Fed Speak: Long Term Hedge With MLPs

us-yellen-cartoon-by-merk-investments

The Fed speaks at 2:00PM EST today. The importance of their diction cannot be understated. Burst commodity bubble has the markets spooked.

In today’s world perception is more important than reality. And right now, the world perceives the Fed’s rate hike cycle as a giant misstep.

If the Fed doesn’t come with a dovish touch today we’ll see an even bigger sell off in the markets as commodities drop on the dollar’s strength forcing more capital out of emerging markets.

The Fed is ignoring a very serious issue with the crash in commodities. We are witnessing a giant transfer of wealth from commodity producer economies to consumer economies. Unfortunately trillions of dollars of funding was based on the exact opposite model.

One of the most important things about QE is that it loses its effectiveness over time. And considering how far commodity prices have fallen, even a 50% rally from these levels wouldn’t be enough to stem the destruction.

Any QE from the Fed at this point would have to be massive in scale and happen as soon as possible just to prevent commodity prices from falling even further.

Considering these are the same idiots who thought it was a good idea to start a rate hike cycle when there was $9 trillion dollar carry trade, falling commodity prices, low inflation, massive capital outflows from dollar pegged nations and a slowing US economy, I find it hard to believe that they will be quick enough to respond to the incredible threats they failed to understand in the first place.

In the short term, I expect the market to bowl over the Fed Speak as it rushes for the exits.

However, I can be wrong, and as this decision does come down to predicting what irrational people will do, it is important not to put all my eggs in one basket.

Which is why, I think an oil reflation trade, although short term is a terrible idea, long term looks quite promising.

By the end of the year, the Fed will most likely be back to easing, and oil will have probably made its bottom. This means that interest rates will fall, in a rising oil environment which is very good for MLPs, who benefit from both the interest rate differential and high price of oil which would allow more US production to stay or come back. Over the next few weeks I am looking to add the beginning of my MLP position.

There is still quite a lot of damage to be done to these guys. A lot of them built up a lot of debt while they were building their infrastructure, and with oil production in the US on decline, their revenues will decline. Throw in a tighter credit market with higher interest rates and MLPs will find it incredibly difficult to finance their debt. In the end, some of the MLPs will die, but the strong balance sheet companies that can take advantage of cheap asset prices will position themselves for years of growth to come.

 

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