Yesterday I talked about the search for maximum pessimism as a way to approach the macro part of the investing equation. I don't make macro forecasts for the simple fact that I am really pretty bad at it. I am a news junkie and can usually put together a pretty good scenario for world events, but the key part for guessing the market's reaction to events is beyond me. Over the years, I have developed a strong opinion that this is beyond most of us and only a very small handful of people get both parts of the macro forecasting correct.
A prime example of the forecasting difficulty is an area of maximum pessimism that has developed the past few months. I don't recall anyone forecasting that Saudi Arabia and other key members of OPEC would act to drive down global oil prices, sending the prices of oil and gas stocks tumbling. It is unprecedented and not too many people, including me, got this one correct. It has caused a pocket of maximum pessimism that looks to me to hold a lot of short-term pain and long-term opportunity.
I am not the only one who feels this way, thankfully. Josh Harris, the co-founder of Apollo Global Management (APO) told investors on the most recent conference call: "In the short term, the price of oil is difficult to predict and it certainly has the ability to detach from long-term fundamentals. Even at these lower prices, we believe energy is a very interesting place to be investing capital. And we're tactically working to take advantage of the market dislocation."
He also addressed the future of oil prices with a point of view that is very much in line with my own. "When you look at the fundamentals of energy, and you really look through the sort of trading trends, what you see is that the supply curve where oil is economic is very, very flat at around $80. And so therefore, if the price of oil were to drop for an extended period of time below $80, you would see -- ultimately that would drop supply in the marketplace. And therefore while the price of oil can go down below $80 for some period of time, of course, and even some moderate period of time, if you're looking over a five-year period, our longer term period to how we gauge our investments, it's likely to be that price or above," he told investors on the call.
I have been getting blasted in energy stocks so far in 2014. My stay-small-and-move-slow philosophy has kept position sizes small, so I am far from destroyed, but it is still worth a wince or two when looking at the energy-related names I have bought in 2014. Stocks like Hercules Offshore (HERO), Rowan (RDC) and Noble (NE) have gone down quicker than Notre Dame's national championship hopes in the past month. Every value-oriented screen I run today is dominated by the oil stocks.
With a five-year view of the world, I think the resource stocks are a great buy. I won't back up the truck any time soon, but I think I can continue to stay small and move slow to continue building a long-term position in the oil and gas names. I will add new ones over time if the prices continue to move to the downside. It may take a few years for activity to pick up, but I am pretty confident that buying a financially sound company like Dawson Geophysical (DWSN) at 60% of book value should work out pretty well for me over time.
It is probably going to be a bumpy ride, but I try to keep that private equity mindset in line. The smart, patient money is not panicking and neither should we. Private equity is buying energy with a long-term view and I think that is probably a very good idea right now with oil at low levels. Many financially sound companies are selling at huge discounts to their asset value.
As a quick aside, if you are not listening to the conference calls of the leading publicly traded private equity firms you are missing out on some of the best investment advice you will ever receive. I have done pretty well over the years by following the folks at Apollo, Carlisle Group (CG) and KKR (KKR) into beaten-up sectors and industries. You have to have a long-term point of view and a strong stomach, but the majority of the time it has worked out very well for me.
