2 Ways To Play America's New Cold War

“As our potential adversaries invest in more sophisticated capabilities and seek to further frustrate our military’s traditional advantages — including our freedom of action and access — it will be important to maintain our decisive technological edge.”

The sentence doesn’t exactly roll off the tongue, but it’s what Defense Secretary Chuck Hagel said a few days before we went to press. By now you can readily deduce that “potential adversaries” can be narrowed down to China…

On Veterans Day 2011, amid much chatter in Washington about a “supercommittee” that would slash the defense budget, we threw caution to the wind and suggested our Apogee Advisory readers buy the iShares Dow Jones U.S. Aerospace and Defense ETF (ITA).

The market proceeded to make us look bad. By year-end 2012, ITA was up about 12%. The S&P 500 was up 14%. As the calendar rolled over to 2013, we noticed a J.P. Morgan downgrade of several big defense sector names: “We believe,” said its report, “that Republicans as a group put a higher priority on spending cuts than they do on preserving the defense budget.”

Remember at that time the “sequester” was looming. We again threw caution to the wind and reiterated our suggestion, sequester be damned. The sequester kicked in on March 1. And ITA has simply crushed the broad market — which itself has been no slouch.

U.S. Aerospace And Defense ETF ITA

“Defense firms,” according to a recent story at the D.C. wonk rag The Hill, “are boosting their profits despite the automatic spending cuts by laying off workers, cutting facilities, buying back stock and taking advantage of prior-year contracts.”

The sequester trimmed $37 billion from planned 2013 Pentagon spending. Another $20 billion is scheduled to be lopped off come January.

“The problem for the industry,” the article goes on, “is that its profits have hampered its ability to convince Congress to reverse sequestration after defense executives warned the cuts would be devastating right away.”

That said, we see congressional Republicans are already angling to reverse the defense portion of the sequester. It wouldn’t surprise us at all to see them get their way in whatever budget agreement emerges to avert the next government shutdown-debt ceiling farce that’s due in early 2014 — probably in exchange for tax increases the Democrats want.

Recently the spotlight turned to the financial warfare the United States is waging against China in the oil market. It comes down to this: The U.S. government is maneuvering to keep oil prices elevated to squeeze the Chinese economy. “High oil prices might give the U.S. a cold,” Mr. Norman suggests, “but China could get pneumonia.”

According to the International Energy Agency, China’s oil imports from the Middle East will swell from a 2011 figure of 2.9 million barrels a day to 6.7 million in 2035. By then, the Middle East would account for 54% of all Chinese oil imports.

You see, China is making inroads in the Middle East… and that includes oil interests. China’s state-owned oil giant CNPC owns a stake in two Iraqi oil fields. But as Mr. Norman explained, the deals aren’t especially lucrative. Meanwhile, Iraq’s descent back into civil war continues apace. The pipelines and terminals haven’t been targeted, but that might be only a matter of time.

“Moreover,” Mr. Norman explained, “the Chinese still have to buy the oil at inflated world prices and ship it halfway around the world. They have to rely heavily on Western firms like Halliburton to do the actual field work, at nosebleed prices.”

Which helped to suggest the obvious investment play: Not Halliburton, but a basket of energy service stocks gathered in the Market Vectors Oil Services ETF (OIH). You profit from the oil industry while steering clear of Middle East turmoil: The service companies will always have work to do worldwide, even if the entire Middle East explodes in warfare.

“The best of the service companies are solid and well run, with long, profitable histories,” says our resident oil field geologist Byron King.

“There’s a growing buzz across the service industry that indicates customers are tending to spend more funds on equipment and services in 2014, although it may not show up in the basic rig count. That is, customers are pushing to do more with less at well sites.”

Baker Hughes — another service company in the OIH investment mix — issues a weekly “rig count,” one of the industry’s most watched metrics. “The U.S. rig count should average about 1,750 active rigs for 2013,” says Byron, “down 9% from 2012. Still, the industry has improved efficiency and is drilling about 6% more wells per rig. Internationally, BHI expects the rig count to average about 1,300 rigs in 2013, up 5% from 2012.

“In a sense, the new makeup of service company earnings reflects the changing nature of demand in the oil fields of the world, as well as long-term supply dynamics. That is, in North America, the demand is growing for complex services associated with fracking. But elsewhere — even in regions where not a single well has ever been fracked — demand is growing for high-end services because the down-hole geology is more difficult.”

That means the high-tech know-how of the firms in OIH will continue to prosper. In the short time since we mentioned this play to our Apogee Advisory readers, OIH has merely kept pace with the broad market. We have every reason to believe it will break away during 2014.

Regards,

Addison Wiggin
for The Daily Reckoning

P.S.  We gave readers of the Daily Resource Hunter a rundown of OIH and other insights last Friday. To ensure you never miss another opportunity or bit of important research, sign up for the Daily Resource Hunter, for FREE, right here.

Original article posted on Daily Resource Hunter

The Daily Reckoning