January 6, 2015 Comments

Tuesday was a nasty day in rated (higher) Buy on NOvember 17, 2012 at $68.12the markets (except for new investors or those who were otherwise largely in cash and who were looking to buy)

The S&P 500 was down 0.9% and Toronto was down 1.0%

Notable decliners on my list included Canadian Western Bank down 4.5%, Melcor down 4.8%, Couche-Tard down 4.1%, Onex down 3.0%, Bank of America down 3.0% and Wells Fargo down 2.1%. There were not many gainers but Costco was up 1.3%, and RioCan was up 1.8%.

I was going to buy some more Canadian Western Bank at just over $29 today. But when I was ready to do the trade it had moved to $29.60 so I instead placed an order to buy a small amount at $29.05

The Canadian dollar is down to 84.5 U.S. cents.

Having a material exposure to U.S. stocks, bonds or cash has been quite beneficial to portfolios (as measured in Canadian dollars) in the past few months.

I transferred some cash from the U.S. dollar portion of my RRSP to the Canadian dollar portion of the same RRSP today. That was because most of my cash was on the U.S. side and I wanted some Canadian dollars to buy Canadian stocks. With TD Direct I was able to do this transfer instantly on line. The problem is I paid approximately 90 basis points over the wholesale rate for the exchange. That seems excessive for a pure electronic transaction. I considered doing it by buying DLR-U ((A fund of US. dollars that trades on Toronto in U.S. dollars) and then transferring that to the Canadian side and then I could apparently sell it as DLR in Canadian dollars (the same fund put priced in Canadian dollars again trading on Toronto). And I would have faced $20 in trade fees plus very likely a bid/ask spread on both trades and I would have had to call TD to do it. When I looked at the trading history of DLR and DLR-U it appears that the buys/sell spread as measured by the daily fluctuations iin DLR and DLR-U can easy be 10 to 30 basis points. I am not sure if it could have been done instantly or not. I think I would have saved money but it seemed like quite a hassle so I just chose to pay the 90 basis points. I had also mentioned the DLR strategy under January 12, 2014 below.

There is of course much speculation about the reasons for the lower price of oil and how much lower it will go.

Some have argued that certain countries are pushing oil lower to maintain market share. However, when you think about it, a country would need to double its market share to make up for an oil price falling by half so the idea that any producer would consciously push the price down by half to just stay at the same market share but with half the revenue does not seem rational.

If certain countries pushed oil prices down to economically harm their bitter enemies that is another thing and may be true.

The idea that certain countries have pushed oil prices down to push the U.S. shale oil out of the market is also a bit hard to understand. They would only be kept out of the market permanently if oil prices are to stay down. Again it is hard to see how pushing their revenues down by half would benefit any oil producing country.

Logically, some production and supply should be pulled off the market as oil prices drop. Certainly no company should continue to produce at a cash loss (selling at less than the marginal cash cost of production). However, if most oil producers happen to face high fixed costs and low variable costs then we may not yet have reached the point where the price is less than the marginal cash cost of production. In the short term most costs of an oil producer may be fixed. However as time goes on the costs can be thought of as variable. Even labor costs are fixed in the very short term. You can’t lay people off today and then expect to re-hire next week. And the costs of layoffs can be quite large. You can’t shut down production today and then restart next week very easily. But if you think oil prices will be too low for the next six months or longer then it may make sense to shut production and keep your oil in the ground for another day.

Hedging also comes into the picture. If an oil producer has contractually sold all production for the next number of months at much higher prices, then that producer has no immediate incentive to curtail production.

All in all, the factors that impact oil prices are no doubt complex and it may take some weeks or months before any significant supply is pulled off the market. But ultimately I would expect that to happen and that the oil price decline would come to an end and start to reverse.

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