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A Lesson from Bitcoin

Written by Briton Ryle
Posted November 6, 2017

Last March, I sat in on some roundtable discussions at an investment conference on Manhattan's Upper East Side.

Funny thing, nobody really wanted to talk stocks. I mean, sure, the hedge fund managers and venture guys gave lip service to Amazon, Apple, and Google. But these were dull discussions. There was no passion for the stocks, no wildly bullish prognostications about Apple becoming a trillion-dollar company.

But all the buzz in the room was palpable when they started talking about Bitcoin and Ethereum and where cryptocurrencies were headed. One venture capital guy was taking heavy positions in Bitcoin. Several fund managers were starting crypto funds. 

Ethereum was around $50 at the time. Bitcoin was a little over $1,000. 

Yep, there was a lot of money to be made since then. And the movers and shakers at this conference were giving the early alert. 

This may sound kind of silly, but there's always a "buzz" factor around great moneymaking investments. People talk. And they like to talk about what they think will be the next big thing. And if you listen carefully, you can absolutely pick up on the profitable chatter without sitting at table with a bunch of other investors in New York...

Prices Going Higher

Oil has been over $50 for a month now. Despite the constant hand-wringing about U.S. shale production continuing to keep a lid on oil prices, that price keeps rising. 

The big players in OPEC — Saudi Arabia, Iraq, and Kuwait — are finally telling us loud and clear that they want higher prices. These three pump about 50% of OPEC's oil. They went on record last week at an oil conference in Bangkok to say that OPEC's production cuts should be extended at least another nine months. 

Russia's Vladimir Putin even seems to be on board.

Now, the production cuts that OPEC agreed to last year are having an effect. Oil inventories have been falling pretty sharply over the last six months or so...

oil 11 6 17

But there's clearly a long way to go before inventories can be considered "normal."

A nine-month extension would surely help oil get the whisper price that's making the rounds: $70. 

My biggest question is: what took so long? 

Saudi Arabia embarked on its oil domination plan back in late 2014. The Saudis thought they could drive U.S. oil off the market and re-emerge as the dominant player in the global oil market. Oil prices did indeed crash when the Saudis announced they would crank the pumps wide open. And over 100 U.S. shale companies went belly-up. 

Still, overall, the Saudi plan has been an amazing failure. And an amazingly predictable one at that. 

This is what quasi-socialist governments never understand. They always seem to think you can just control prices and there won't be any backlash. But price is always the ultimate motivator in a free market. It drives innovation and efficiency. The response from U.S. shale producers was predictable: innovate or die. 

They innovated all right, cutting the price of production in half. Now, Saudi Arabia has lost over a few hundred billion in oil revenue. Plus, its weakness has been revealed to the whole world. The only way the Saudis can get to back into the oil conversation is if they accept their role as production cutter. 

Personally, I'm loving every minute of their comeuppance.

The Aramco IPO

I've written several times that the Saudis would push prices higher as the timing for the Aramco IPO approaches. (If you don't know, Saudi Arabia is planning to take a small portion of its state-run oil company, Aramco, public sometime next year.)

Seems to me that pre-IPO price spike is happening now. And yeah, it's likely good for $70 a barrel. Take note that hedge funds have been loading up on oil over the last few weeks. This is not a contrarian moment — hedge funds have been underperforming for years. So when they get a trade they think will work, they're gonna ride it. And talk about it. 

But I gotta tell you and anyone else who will listen: do NOT buy into the Aramco IPO. 

To buy into Aramco is to partner with the Saudi Arabian royal family. Would you trust a partner like that? Yeah, me neither. 

They're not going open their field for an independent assessment. You're going to have to take what the Saudis give you about their reserves as an article of faith. I'm sure there will be plenty of international investors ready to buy into Aramco. I will definitely not be among them. 

I'd much rather make my loot on good ol' American shale companies.

A Beaten-Down Permian Play

Laredo Petroleum has been brutalized over the last month. The stock just broke an important support point at $11.25. It is more than 10% below the 50-day MA at $12.31.

But Laredo works the Permian Basin, the most prolific U.S. oil field. I'll tell you why I think it's due for a strong comeback in a minute. But first, the backstory...

Laredo shares started falling on October 16. On that day, Laredo released its hedging strategy for 2018. Here's the important info from the press release: 

At September 30, 2017, for 2018, the Company had hedged 9,515,375 barrels of oil at a weighted-average floor price of $47.42 per barrel, representing approximately 95% of anticipated oil production for 2018. All of the Company's 2018 oil hedges enable Laredo to benefit from an increase in the price of oil from current levels with 4,088,000 barrels structured as collars with a weighted-average ceiling price of $60.00 per barrel and 5,427,375 barrels hedged with puts and thus do not have a ceiling.

When you see that 95% of production is hedged at $47.42 a barrel, it sounds like the company has cut off its ability to profit if prices rise. Except the release says: "All of the Company's 2018 oil hedges enable Laredo to benefit from an increase in the price of oil from current levels..."

I'm not sure how people could misread that. And they are clearly still disappointed with the news, hence the eight-day sell-off. But that's not all there is for Laredo...

About a month ago, Laredo agreed to sell off its interest in Medallion Gathering & Processing, the Permian's biggest pipeline. Proceeds will be approximately $825 million. Laredo has already made a redemption offer to pay down a good chunk of its $1.4 billion debt load. Interest expense on that debt will go down a lot.

Then last week, Laredo released in-line earnings... and the stock got creamed. You see, Laredo said it's going to spend money to raise production. This comes at a time when most shale companies are standing pat, mostly focusing on efficiency. 

Now, here's the thing: Laredo's production plans fit nicely into the OPEC-fueled oil price rally. Investors will figure this out, and probably soon. So, if you wanna get an early jump, pick up a few shares of Laredo Petroleum (NYSE: LPI).

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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