Luskin: Cheap Oil To Spur Another US Housing Boom

February 10, 2015

Don Luskin is chief investment officer of Trend Macrolytics, an institutional-based market research and consulting firm based in Chicago. Trend Macro's research stretches across all asset classes, and incorporates valuation metrics and political sentiment in its macroeconomic analysis. Luskin has authored numerous books, including "I Am John Galt." He is frequently seen and quoted in the financial media, and appears weekly on CNBC's "Kudlow Report."

Luskin recently sat down with to discuss the secondary and tertiary effects of cheap oil, and what that means for the U.S. economy and emerging markets. He also tells us why he remains bullish on Europe but doesn't have strong opinions on currency-hedging eurozone equity exposure. In November, when WTI was still at $75/barrel, you said oil prices would plunge even further. Within a week or two of that interview, WTI prices fell off a cliff. What is your forecast for oil prices?
Don Luskin: We have a long-term and a short-term forecast for oil. Our long-term expectation—and this is based on observing 160 years of inflation-adjusted oil prices, in today's dollars—is that the right place for oil is a range between $15 and $40. That has been where oil has traded for 160 years, with the exception of three periods.

Each period lasted about 10 or 12 years. One was right after the Civil War. Another was the 1970s, during the era of oil embargo and the Shah of Iran crisis. The other period is the one that just ended. Those are times when, for various economic and geopolitical reasons, the oil price gets temporarily very high.

It takes a while for that high price to send a signal into the investor, business and science world to figure out something to do about this. If you give them long enough, technology always finds a way. So think of oil as an arms race between scarcity and technology, where in the long run our belief is that there is a stand-off in the contest between $15 and $40 in today's dollars.

Fifteen dollars is too low a price, because at that point there is just no incentive to produce. Forty dollars, in the long run, is the high end of that range, because at that price it's enough to get more production. But anywhere in between there you can have a nice, happy marriage, where oil producers can make money and the economy can grow. So with WTI now trading around $50 [Feb. 4, 2015], does that mean you're bearish on oil?
Luskin: I'm saying that, five years from now, if you adjust for today's dollars, we're going to be between $15 and $40. That's been our forecast all along and it still is.

However, it takes time for technology to play out. Right now there are frackers who can produce a barrel of oil for $23 and there are frackers who can produce a barrel of oil for $90. Somewhere in between there is a fracker who can produce a barrel of oil for $50. Right now he's the one for whom there is just enough demand. So that's why the price is where it is.

OPEC is no longer the swing producer. It's the American fracker who is the swing producer. American frackers have, at today's level of demand, a cost function that is between about $25 and $80. So, unless there is a demand collapse—and I can show you all kinds of statistics that show that demand is actually growing, which is what you would expect when prices come down—we're moving up through the cost structure.

During this year, it's going to get to the point where demand is such that people are going to be moving into larger cars. They are going to be running their air conditioners more—just all the things you can do when energy is cheaper. That means that the oil price, this year, probably wants to live between about $55 and $65. Then, given just the way markets work, there are overshoots. When we got down into the low $40's a couple of weeks ago, I think that was an overshoot on the downside. That was just fire sales. That was just momentum.

It wouldn't surprise me if sometime during this year—probably the first half of this year—you see oil trading in the $70's, maybe a couple of prints in the low $80's. It is not unusual for a super-high-speed bear market like we've had in oil to have a 50 percent retracement. That gets you into the $70's easily.

So, short term, oil is below the bottom of its range right now. I would be a buyer of oil here for this year. I know you're bullish overall on the U.S. stock market. Obviously, you can buy the whole market through an index ETF, but considering the plunge in oil prices, what sectors or themes are poised to do well in the coming years?
Luskin: Automakers and home builders are major beneficiaries by the end of the year. This is not a unique insight. You hear it all the time. Don't overlook the obvious. We know from the University of Michigan studies that over the last six months, while the oil price has fallen, that consumers are shifting to less and less fuel efficient cars.

It's just a truism in the automobile industry that they don't make any money on those little, gas-efficient compacts. They make all their money on the big hogs. So the demand mix is moving in Detroit's favor. People don't realize that just as transportation is a major component in the oil price, transportation is also a major component in the total cost of ownership of the home. By "transportation," I mean commuting.

In most major metropolitan areas, if you are a young, starter family and you want a starter home, you've got to get outside of the urban area where you probably work—which means you are going to be commuting, which, in most places in this country, means you are going to be driving a car.

If you want to be able to have a safe, comfortable, long commute, you're not doing that in a Yugo. You're doing that in a Toyota Highlander. You're going to be guzzling more gas. If you can't afford to do that, you'll just stay in your urban apartment with your three kids crowding you out. You're not going to like it, but you're not going to have a choice.

All of a sudden, it's going to be possible to have another suburban boom like we did in the mid-2000s. Because in the mid-2000s, the whole housing boom started when oil was at $10 a barrel. Do you remember that oil was at $10 a barrel in 1999 when the housing boom started?

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