Wilkinson's
Edge
The Cutting Edge of
Financial Analysis
Dear MoneyNews Reader,
What should we make of the relative movements in the prices
of crude oil and copper?
The price of crude has fallen by around 28% since its July
14 peak at $78.40 per barrel. According to inventory data,
refiners were paying around $59 for the sticky black stuff
this week.
|
Oil falls
back down the well |
[Editor's Note: Andrew has picked up profits of 53%,
26%, and 17% on recent oil trades.
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now.]
Behind the slide has been a rise in inventories, which has
led to a reduction in refiners' capacity utilization. Fears
over a global slowdown haven't helped the oil bulls of late
either.
World crude oil demand has steadily increased from 82.5
million barrels per day in 2004 to 85 million in 2006. The
Energy Information Administration predicts demand will rise by
1.8% to 86.5 million barrels per day in 2007.
That rise comes despite an American economy growing at an
expected 2.4% next year after 3.3% growth in the last two
years.
The OPEC oil cartel recently agreed to cut global oil
output amongst members by 1.2 million barrels per day in order
to address the sliding price of crude oil. The threat of more
cuts is not preventing oil speculators from targeting $50 per
barrel. Traditionally output cuts have been hard to administer
by the cartel over its members.
It's hard to say just where the price of oil will bottom
out under these circumstances. We all saw the pick-up in
global demand and we all saw that refineries couldn't do much
about the lag in converting crude into refined products. No
one could stop China from growing.
Had it not been for a proactive Federal Reserve that was
willing to ratchet interest rates up from 1.00% to 4.25% in
the two years to June 2006, the situation might still be
tight.
While the economy is still making headway, the prospects
for 2007 are as yet unclear. Higher mortgage rates have slowed
demand for new homes and an inventory overhang is forcing
prices to correct downwards.
In short, it's too early to predict that the price of oil
will resurge in 2007 until the green shoots of recovery
emerge.
It would also be myopic to state that earnings at oil
companies will crater too. They will certainly face poor
year-over-year growth comparisons, but they will still be
raking in pretty big numbers. As I'll explain later, there is
one area that might reward investors who are prepared to risk
a weaker price of oil looking forward.
But first I want to turn to the price of copper. Used in
construction for electrical wiring and for air conditioning
piping, copper is a useful gauge for industrial and building
activity. Take a look at the recent decline in the price of a
pound of copper, which fell from just over $4.00 per pound to
exactly $3.00 per pound recently
|
Copper
decline: a headfake or not? |
[Editor's Note: One of Andrew's commodity trades
nearly tripled subscribers' wealth.
Go here
now.]
Last week copper rebounded on news of a small turnaround in
warehouse inventories. It was only a blip on the radar
following a daily inventory rise since the middle of October.
In the first eight months of the year, global usage of copper
expanded by 3%. Meanwhile an excess of 84,000 tons was mined
over and above demand according to a recent report from the
International Copper Study Group.
While demand cooled in the United States alongside the housing
market, it did too in China, where the country is developing
its own mines and smelting plants. Meanwhile copper demand is
growing in Europe and Asia.
News in London this week of a sharp rise in so-called
"cancelled warrants" sent copper prices higher amid
speculation that Asian and perhaps Chinese demand was set to
rally.
Cancelled warrants represent stockpiles booked and due for
future delivery. This week a 16% surge was the highest since
June 8 and represented 13% of the overall stockpile in
warehouses. Could this be the turnaround that copper bulls are
waiting for?
Moreover the rise in cancelled warrants occurred at LME
registered warehouses closest to China, in South Korea and
Singapore. That could turn out to be a bullish factor for the
commodity.
During the week the world's largest mining merger was
announced as Freeport McMoran and Phelps Dodge got together in
a marriage that will cost $25.9 billion.
Dennis Gartman, the celebrated market commentator noted that
with copper at $3.00 per pound, this deal makes no sense when
it could have taken place several years ago when copper prices
were less than a buck a pound. He makes a solid point, yet
prices are 25% off their 2006 high too.
With the prices of both oil and copper perhaps in a state of
flux and waiting signs of growth before rallying sometime in
2007, where do investors turn to park there money?
Take a look at some Canadian royalty trusts. These oil
producing companies are structured to avoid paying tax, which
means that they have to pay out regular dividends from cash
generated by producing oil from dilapidating oil fields.
On October 31 the Canadian government announced that they
would start to tax these funds because they were missing out
on taxes since too many companies chose to incorporate
specifically to avoid payment, changing the landscape for
these funds.
|
Canadian
Royalty Trusts slide! |
[Editor's Note: Andrew just recommended a new energy
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Go here now.]
When you buy shares in these oil royalty trusts, you're at
risk of capital loss despite the dividend. Some investors in
Canadian major Enerplus Resources Fund (Ticker: ERF) learned
that the hard way in November.
Shares slumped in the wake of the announcement from Canada's
minister in charge of raising oil-related taxes. An investor
who had bought shares in the fund the day before the
unexpected announcement, bathing in the beauty of the 10%
annualized dividend handout saw a two-day, 22.3% loss of
capital. Shares continued to fall until last week before
turning around.
But is the Canadian government's decision all that bad? They
announced a tax on new income trusts starting in 2007, while
existing trusts received a stay of execution until 2011.
Is this merely a storm in a teacup? Perhaps the whole affair
requires more research, but still the share price declines
sent yields on these funds back higher and made already
attractive shares more appealing.
While the price of oil is under pressure and I have no idea
for precisely how long, I can't help but feel that this
dividend-rich play is the way to go. Enerplus is merely one
company involved in the business. Others worth looking at are
Penn West Energy Trust with a yield of 11.4% and Arc Energy
Trust, which yields 10.9%.
Have a great weekend!
Andrew Wilkinson
Senior Newsletter Editor
P.S. Triple Edge Alert, my options service, aims to
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