Top stocks to invest in – Peter Zeihan: The Geopolitics of a Fragmenting World

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The United States has experienced an upsurge of populist rage against the political establishment and knowledge elites which could compel it to step back from the global stage, just as the Brexit vote forces the United Kingdom to withdraw from the European project of ever-closer regional union.

Boxed in by its troubling economic metrics, demographics, and politics, a United States in relative decline compared to China and India could be about to partake in the greatest geopolitical transformation in at least the past three generations.

Policy strategist Peter Zeihan anticipated both the outcome of the Brexit referendum as well as the election of Donald J. Trump as the next president of the United States. He spoke at CFA Institute 69th Annual Conference about how the US need for oil has greatly diminished, and its goals in the Middle East have changed.

The United States now views the world wholly in relation to its own interests, according to Zeihan. Global and local demographics, new players in the area, and an intensifying contest for dominance between Iran and Saudi Arabia contribute to continuing instability in the Middle East. A global energy crisis could soon draw many countries into the region, and a simultaneous political crisis could erode state authorities there, unleashing a new wave of violence and terrorism.

Zeihan touched on these themes in the question-and-answer session (reproduced below) which followed his presentation.

A full version of his entire presentation is available in the CFA Institute Conference Proceedings Quarterly.

Audience Member: What does the new order mean for the price of oil?

Peter Zeihan: In the short term, until the Russian conflict or the Saudi–Iranian conflict gets going, we’re looking at an absolute ceiling on prices. One of the funny things that’s going on in oil shares is that the price structure has dropped so much that there really is a functional ceiling right now, probably about $50.

That ceiling will continue to drop as shale techs continue to improve, with shale production displacing higher-cost production in such places as Canada, the “nodding donkey” fields in western Texas, and California.

So, output is relatively steady. It has even risen a bit. It’s not falling. And as long as those geopolitical shocks don’t occur, prices should not rise anytime soon.

As soon as those shocks happen, everything changes. If a break occurs in the global market, the populist government of the United States, whether it’s Clinton or Trump, will most likely immediately slap on an oil export ban to protect US voters from high prices. So, prices might be high and erratic globally but relatively low and stable in North America.

How can investors profit from that situation? They can’t on the production side. But take a look at chemicals and refining.

One of the side aspects of the shale revolution is that natural gas in the United States is, in essence, free. Methane, ethane, and liquefied petroleum gases are eating into the feedstock that has normally dominated the chemical industry. US refiners and petrochemical industries are expanding massively because the costs in North America are minimal and the product can be sold on the international market for a hefty profit.

In short, a complete bifurcation in the oil and gas market will occur. In Anglo-America, prices will have a ceiling of $60–$70 per barrel. Everywhere else, the floor will be about $150. For producing countries that enjoy Western hemispheric security, such as Venezuela, this bifurcation will be a wonderful opportunity; investment will not go to Venezuela when prices are $50, but it will go there when the price is $150.

Can the huge flow of refugees into Turkey and Europe — Germany, in particular — actually come to the rescue of Europe’s demographic problem?

The short answer is no because the wrong people are leaving. About 80% of the flow of Syrian refugees are men aged 15–25 who don’t have technical skills and don’t speak the European languages, so they are looking for low, baseline work. All of the Syrians who had the skills that were marketable left three years ago, and they didn’t go to Germany or Turkey — they went to France, the United Kingdom, Canada, and the United States. And they’re not going home.

Europe needs skilled labor, and the big problem with global emigration in the new era is that the cream of the crop—the skilled laborers who have a suitcase of cash or a degree — are going only to the countries that are economically stable, not necessarily the ones that are demographically hurting.

Do the recent Iranian election results suggest some long‑term reform in terms of the next supreme leader? What effect does that have on the Islamic Revolutionary Guard Corps (IRGC)? How does it react? How does that change the picture, and how does Israel fit into these changes?

Let’s start with Israel because the question is pretty simple. Israel’s problem is that it won. Every conflict that it’s been involved in that was strategic, it’s won. Now, every country that borders Israel — Lebanon, Syria, Jordan, and Egypt — is either a failed state or militarily incapable of posing a threat.

Now, beyond those countries is another belt of states that are potentially threats, and Israel would certainly appreciate it if the United States would fight those wars for it. The United States has no interest in doing so, but Israel will be fine. In fact, it has already replaced the United States with another ally, Saudi Arabia. It is a nice little deal: Israel is providing military assistance to Saudi Arabia to teach Saudi Arabia how to use its own weaponry (almost all of it is from the United States). If push comes to shove, Israel will be getting Saudi oil.

