How You Can Profit from Rising Inflation
For the past year critics of the Fed’s decision to raise interest rates have pointed to low oil prices as proof that inflation was dead. The price of a barrel of oil was below $50 as recently as October 9, but since then it has shot up to more than $57.
That’s a big deal because higher energy costs are a drag on the economies of the developed world. Although rising oil prices are good for most companies in the energy sector, for everyone else they represent smaller profit margins. For manufacturers its means greater production costs, for wholesalers it results in more expensive fuel to transport goods to market, and for retailers it translates into higher utility payments.
So far, the stock market is shrugging off higher oil prices as a non-event, but if they persist through the winter then a lot of businesses will need to scale down their profit forecasts for next year. Just as we once thought oil for less than $50 a barrel was impossible, we now seem to think that oil above $60 is equally unlikely.
Earlier this month Saudi Arabia’s Crown Prince Mohammed bin Salman shocked the world by arresting dozens of his political rivals on corruption charges, but many outsiders view it as little more than an old-fashioned power grab. If so, then the timing of these events may be telling given Saudi Arabia’s plan to sell a stake in its government-controlled oil company, Saudi Aramco, next year.
The Saudis have made no secret of their desire to value that business at $2 trillion by selling 5% of it in an IPO for $100 million. The higher the price of oil, the more valuable that business becomes. Clearly, it behooves the Saudis to drive up the price of oil heading into the IPO so they can extract maximum value.
So far, only a mild rise in oil prices is factored into most energy stocks. At a recent share price of $116, Chevron (NYSE: CVX) is trading exactly where it was at the start of the year. It has staged a nice rally off of its summer low below $105 but is still well below its high above $130 three years ago.
In contrast, oil refiner Marathon Petroleum (NYSE: MPC) just pushed above $60 to reach an all-time high, even though higher oil prices hurt profit margins for refiners. Although Marathon can adjust pump prices at its chain of service stations to protect those margins to a degree, it does not directly benefit from higher oil prices as a producer like Chevron does.
This sort of irrational pricing disparity is not unusual when the global economy is passing through an inflection point that has not yet been recognized by the market. As an investor, you can make a lot of money in a short period of time if you know how to take advantage of these rare opportunities.
What is not yet fully priced into the market is the inevitability of higher commodity prices if the global economy continues on its current track. Companies that drill for oil, mine for metals or produce basic materials stand to benefit the most, yet many of them are trading at forward earnings multiples well below the market average.
It has been so long since we have experienced inflation that many of us have either forgotten how to profit from it or don’t believe it is really going to happen. However, we believe it is happening and recently added Stephen Leeb’s commodity service Real World Investing to give our readers an early edge on the market. His portfolio contains dozens of energy, metals and commodity stocks that should lead the market higher in the years to come.