I’m a long term bull on oil, and consider $70-75 as pretty much the lower bound on prices, coupled with frequent and ultimately sustained price spikes above $100. I see WTI at $98.99 right now, and it looks like it’s finally ready for another $100 break. This will probably further narrow the current $15.17 Brent-WTI spread. You know, I generally believe in the mean reversion of historical spreads and correlations, but the mind boggles at the history of this spread! For 10 years the spread averaged zero, with about +/- $5 of noise, and then it exploded in 2011! I shudder to think how much money has been lost playing against this spread – a real lesson in risk control – I’m convinced we’ll see the spread back to zero, but if you were in a trade like this would you bail out when the spread blew through, say, a $10 stop loss to avoid further pain, or grit your teeth and attempt to remain solvent through a $27+ peak?
A particular reason I’m a bull is the fact that we continue to see uninhibited daily oil consumption (89.2 mio barrels per day in 2011) and $100+ price levels despite the continuing economic ‘crunch’ conditions in the US, Europe and Japan. Doesn’t bode well for prices when (if?) we see the next economic boom… Perhaps a good thing in the end, unfortunately – with government finances now constrained, they just can’t afford alternative energy subsidies (as solar investors have concluded, see the 90% decline in the Guggenheim Solar ETF (TAN:US) – hmm, what can investors expect when they chose TAN as a ticker?!), so the only way oil sands and alternative energy sources are ever going to be meaningfully developed (to properly substitute for oil) in the long term is if they’re supported by sustained higher oil prices.
I’ll talk about oil companies and Russia another day, but now I want to talk about an alternative investment thesis to exploit my bullishness in oil (see my ABOUT section for some further insight into the development of my investment approach). The obvious beneficiary of higher oil prices, ever since the 1970s, is of course the Middle East, particularly Saudi Arabia. This means more and more wealth is being accumulated in the hands of Islamic governments, companies and investors. I explored this further, and considered investing in the Qatar Investment Fund (QIF:LN), Investcorp (INVCORP:BI), and/or some of the available MENA/frontier market investment funds/ETFs, but I wasn’t particularly excited/comfortable with the risk or exposure. It then occurred to me that Islamic finance was really the global ‘conduit’ for much of this oil wealth, and that was much more exciting – particularly as it also offered exposure to other fast growing nations/regions such as Indonesia, Malaysia, the Central Asian republics and North Africa.
What puzzled me, however, was the fact that Islamic finance in the Middle East has developed hand in hand with the accumulation of OPEC wealth since the 70s, but still seemed to be vastly under-represented in London, New York etc. Over two thirds of Islamic finance business is still originated in the Middle East. Considering rich Middle Eastern interest in, say, London property, casinos, department stores and posh knocking shops, surely they’d be keen to have ‘their man in London’ also?! I enjoy reading old finance books (inc. ‘The Money Lenders’, and ‘Paper Money’ which I’d particularly recommend if you can get hold of a copy: Adam Smith is a very entertaining writer, and this book is eerily apt for 2011 despite being published 30 years ago), and virtually every book harps on about recycling petrodollars – a financial markets phenomenon in the 70/80s, and still going strong – surely banks and investment managers are now ready to offer something a little more sophisticated to Islamic investors? The more I thought about it, the more it made sense – even if this trend ultimately proved a bust, financial institutions, like nature, abhor a vacuum: if they see an opportunity they will (eventually) rush in…something to exploit in the meantime.
Despite the somewhat limited development to date, it looks like the UK is set to grab this territory – it’s the only Western country among the global top 15 for Sharia’a compliant assets, ranking ninth, according to industry group International Financial Services London. The UK government has even contemplated issuing a sukuk bond. By comparison, Islamic banks in the US are generally small and focused on domestic/retail business. London is also far ahead in training for the industry. The Islamic Finance Qualification offered by its Securities and Investment Institute is recognized around the world and the Chartered Institute of Management Accountants’ Certificate in Islamic finance is the first offered by a professional chartered accountancy body.
Alas, most Western-based Islamic finance businesses are either unlisted or buried within the larger banks and asset managers, so investment opportunities seemed pretty limited. Of course, the other problem is that even when I find a good opportunity or two, their stocks are often horribly mispriced from a value perspective – but in this instance, I discovered the perfect safe and cheap stock to exploit my investment thesis! It’s now my second largest portfolio holding at 5.9% – I look forward to writing about this stock and its valuation in one of my next posts…