Iran’s situation is more complicated. Assume for the moment that everything goes in the liberal direction and that everything in Iran is built around the reform process. In that case, we will see in about five years the first meaningful development in Iran of a consumer market on an industrial base. But Saudi Arabia’s price war will destroy its finances long before that. Had liberalization happened 5 or 10 years ago, Iran would have recovered. Now, it’s simply too late in the game.

The IRGC has no problem killing a lot of people to get its way, so I’m not convinced that this reform process is going to go as well as people hope.

What economic or political benefits does Saudi Arabia expect to get by destroying Iran economically? Can’t Iran and Saudi Arabia develop into a peaceable area, as happened in Ireland?

The economic development plan that Saudi Arabia is putting into place is honest and real, but it will not bear its first fruit in the next 15 years because the first thing it has to do is bring in experts to train the local population. Therefore, Saudi Arabia’s goal is to destroy Iran as a functional economy. Otherwise, after a conflict, Iran could be left as the predominant energy player in a newly volatile world with double energy prices (triple energy prices from where it is right now).

The cultural aspect of the Saudi economic plan alone is a decades-long process. It has potential — Saudi Arabia is certainly going to splash a lot of cash on this program — but the initial output is going to be a long time coming.

As for the Ireland comparison, the reason Ireland was able to pull itself into the modern world is that it served as a bridge, or lily pad, between US investors and the eurozone market, using England as the logical linchpin. For demographic, financial, political, and geopolitical reasons, European stability is breaking down.

Brexit has brought this crisis from the theoretical and future to the actual and present. Ireland now has to figure out how to succeed without foreign investment or trade or European financial assistance. The only way the country has ever done this successfully in the past is encouraging half of its population to leave. Unless Ireland can develop an entirely new model within the next three years, its future is going to look a lot more like its past.

How would a pipeline to Canada’s east or west coasts affect the tanker war you were discussing?

No pipeline is going through British Columbia because the province has basically said, “We’ll take half of revenues” — not half of profits, half of revenues. That deal is already dead.

As for an east coast pipeline, assume for the moment that all of the provinces that have to be crossed ultimately come to a deal: That’s a five‑year construction project. So, Alberta does not have meaningful alternatives for getting the crude to market that don’t involve the United States. Albertan crude oil is heavy and sour. Shale crude oil is light and sweet. The goal was to mix the two in refineries in the center of the United States, where most of the shale output is, creating a medium sour blend that all US refineries could use.

But it’s too late. The US refineries have given up on that deal, and they are retooling their refineries to work with the light, sweet shale crude.

That’s the first problem for Alberta, that their core market has now been destroyed. Problem two for Alberta is that it’s the only province in Canada with a US‑style demographic, with Gen Y-ers.

Problem three for Alberta is that it’s the only province that is paying into the federal budget now. Everybody else is a recipient.

Problem four is that the Canadian government, led by Prime Minister Justin Trudeau, has now announced its budget for the next three years, and it calls for enough financial transfers from Alberta to the center to impose a Greek‑style depression on Alberta — even assuming the energy price recovers, which it probably won’t.

Problem five, which is more Canadian than Albertan, is that secession is legal. Alberta could secede and join the United States.

We’re now in a situation in which Canada can’t enjoy its standard of living without Alberta and Alberta can’t enjoy its standard of living as long as it’s in Canada. Anywhere else in the world, firearms would already be in action.

Could advances in renewable energy technology change things?

Such advances could actually speed the changes up. The only developed country that’s relatively close to the equator is the United States, which means that the only developed country that could impose solar en masse is the United States. People talk about lithium batteries being able to maybe square the circle on the intermittency issue with solar, but you just can’t get by the fact that the United States gets 12 times the solar radiation of Germany.

Even if lithium lives up to its hype (and I’d not bet on success there), it really only helps the United States because the United States would only need storage that works for three to six hours, whereas Germany needs to store it for three to six months. That sort of technological breakthrough is not even being considered right now. The United States could actually achieve a greater level of independence in a decade than is possible for Japan, South Korea, Canada, or Europe.

The video and additional analysis of this presentation is available in the Conference Collections section of Enterprising Investor, where CFA Institute members can receive continuing education (CE) credit.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: CFA Institute

Mark Harrison, CFA

Mark Harrison, CFA, is director of publications at CFA Institute, where he contributes to a suite of publications that includes the Financial Analysts Journal, CFA Digest, and Conference Proceedings Quarterly. He has more than 12 years of investment experience as a portfolio manager and securities analyst. As investment manager of the West Midlands Pension Fund, part of the UK local government pension fund, Harrison managed a portfolio of European equities and had oversight of external managers and hedge fund selection. He is also the author of The Empowered Investor and holds the ASIP designation. Harrison holds BA and MA degrees from the University of Oxford.

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