Gregor Macdonald

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Promising Investments as the Race for BTUs Heats Up

Hopefully readers will not be too shocked by my openhandedness towards a cyclical global expansion — restrained by oil for sure, but made possible by several years of continued reflationary monetary policy and the ability of humans to tactically access new sources of energy.

Let’s remember that a tremendous amount of pain, in industrial terms, has already been taken by the OECD over the past 7 years as it shed nearly 15% of its oil demand. Readers will also recall my previous essays, in which I warned that an export boom was continuing to unfold in the United States. And readers of my work over the past several years know I’ve been adamant that the 5 billion people in the developing world have plowed right through the 2008 financial crisis increasing their reliance on coal.

Thus, I identify three areas of investment as the world stumbles forward with poor growth in the OECD, restrained by oil but becoming increasingly desperate to find some — any — additional energy resources. These are not stock recommendations, nor am I making a timing call as to when to invest in these areas. Rather, these are indicative of three means by which an investor could participate in emerging, secular trends over the next 2 to 4 years.

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: Get Ready for Oil Price Volatility to Kill the ‘Recovery’

To the extent that the US economy has been redefined as the health of its corporations, rather than the health of its people, it makes sense that many may hold the view that oil prices have an “unclear” effect on the economy.

To be sure, if your corporation is sited in the US and your labor force is manufacturing goods in Asia — which runs on coal — then at least for a while, a shield from rising oil prices can be sustained. However, the 2 mbd taken offline from US consumption and the 1.0 mbd taken offline in Europe over the past seven years have removed about as much discretionary demand as possible. From this juncture, the next layer of demand to be removed will directly impact the industrial economy, especially through its transport and logistics systems.

As we came out of the September 2011 lows in global stock markets and oil once again regained the $90 level, I began to watch the Dow Jones Transportation Index (TRAN) for signs of recovery or recession. As many of you understand, I have been a long-time advocate of rail transport for its outsized advantages compared to trucking and automobile transport, owing to its incredible energy efficiency. And the railroads have indeed thrived in the first stage of Peak Oil, taking share away from trucking.

However, despite strength in the TRAN, largely owing to the representation of railroads, there is still a large portion of the global economy running on airlines, trucking, logistics, and delivery services. Companies like FedEx and UPS use a lot of oil and cannot escape their reliance on it in their mission to connect the world globally through door-to-door services. Equally, it is not just consumer-related demand that drives the global delivery companies. World industry uses FedEx and UPS to ship critical parts throughout the global supply chain.

Here is a chart of the components of the Dow Jones Transportation Index (TRAN).

As you can see, while railroads compose 29% of the TRAN, airlines, delivery services, trucking, and other truck and transport services compose 44% of the index.

Now, as I said, I have been waiting to see how durable the recovery in the TRAN would be once we started hitting the wall of higher oil prices. Using the iShare ETF which represents the TRAN, symbol IYT (NYSE), I have noticed the following turn in the chart:

Some of you may be familiar with Dow Theory, which holds that the Transportation Index (TRAN) needs to continually confirm new highs in the broader Jones Industrial Average (INDU) to maintain the prospect for even higher stock prices on the back of a healthy economy. I don’t wish to invoke that particular theory here, as that would over-complicate my analysis and force a digression into the flaws of using the broader Dow Jones Industrial Average (INDU) as a tell on the economy.

Instead, I want to keep it simple: Reflationary policy can keep economies from collapsing, push up the prices of stocks, and ensure that some moderate consumption flows into demand for goods.

But reflationary policy cannot rescue the most energy-sensitive sectors of the economy. As Bernanke himself said: “The Fed cannot create more oil.” Accordingly, what I find in the above chart of the TRAN is that investors are losing confidence that global logistics can keep expanding, now that WTIC oil has been pressing up against $110 and Brent is trading near $125.