Peak Oil News: Stagflation and Peak Oil: How Related Are They? (Part II)

Sunday, July 27, 2008

Stagflation and Peak Oil: How Related Are They? (Part II)

Seeking Alpha

By Larry Bellehumeur

Investing in a Stagflation environment reminds me of a game that we used to play when we were kids. You would think of two disgusting scenarios, and have to pick the lesser of two evils. Stagflation reminds me of that. Quick, choose between slow growth and high inflation. Unlike when we were kids, however, you get to be stuck with both.

So, what does well during a period of Stagflation? Not much - but, you can at least protect (and gain somewhat) by changing your portfolio to reflect the times. Earnings will rise dramatically, so at first glance, things don't look that bad. However, when you strip out the rise in earnings that is directed attributed to inflation, the generic growth of companies slows to a halt, which does a nice job on P/E ratios. Consumer discretionary stocks normally take a beating, as people can barely afford to eat, heat their homes and put gas in the tank...

So, what might work? No one knows for sure, but here are some ideas:

Invest in what is going up

This one makes sense, but it is often overlooked. What does well during a time of Stagflation:

1. Interest rates. In order to combat the inflation spike, rates go up accordingly. One play on this is Treasury Inflation Protected Securities [TIPS]. These are tied to inflation, and provide a little bit more return than the inflation rate. You won't get rich, but you'll keep up your buying power. One way to play them is through Lehman's ETF (TIP).
2. Gold. In past bouts of hyper-inflation, Gold has been a great hedge. No one knows for sure if this will still be the case, but the odds are good. Two ways to play this are the commodity itself and its producers. The commodity takes out the risk of exploration and high costs of production, but also takes out any extra leverage. If you like to sleep at night, look at an ETF such as streetTracks Gold (GLD), which gives you a straight relationship to the price of bullion, minus a small management fee. If you like the extra leverage of a gold producer, now is not the time to look for a small fry - think big. Two great plays at Barrick (ABX) and Newmont (NEM). A third player (still large, but with a bit more of a growth pattern) is GoldCorp (GG).
3. Real Estate. Most homeowners will see a rise in home prices inline with inflation. So, if you own a home, you might be able to skip this part. If you don't, I'd look for a REIT ETF. Unless you follow the actual REITs themselves, this is an easier way to play it.
4. Oil Producers. The inflation is likely going to be directly related to the higher price of Crude. One way to play this is to own those who own the Oil. There are two types of companies that you can look at. Either way, think big cap here too. First, some of the State owned companies are listed on the various markets, and they tend to have a more consistent reserve base. Two to look at are Statoil (STO) and PetroBras (BZE). A third one, if it continues to come back to a more reasonable evaluation, is PetroChina (PTR). The second type of companies are the Publicly traded ones. Again, think big, but also think those who have a decent reserve life. I personally like Devon Energy (DVN) and Conoco-Philips (COP). Devon has a great growth profile, and just seem to know how to effectively and cheaply raise their reserves. COP is relatively average in performance, but always trades at rock bottom prices.
5. Oil Service companies. A more leveraged way to play the price of the crude. These stocks tend to swing at a much more leveraged rate to the price of Oil than Producers. There are three that stand-out in my mind. First, Schlumberger (SLB) has a dominant stance in this field. It is an expensive stock, so wait for a pull back. My value play is Baker Hughes (BHI), who does tend to disappoint investors once in a while, so be forewarned. Finally, my third play is to provide leverage to the increasing drilling happening off shore, and that is Transocean (RIG).
6. Companies that can easily raise prices. Here, you want to look for companies that have little trouble passing on costs. I tend to like companies with very strong presence/brands and those with an international scope (to better play the shrinking Greenback). Two that I like are Coca-Cola (KO) and Intel (INTC). Even if the cost of Coke were to double, it is unlikely that people would change their habits too much. Their strong distribution network also protects them from lower cost alternatives. As for Intel, their dominance in the growing Processor market is one that isn't likely to end soon. There is a large movement to push all of the world to a Digital Age, and Intel is a great way to play this. They will also benefit from a shrinking greenback.
7. Companies with a low P/E now. These companies, especially ones that are well financed, can often weather the storm well. One that comes to mind is Pfizer (PFE).
8. Areas that will benefit from what is causing the inflation. In this case, those who can help us kick the reliance on Oil. One easy play is General Electric (GE), with their strong stance in the Green space. The next two may shock you at first: Honda (HMC) and Toyota (TM). I mean, aren't they part of the problem? Yes, but people will still need to get around, even in booming oil times. These two companies are the leaders in low-energy cars, and this isn't likely to change (Sorry, Rick Wagoner!).

Areas to avoid (in no particular order):

* Auto (except Toyota and Honda)
* Airlines
* Transportation
* Travel
* Durable Goods / Consumer Discretionary


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