December 06, 2007 11:06 AM EST
As Chief Investment Strategist for Oppenheimer & Company, Michael (Mike) Metz is paid to think big about the investment universe. In this role, he has developed a reputation for incisive analysis of the commodities space. He spoke recently with the editors of HardAssetsInvestor.com about oil, gold and the outlook for commodity prices.
HardAssetsInvestor.com: The big topic on everyone's mind these days is oil. Is the current run-up in energy prices driven by speculation, or are there real fundamental reasons behind it?
Michael Metz (Metz): I think the last run-up was probably more speculation than a matter of excess demand over supply. I think that $10-$15 per barrel of the overall price of oil reflects speculation and market momentum.
HardAssetsInvestor.com: Does that take away from the long-term picture for oil?
Metz: No. Long term, I'm very bullish on oil - for a number of reasons that many people have overlooked.
First, non-OPEC production has peaked. In fact, it's declining.
Second, spare capacity in world production is something like 3 million barrels a day. Meanwhile, we consume something like 85 million barrels a day. So there's very little spare capacity, and almost all of it is in the hands of Saudis, which means the Saudis basically control the market. It's not as if there are a lot of producers that could turn on the spigots and push prices down if they wanted to grab market share. As a result, I believe that prices have a very strong bid underneath the market.
Also, people overlook the fact that 25% of world production is in the hands of Russia and Saudi Arabia combined. Russia's not a part of OPEC, but certainly, the Russians will collude with the Saudis to prevent prices from going down.
When you have so much production concentrated in two producers and so little spare capacity worldwide, that creates a situation where there is very little downside risk in oil. I don't think oil goes back down to $50, $60 or even $70 per barrel. What's the floor price? I don't know. But I think that oil has a very strong floor not far from where we are today.
HardAssetsInvestor.com: One thing that has always kept OPEC in line is their worries that especially high prices would slow down the global economy. But that doesn't seem to be happening, does it?
Metz: No it doesn't. If oil prices fell significantly it would help the economy. But so far, high prices have not been a major drag on economic growth. Remember, the OPEC countries are getting addicted to very high oil prices; they're spending the money like it's going out of style and enjoying it. And as long as the Western economy doesn't collapse, they are happy.
HardAssetsInvestor.com: Speaking of collapse, is there further risk to the dollar if countries like Saudi Arabia diversify away from it?
Metz: Saudi Arabia would be the biggest loser next to China if the dollar were to fall more, so I don't think they would take major steps in that direction. Also, at the moment, there's really no alternative as a reserve currency.
Frankly, I think the dollar is going to hit bottom in the first quarter of next year as the trade imbalance turns up, imports slow down and the consumer slows down in America. I think we're just about at the last phase of the dollar bear market.
HardAssetsInvestor.com: That's a positive for the dollar, but it paints a bearish picture for the U.S. economy. What do you think about the U.S.' prospects?
Metz: I'm extremely ... what's the euphemism? ... cautious. I think we'll enter a recession that lasts at least a year, maybe two years.
HardAssetsInvestor.com: How bad do you think the housing markets will get? Have we hit bottom there?
Metz: I've seen no signs of a bottom. I think it's got much more to go, both in time and price.
HardAssetsInvestor.com: Will there be contagion to the rest of the world, and particularly to China?
Metz: No, I think the real contagion is to the U.K. and Spain, which have the same bubble. I think China is OK. There will be some slowdown in growth but I still think it's the most dynamic economy in the world.
HardAssetsInvestor.com: Turning back to energy, how should investors approach the energy markets?
Metz: You've got to discriminate among the different sectors of energy. For example, I'm not crazy about the integrated oils like Exxon, which is frankly running out of oil. On the other hand, I think the big North American exploration and development companies are a great store value. These companies don't reflect $90/barrel oil or even $60/barrel oil. And to me, they are the way to play the oil boom. If oil goes down, I don't think they get badly hit. And eventually, I think they will all be absorbed by the big integrated oils.
HardAssetsInvestor.com: What kind of companies are you talking about?
Metz: I'm talking about companies that I own myself, like Anadarko, Chesapeake, Devon, and Apache. I'd also buy the Canadian oil trusts.
HardAssetsInvestor.com: What about natural gas? The pricing there has been erratic.
Metz: Natural gas pricing is local in a sense, but to me, it's a very attractive commodity. I think relative to oil it's cheap, and while there are all kinds of risks (weather, etc.), at this level, I think it's a buy.
HAI: What do you think about the prospects for alternative energy sources?
Metz: They're not significant yet. Things like wind power are long-term projects. Also, I think this whole biofuel business is ridiculous. It's not economically sound and I don't think it ever becomes a major factor.
HardAssetsInvestor.com: What about nuclear?
Metz: When was the last time we had a nuclear facility in the U.S.? Thirty years ago? The French are very advanced on nuclear projects, but in the U.S., there's too much political antagonism towards the idea.
HardAssetsInvestor.com: In the past, you've been very bullish on agriculture. Does that position still hold?
Metz: Yes, for a couple of reasons. First of all, affluence in the world increases the demand for animal protein. And to create animal protein, you have to have a large input of grain, so that increases the demand for grains. Meanwhile, world carryover stocks are about the lowest I think in history. You've also had extraordinarily erratic weather patterns, and there's no indication that's going to end. Finally, you have a degradation of a lot of agrarian areas in the world. So I think that, long term, we face a strong bull market in agricultural commodities.
HardAssetsInvestor.com: What about gold? It's had one of the most impressive runs of any commodity. Is there still room to run?
Metz: I'm very bullish on gold and I have been for quite a while. There are a number of factors. First, world production has peaked. Secondly, it's getting increasingly expensive for miners to produce gold, so that underpins the market. Next, I think you're going to see a slowdown in gold bullion liquidation by Western central banks, and accelerated accumulation by the central banks of developing nations like Russia and China. Last but not least, you have the current great transfer of wealth in the world to the developing nations. They, unlike us, use gold as a store value.
Meanwhile, currencies are extraordinarily volatile, highly uncertain and no longer represent a safe store value, whether you're talking the euro, the dollar, the yen or any of them. So I think gold is only midway in the huge bull market.
HardAssetsInvestor.com: Does that extend to other precious metals like platinum and silver?
Metz: I think they sort of follow in tandem, but to me gold is the monetary metal. It drags the others up.
HardAssetsInvestor.com: What other big-picture themes are playing out in the commodities market?
Metz: One point I would make, which is remarkable about this cycle, is that the big mining companies really have not been very aggressive in trying to develop new sources of metals. What they've done instead is use their under-leveraged balance sheets to buy other companies, like BHP trying to buy Rio Tinto. When they merge, it will not create one incremental pound of new capacity to produce anything. What it will mean is the final company will be so leveraged that it won't be able to go off and develop new mines. So to me, this staves off the period in the cycle when you would typically see overinvesting in new capacity, which could extend the cycle for a number of years.
HardAssetsInvestor.com: So are we in second inning or the eighth inning of the commodities boom?
Metz: I'd say it's the fourth inning.
HardAssetsInvestor.com: Thanks, Mike, for your time.
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