HardAssetsInvestor

Written by Julian Murdoch  |

August 04, 2008

A Tale Of Two Industries

Details

With Exxon reporting record profits, and GM posting record losses, how will the political climate change?

• The drive for redistribution
• The drilling debate
• A pairs-trade hypothetical

It's been a rough few weeks to be a stock investor - especially if you don't like volatility. On Friday, GM posted a horrific quarter, posting a $15.5 billion loss. Its stock lost 10% in market value, and is now trading at a 54-year low. Meanwhile Ford announced that sales had plummeted 15% in one month (July). The biggest victim (if there were any doubt) were SUVs, with a 26% drop in sales that gas-guzzling vehicle and pickup trucks.

Even Toyota, one of the best-positioned companies with the strongest presence in the hybrid market, posted a 12% drop in sales. In Toyota's case, the drop can be accounted for almost entirely by SUVs and pickup trucks, with car sales flat. And Toyota still can't make enough Priuses to satisfy the market. It's the Nintendo Wii of cars.

Now let's look at the other side of the profit spectrum. Exxon just reported its best quarter ever, with $11.68 billion in profit. A naive (read, political) interpretation of these two news items would be that some kind of transfer of wealth had happened - high oil prices mean big money for big oil, and layoffs and doom for Detroit.

As noncausal as these two events actually are, there's a certain intellectual purity to the argument - in every commodities story there is a winner and a loser. Higher commodity prices nearly always benefit the producer at the expense of the consumer, and in this case, the consumer's enabler: the car maker.

It's inevitable that these kinds of numbers stir up a kettle of hate. As expected, there's been a barrage of calls for windfall taxes, and some minimal defense of fundamental capitalism. Perhaps more troubling is the consumer sentiment problem. With major news outlets running nonsarcastic headlines like "Should the Oil Industry Make a Profit?" the specter of radical change is out there. Now, I don't honestly think we're in any danger of a nationalized oil industry. After all, companies like Exxon and Mobil are hardly "U.S." companies in any meaningful sense of the word; they're global. But increased scrutiny will put pressure on big oil to explain itself - like a petulant child caught with its hands in cookie jars.

Production Is King 

That scrutiny will inevitably focus most sharply on production. Exxon reported that global production was down 8%; most of that from strikes in Nigeria, but down exogenously a few percent as well. One would hope - indeed expect - that the combination of free cash and record high net sales would result in increased exploration and production, which hasn't really happened. Of course, tossing a windfall tax on Exxon and its ilk won't actually do anything to stimulate exploration; if anything, it will suppress exploration over the long term by lowering the marginal return for each dollar invested in getting new oil.

The best case scenario, oddly, might be continued high oil prices. It's only feeling the pain that will spark increased investment not only in exploration, but in alternative energy sources. Of course, in the current political environment, that's not a tenable position. Neither candidate will sing the praises of high oil prices. Neither will come out and defend big oil and tell Detroit to suck it up. If anything, the pressure will be to do exactly the opposite - come to the rescue of the U.S. automotive industry at the expense of big oil. In other words, to effect a classic corporate redistribution of wealth.

That's got us thinking about a possible pairs trade. Going long the beaten-down Autos and short the high-flying Oils might seem to be playing everything in the wrong direction, but that's often the place where the biggest money can be made. Heading into the election, there will be tremendous pressure to help one at the expense of the other, and that could show up in the vectors of the two groups.

If you don't want to (or can't) go short with individual stocks, you can get short oil and gas with the ProShares Short Oil & Gas fund (DDG). You're going to have to get your auto exposure one at a time though - there's no automotive ETF yet.

Of course, that's not a recommendation to make that trade - just an example of the kind of thinking that's worth considering as we move into the political season.

As always, caveat emptor.