Running Out of Gas

by | Oct 13, 2005

There aren’t many iron-clad rules in investing, but there’s one: Bet against anything that the vast majority of investors agree upon. Right now, based on conversations with my clients, who are some of the best and brightest investors on Wall Street, I’m seeing a strong bullish consensus about energy and energy stocks. While I hate […]

There aren’t many iron-clad rules in investing, but there’s one: Bet against anything that the vast majority of investors agree upon. Right now, based on conversations with my clients, who are some of the best and brightest investors on Wall Street, I’m seeing a strong bullish consensus about energy and energy stocks. While I hate to disagree with my clients, this is one of those times when I just have to.

It always pays to bet against the majority, but not because investors are stupid. Quite the opposite. It’s because investors are so smart and have such strong incentives to get the facts, that anything they all believe will quickly become reflected in prices. So even when they turn out to be perfectly correct about whatever they believe, you won’t make any money in stocks by agreeing with them.

On the other hand, suppose you take the opposite side of the bet. When virtually everybody knows the story about why some company is in trouble, don’t sell it — buy it. If they turn out to be right you’ll break even because the bad news was already out when you bought the stock at fire-sale prices. But if they turn out to be wrong, which happens a lot in markets, then you’ll make a ton of money, because the stock will soar as bad expectations are replaced with not-so-bad realities.

Over the past few weeks I’ve noticed more and more of my clients speaking with pride — not bragging, but close — about the fortunes they’ve made this year in energy stocks. I’ve heard dozens of stories about some obscure oil exploration company that they bought a year ago for 10, and now it’s 100. And no wonder. Even the stodgy energy sector of the S&P 500, consisting of 29 mostly large-cap companies, has gained more than 41% year-to-date through September 30, while the overall market was about flat.

There’s no end to the stories explaining why this is so. Insatiable demand from China. Greedy SUV drivers. Overzealous environmental regulations. Lack of spare pumping capacity in OPEC oil fields. Lack of refining capacity in the US. The world is running out of oil. And of course, back-to-back hurricanes.

But none of that matters. When everybody knows all the reasons backward and forward, and when investors get a little too much swagger about their successes, that’s a pretty clear sign the game is nearly over.

Just take a look at the price of crude oil. Today it’s lower than it was before anyone had even heard of Hurricane Katrina. And of all the oil freed up from the nation’s Strategic Petroleum Reserve, only a small fraction has actually been bought by anybody. And oil company stocks have come off their peaks, in tandem. Prices were assuming the worst. If the worst had happened, they couldn’t have gone much higher. But the worst didn’t happen, and now prices are heading lower. I think they have much further to fall.

There’s another even more reliable sign that the energy game is nearly over, and I’m seeing that one, too: fear.

Last week I visited an extraordinarily intelligent and capable hedge-fund manager who’s earned a fortune as a trader. He was visibly shaken, his face ashen as he stared into the bank of quote-screens that flank his desk. He was watching the price of natural gas futures surge to all-time highs, explaining in great technical detail the terrible destruction of gas infrastructure in the Gulf as the result of Hurricane Rita.

It reminded me in several respects of that memorable time five years ago, in 2000, when the tech bubble had begun to burst after the NASDAQ topped 5000 in March. The dot-com stocks were the first to be wiped out. Die-hard tech investors transferred their loyalties to the so-called “infrastructure plays” — the companies that made and operated the equipment that makes the Internet run. And it was all explained with lots of technical details about the particulars of different kinds of routers, switches and fiber cables.

But in the end, the infrastructure plays of 2000 were no safe harbor from the tech crash. Companies like JDS Uniphase got hit just as hard as companies like Yahoo.This time around, natural gas is going to get hit just as hard as oil.

And it doesn’t matter how much technical detail you think you know about natural gas, either. In fact, the more you know the worse it is. If you truly know it all, then everyone else knows it too (after all, you’re probably no expert on natural gas). So that means whatever you know is already in prices, so you can’t profit from it.

Here are some things I know about natural gas. I know from National Gas Intelligence, the news service for industry insiders, that virtually all the local distribution companies already have all their supplies for the winter laid in. So there’s no actual shortage. And I know that the Henry Hub, the transmission nexus that’s used for delivery of NYMEX natural gas futures contracts, was shut down on September 22 and has only begun to come back on line this week. That kind of technical disturbance to a marketplace can cause temporary price distortions as standard delivery arrangements must be renegotiated under stress.

So right now natural gas is more expensive than crude oil per unit of energy. That rarely happens. Crude is almost always more expensive, except for a very small number of very short-lived periods. There’s no fundamental reason to think that it will last.

So the message is this: Take profits in your energy plays, and most of all the natural gas plays.

But there’s more. If the majority of investors believe that energy prices (and energy company stock prices) are going to just keep on growing forever, then they must also believe that the US economy is in big trouble. In fact, I hear that argument over and over from my clients. The typical investment idea that flows from that is to sell retail stocks, on the theory that higher gasoline and heating bills will keep consumers from spending as much at the store.

Well, maybe it’s true. Maybe even energy prices somewhat lower than they are today are going to put a dent in consumers’ wallets, and that won’t make a pretty sales season coming up here. All the money during the holidays will be made by Exxon Mobil, not Wal-Mart Stores. But remember, that concept is so terribly obvious. I just don’t see how you can expect to make any money betting on it. Everybody already believes it, so it’s already embedded in stock prices.

So you might as well bet against it. If you’re wrong, you’ll break even. If you’re right, you’ll make a killing. So bet against the majority. Bet against what everyone knows. Sell Exxon Mobil, and use the proceeds to buy Wal-Mart.

It might just turn out to be a merrier Christmas than anyone can imagine.

The above is an “Ahead of the Curve” column published October 7, 2005 on, where Luskin is a Contributing Editor.

Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at He is also a contributing writer to

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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