Long-term Investing In Energy Equities
TWST: Before we get into the details of your fund, please tell us why you believe right now is a good time to be investing in energy.
Mr. Guinness: To answer the question properly, I think there are three scenarios you have to consider. We first have to say: How will energy shares fare in a double-dip recession scenario? Here, there are the following important things to say: There are two unique commodity features about energy markets that give energy equities value-protection characteristics. The first is that the OPEC and Russia monopoly capability to create a floor under $80 oil is a very valuable and too-little-commented-on protection for investors. The second is the extreme cheapness of U.S. natural gas, where in particular we think that the U.S. natural gas price now at $4 is right on its back. In the short run this has happened because of a supply shock - the very interesting breakthroughs in horizontal drilling and fracking that are allowing gas shales to be developed. This has short-term unbalanced supply and demand, but we are absolutely convinced that fundamentally the marginal cost of the marginal cubic foot of gas, 1,000 cubic feet of gas, is actually well above $4. In fact, it's nearly $6. The floor under oil and cheap gas are two important deriskers for energy investors.
Then there is another double-dip recession positive for energy equities, which is that they give a good exposure to what's going on in emerging economies. Really emerging economies - China, India, Africa and Latin America, the resource-rich countries - are driving energy demand and many energy companies' businesses are driven by this. Emerging economies reach a tipping point when incomes get to $3,000 per head. What's happening there is a lot more important than what's happening in the troubled, developed world. So that's the double-dip recession scenario. It means that this chunk of any equity portfolio has, in our view, got good downside protection. By the way, it doesn't mean that they won't dip off in value, but these characteristics will of course then recover quickly from any market weakness.
Then we come on to the next scenario, if we get not a double-dip recession, but a continued slow recovery. I should say that this is, in my own view, what we're most likely going to see unfold. I believe that the recent pessimism fever that has caught hold among a lot of the investors - and indeed, other commentators and politicians - is very much overdone. I think that the business cycle forces that exist, let's say in the U.S, will be the engine for this. By which I mean that eventually housing starts, which are really on their bank languishing now, will start to recover. They always do. And then eventually, vehicle sales will pick up from their pretty anemic 12 million cars a year and go back to a more normal 16 million.
The consumer, meanwhile, has already rebalanced his spending. The savings rate has gone up. That's a key one-off adjustment. We're left with the government deficit. In my view, solving that will cause a headwind going forward, but it will increasingly be offset by the business cycle beginning to kick in. So we don't believe in a double-dip, we believe in continued slow recovery.
In this world, we think energy equities offer fantastic value. Markets continue to slowly recover. Confidence is going to seep back in and energy equities are very cheap on price/earnings multiple terms, very cheap in terms of their current valuations relative to net assets behind those valuations as compared with where they have been historically for many years. And there's also the standout dividend yield of a number of the super majors, and you've got the services sector, which was beaten down in 2009 and 2010, but began to recover in the second half of 2010, actually beating to quite a different drum to much of the rest of the economy. There's a very distinct uptick now in the oil and gas service company business cycle. So those are all strong positives. We've then got interesting growth opportunities arising from these new horizontal fracking developments enabling us to get energy out of shales, and they exist both in gas shale and in oil shale. You've also got as a last point, one of the points I mentioned before, which is exposure to growth in energy demand in emerging economies. As I mentioned, many of your U.S. oil and gas companies have got significant exposure to what's going on in the emerging world.
Lastly, let's imagine a different world. This is a third scenario investors have got to think about. What happens if inflation takes off? Energy equities are one of the real places to hide, along with gold and index-linked bonds. I've just been looking at the long-run ratio of oil, gold and property. It's very interesting how if you go back to, let's say the 1960-1970 period, gold was around $35. A few months ago, it was trading at $1,400. It's now gone up rather higher, but just to make my point, I'm going go get back to that moment, when it was up 40 times. I wondered how much oil has gone up over that time period. Well, if you go back, oil was trading at about $2 a barrel in 1970, and it was then trading at about $80 four months ago, so it had gone up 40 times. I then decided to look at what has happened to the real value of property. I happened to look at U.K. property prices, and they've gone up 35 times measured in U.S. dollars. What's happened in the last, I suppose, 12 to 18 months is that actually gold has recently begun to accelerate away from oil. It's again beating to a slightly different drum. But if you're worried about inflation, oil is a real asset. It will be a good place to hide. We also make the following point to people - we think that over the next 10 years oil is going to trade, in today's money, somewhere between $80 to $100 a barrel. But if you adjust for inflation, you'll find in nominal terms you'll be getting $150 to $200 a barrel in 2020 with quite modest inflation.
To recap, there's a series of different reasons why energy equities are a good place to put quite a bit of your equity capital today, whether we have double dip, slow growth or inflation.