Thursday, April 23, 2020

The Oil Conun-Drum

By now, you may have heard of the news of crude oil prices plunging to the negative regions (minus 37.63 US dollars (USD) per barrel, from this news source) due to the drop for its demand in the current COVID-19 situation. 

Before assuming that free oil is around the corner (hurrah for vehicle owners), the crude oil market is not as simple as it looks. First, if you read carefully from the same news article, the negative price is for the West Texas Intermediate (WTI) May 2020 futures contract, which had just expired on Tuesday (21st April 2020). The WTI June 2020 futures contract as at the time of my writing was USD 14.57. Oil, being a commodity, is mainly traded through futures, which I had explained the mechanism of it in my ebook1. Because of oil’s low demand, very little buyers would want to take delivery on the batch of WTI crude oil associated with the May 2020 contract, and the producers would instead have to pay the buyers to get it from them, if any.

Second, there are many other crude oil types traded in the market, not just WTI. The other oft-traded crude oil is the Brent, which was at USD 20.58 as at the time of my writing, and it is extracted from the North Sea between the United Kingdom and Norway. There are many others, like Dubai Crude from Dubai, Bonny Light from Nigeria, etc., hence there is no universal crude oil price.

Third, even if a barrel of oil is at the negative price region, there are costs incurred in storing, refining and delivering before it reaches the end user, which brings the price back to the positive region (so no more hurrah for vehicle owners). On a side note, a lot of companies are involved in this whole process chain, and by sectoral association, most of their profit margins may be affected with the low oil price.

So Why Talk About Oil?

Crude oil is one of the three items that I had stated in the ebook2 for the commodities portion of the Bedokian Portfolio. Investing in oil is a bit tricky; Unlike the other two commodities, which are gold and silver, there is no convenient way of holding physical crude oil (unless you have a large tanker ship or own a regulated oil storage facility). Although investing in oil related companies is one common way, I would not recommend it as they are still companies at heart, i.e. equities, and profit margins, expenses, productivity, etc. varies across them, even if the price of oil is the same. Another way is to go the oil futures path, but if you are not familiar with this instrument then I suggest you steer clear from it.

There are exchange traded funds (ETFs) for crude oil, but unlike its commodity siblings gold and silver, which have the actual physical assets backing them, their holdings are consisted of oil futures. With this characteristic, the prices of oil ETFs do not really correspond the actual rate of increase or decrease on the item that they cover (e.g. the price of spot oil may have gone up by 10%, but the ETF price may be only up by 3%). This is due to the result of contango3, which is existent in futures market.

Having stated the above, plus the points on oil in my ebook, it is up to you on whether to add oil into your portfolio, especially now the price had hit rock bottom. If you are not familiar with futures and the dynamics of the “black gold”, then you could just remain with gold and silver as your commodities.

Disclaimer: The Bedokian is vested in United States Brent Oil Fund (BNO).

1 – The Bedokian Portfolio, p37-39

2 – ibid, p42-43

3 – Chen, James. Contango. Investopedia. 20 Apr 2020. (accessed 23 Apr 2020) 

Monday, April 13, 2020

Of Emergency Fund And Liquidation Of Portfolio (To Tide Things Over)

A global recession is in the works; Due to the disruptions caused by the measures (e.g. lockdowns) in response to the COVID-19 pandemic, the global economic machine has slowed down tremendously. Unless a quick relief, like a vaccine or falling rates of infection, takes place, a longer delay may result in irreversible changes, as businesses may not sustain the fixed overheads despite grants, force majeure of loans and contracts, and macroeconomic stimulus being rolled out. The entire global economy, like a huge machine, is made up of different parts (countries, sectors, industries, companies, etc.) that are interdependent on one another. A stop in certain parts of the machine will cause others to slow down, and a prolonged halt may cause the whole thing to be damaged.

With this, individuals like you and me not only being preoccupied of keeping one’s family safe from the pandemic, but also keeping them sustained with a constant flow of income. In such times, for most of us, our primary sources of income, which are employment and/or business/profession, could be threatened, in terms of a huge reduction or worst case, a total cut-off. Even if we have secondary sources of income such as from investment portfolio and/or properties, these, too, are likely to suffer a cut as almost everyone and everything around are facing the same issue.

There are a few ways to mitigate this predicament, such as adjusting the lifestyle and cutting down on unnecessary expenses, look out for some side gigs to tide things over, and/or use your network built over the years to gain some opportunities. For this post, I will take on the investment portfolio side of things and most of the points here are related to what I had in my eBook.

The Emergency Fund

The emergency fund, by definition in my eBook, is for you to tide over unexpected situations in life, such as sickness, unemployment or just about anything that will eat into your money1. I had also mentioned here that the emergency fund is separate from your savings. There is no agreed upon quantum as it depends on your income, expenses and number of dependents.

I had recommended that the emergency fund be built before starting any investment, as this amount is treated as a buffer between your daily monies and the investment pool. If a drawdown has to be done, do it from the emergency fund first. 

The Cash Component

Depending on the size of the emergency fund, it should last at least a month or two and hopefully the COVID-19 would be controlled or optimistically be gone by then. However, if it does not abate, and if there are not many or ineffective alternative income streams, then the painful decision of drawing from the investment portfolio is to be made.

If you are following the Bedokian Portfolio’s methodology or any others of having a cash component in the portfolio, then shift that amount back into your emergency fund.

Partial Liquidation Of The Portfolio

If the conditions, be it the COVID-19 or your other income streams do not improve by the time your cash component is used up, then the liquidation of your investment portfolio is inevitable. Frankly speaking, by this time the portfolio would have shrank and the equities and REITs asset classes would have been hit the hardest.

The next question will be what to liquidate first? For this, my opinion is to firstly suspend the notion of asset class allocation and diversification temporarily. Secondly, see which asset class(es) the market is flocking to (note: capital moves between those that provide the greatest returns during boom days and the greatest safety during bust days), and liquidate that off, which in this case government bonds and commodities (especially gold and silver) are the probable ones.

For individual securities, you could use the selling triggers2 in the eBook as an initial screener, then conduct a full fundamental analysis before deciding if the counter is to be kept or sold off. At this stage you must be objective and keep your emotions in check; never mind the losses incurred or harping on the efforts in building up the portfolio. Live today, fight tomorrow. Once the whole thing blows over, set a time and conduct a full rebalance of your battered portfolio to the preferred asset class allocation.

Stay safe, stay liquid and stay invested.

1 – The Bedokian Portfolio, p64-65
2 – ibid, p101-103