We’ve all woken up to rampant panic in the markets this morning. If you hadn’t read any headlines yet, you might think this was down to some dramatic mutation in coronavirus. But today’s panic is only tangentially linked to the bug.
Today we’re panicking about an epic plunge in the price of oil.
Saudi Arabia and Russia declare an oil war
When markets opened this morning, the price of Brent crude – the European benchmark price for oil – dived by nearly a third, to as low as below $32 a barrel.
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I know that you probably don’t follow the oil market quite as closely as the stockmarket, so for the avoidance of any confusion – that is extraordinary. We haven’t seen the oil price crash this hard since 1991.
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That was the start of the first Gulf War, arguably the last war in the Middle East that everyone broadly understood and largely felt was justified. Iraq under Saddam Hussein invaded Kuwait, and America pushed back.
Why did oil prices crash, given that a war could presumably only hinder supply? Because the US opened up its strategic reserve and effectively flooded the market. And something similar has happened this time around.
Oil prices have been hit by fears over global recession, induced by the coronavirus. Hence, the bug has brought the tensions in the oil market to a boil. Saudi Arabia-led oil cartel Opec and Russia – the biggest non-Opec oil producer – have been tentatively co-operating to keep the oil price from collapsing under the weight of US shale production.
They had been expected to announce further production cuts at the end of last week in order to keep the price from succumbing to coronavirus. That didn’t happen. Instead, to cut a long story short, Saudi Arabia and Russia fell out.
On Friday, Opec talks broke down. And over the weekend, Saudi Arabia slashed prices to its customers and said it would ramp up production. Russia similarly unleashed its own oil producers.
What’s the point? Mostly, to flood the market, steal market share from each other, and kill off US shale production where at all possible. There’s also the added bonus (for oil producers) of pushing back on the rush to electric cars by making petrol an awful lot cheaper.
There’s an added, slightly esoteric geopolitical twist in that oil is one of the key underpinnings of the current global monetary regime. Russia in particular would like to undermine the role of the US dollar as the global reserve currency, and crashing the oil price helps in that goal. (We’ll talk about this a bit further down).
The secret to making money in a crash is to have money when no one else has
Anyway, it’s causing havoc in markets right now.
At the time of writing, shares in the UK have tanked to below 6,000 on the FTSE 100. US shares look set for similar falls. That official bear market – the 20%-plus correction that hasn’t happened to the S&P 500 since 2009 – is about to land.
I’m going to sound like a stuck record here, but the worst thing to do today is to panic. Sit tight. Or if you have been preparing a watchlist of things you’d like to buy, it might be a good time to get it out.
If you must look at your portfolio, try to do it with some objectivity. It’s going to look ugly. But don’t make hasty decisions.
For example, do I think that BP should be down 25% this morning? I don’t know. But while I’m not hitting the “buy” button right now, I certainly wouldn’t feel confident about selling at this level. Is this really more of an existential threat to BP than the Gulf of Mexico disaster was in 2010? Not convinced.
What you probably do need to be aware of as an individual investor is that big moves like this tend to break things. Elaborate or illiquid things tend to blow up as levels that no one ever expected to be breached, are breached. If you have money in funds or ETFs that you don’t really understand, today might end up being a learning experience.
I’m also keenly aware that – as we’ve noted a few times recently – the corporate debt market is overstretched. And the most overstretched sector in that market is the energy sector. In 2015, there was a panic over energy junk bonds. In the absence of some sort of intervention (which I wouldn’t put past the US government), we could see a blow-up in that area.
The other point is that when fragile things break, other things – even “anti-fragile” ones, to use Nassim Taleb’s term – suffer the knock-on effect. Sometimes this can prove to be a buying opportunity. There are few things better than being someone with ready cash available in a market stuffed full of forced sellers.
That – fundamentally – is Warren Buffett’s secret. He’s always got money when everyone else needs it. Hopefully you do too.
On a wider basis, a steep fall in the oil price is not necessarily a bad thing.
It’s good for airlines, who’ll get much lower fuel bills (depending on their hedging strategies), although at this point that’s a bit like chucking a sticking plaster to someone who just tangled with the business end of a combine harvester.
It’s good for consumers. They don’t feel like spending right now, so any sign of an improvement in the coronavirus spread might change that, although not for a while.
And the deflationary collapse in bond yields means that interest rates aren’t going anywhere for now. For the first time ever today, UK bond yields have turned negative. That’s right, people are willing to pay our government to lend it money. That’s the same government that’s on the brink of a serious spending splurge.
If nothing else, that’s going to keep mortgage costs down.
So if you can be patient and hold your nerve, you should be more capable of spotting where the market is pricing in too much disaster. It does feel like this is one of those days.
The days of the US dollar standard are numbered
At a deeper level, I entirely agree with Bloomberg’s John Authers when he writes this morning that “the world has at last arrived at a point that it appeared to have reached a decade ago. Some new financial order, to replace Bretton Woods and the system that [Paul] Volcker built to replace it, is now needed.”
I’ll discuss this in more detail at some point, but since 1971, when Richard Nixon severed the dollar’s link to gold, the world has effectively been on some form of “dollar” standard. Oil has played a big role in the mechanics of that, as has faith in central banks.
Shale production and effective US energy independence has upset that apple cart in ways that no one fully understands. And faith in central banks has been eroding since the global financial crisis. This might be the point where all of that comes to a head.
Again, I know I keep saying this, but this is why we own gold in our portfolios. It won’t go up every day and it might even crash in this environment (when you need liquidity to meet margin calls, you sell your most liquid assets – that’s when money moves from “weak hands” to “strong hands”). And if everyone decides that today is a climactic panic – doesn’t feel like it this morning, but you never know – gold will succumb in any return to “risk on”.
But gold has a longer record than any other asset of being at or near the core of the financial system. So if that system is going through a generational shift, then it’s a good idea to own some.
And subscribe to MoneyWeek magazine if you don’t already. I like to think that we might help you to stay on the straight and narrow through all of this. Get your first 12 issues for a measly £12 here.
