity expansion as opposed to price sensitivity.David R. Kotok, Chairman and Chief Investment Officerspacer

    Cumberland Advisors® is registered with the SEC under the Investment Advisors Act of 1940. All information contained herein is for informational purposes only and does not constitute a solicitation or offer to sell securities or investment advisory services. Such an offer can only be made in the states where Cumberland Advisors is either registered or is a Notice Filer or where an exemption from such registration or filing is available. New accounts will not be accepted unless and until all local regulations have been satisfied. This presentation does not purport to be a complete description of our performance or investment services.Please feel free to forward our commentaries (with proper attribution) to others who may be interested.
    For a list of all equity recommendations for the past year, please contact Therese Pantalione at 856-692-6690,ext. 315. It is not our intention to state or imply in any manner that past results and profitability is an indication of future performance. All material presented is compiled from sources believed to be reliable. However, accuracy cannot be guaranteed.

    About The Author

    Images: Flickr (licence details)

    About the Author

    David R. Kotok cofounded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in economics from The Wharton School of the University of Pennsylvania, an M.S. in organizational dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a masters in philosophy from the University of Pennsylvania.

    Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a participant in Bloomberg radio programs.  He is a frequent contributor to CNBC programs, including Morning Call, Power Lunch, Kudlow & Company, Squawk on the Street, Squawk Box Asia, and Worldwide Exchange. He co-authored the book Invest in Europe Now!

    Mr. Kotok currently serves as a Director and Program Chairman of the Global Interdependence Center (GIC) (www.interdependence.org), whose mission is to encourage the expansion of global dialogue and free trade in order to improve cooperation and understanding among nation states, with the goal of reducing international conflicts and improving worldwide living standards. Mr. Kotok chairs its Central Banking Series, and organized a five-continent dialogue held in Philadelphia, Paris, Zambia (Livingstone), Hanoi, Singapore, Prague, Capetown, Shanghai, Hong Kong, Rome, Milan, Tallinn, and Santiago, Chile. He has received the Global Citizen Award from GIC for his efforts.

    Mr. Kotok is a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), serves on the Research Advisory Board of BCA Research, and is also a member of the Philadelphia Council for Business Economics (PCBE).

    Mr. Kotok has served as a Commissioner of the Delaware River Port Authority (DRPA) and on the Treasury Transition Teams for New Jersey Governors Kean and Whitman. He has also served as a board member of the New Jersey Economic Development Authority and as Chairman of the New Jersey Casino Reinvestment Development Authority.

    Mr. Kotok hosts an annual Maine fishing trip, where, it is rumored, most of the nation’s important financial and economic decisions are actually made.