Supply, Demand and Storage – 27th April 2020
Last week saw the dislocation of the oil market. Having suffered a demand shock when economies around the world hit a sudden stop, the Russians and Saudi Arabia decided to magnify the problem by trying to gain market share, in the process pumping vast quantities of oil which few needed. Basic economics dictates that too much supply and not much demand equals falling prices. And so it proved. The problem was compounded by the over-supply that resulted in almost all storage facilities being full of the black stuff. That’s the problem with owning physical items like commodities, you need somewhere to store them. For gold, you need a bank vault or Fort Knox and there’s a charge for that. So last week saw negative oil prices as traders did whatever they needed to do to avoid taking delivery for the May futures contract. The winners? Those that have storage capacity.
Supply and demand mismatches in financial markets have been prevalent since the final week of February. In mid-March, even the US Treasury market suffered from a supply/demand imbalance and yields oscillated accordingly, prompting the US central bank, the Federal Reserve, to intervene – for the first time – before coming back again as we commented in our recent ‘The Cavalry Arrives.’ Of course, many governments and central banks have ‘stepped up to the plate’ in the past few weeks but the scale of the Federal Reserve’s injections to support liquidity, primarily demand for government and corporate bonds and keep markets functioning for all participants, is quite staggering. The following table from the Wall Street Journal’s Daily Shot gives some relative perspective on the size of the Federal Reserve’s injections and how the US trumped the rest.
The US Federal Reserve’s total injection of USD2.8 trillion is a staggering figure and represents a huge amount of money-printing or quantitative easing. In other words, up to an extra USD2.8 trillion of supply of US currency in circulation – far greater than any other central bank. Consequently, you could expect the US currency to weaken. The following chart sourced from NS Partners shows the speed of the expansion in US money supply via two measures, M1 & M2.
The last iteration of Federal Reserve support was to offer support to ‘fallen angels’, those bonds once rated investment grade (BBB or above) that got downgraded to high yield/junk (BB and below). Companies as big as Ford have already become a ‘fallen angel’ and the size of the outstanding debt of companies rated BBB (shown in the graph below sourced from the Wall street Journal’s Daily Shot) offers plenty of candidates for ‘fallen angels’. Fair play to the Federal Reserve for getting ahead of the curve.
Back to storage and non-physical items are easier to store than their physical counterparts. One of the clear winners going forward, and where our investment focus lies, is the digital economy. Within that theme, cloud computing has been a prominent business where both Microsoft and Amazon are key players. Others, whose share prices haven’t already ascended to lofty heights, will also benefit.