Ripple Trading An Oil Spike
by Tom Dyson
May 1, 2006
Last Wednesday we introduced you to Alexander.
Alexander sold bonds at Salomon Brothers during the 1980s. He was such a talented trader that the most senior managers on the trading floor would ask Alexander for advice with their personal investments.
We discussed Alexander’s two favorite tactics – betting against the crowd and quickly anticipating the ripples after a major dislocation in the markets.
Today I’ll show you a great ‘ripple’ trade. If there’s a spike in oil, you should buy these stocks immediately. It’s not an obvious play, so we’ll have time to pile in before the market catches on.
I’m talking about railroad stocks.
Diesel fuel is a major expense for the railroads. A spike in oil prices will raise railroads’ fuel bills.
Most people call this bad news, but they’re wrong. An oil crisis may be the best thing a railroad could wish for.
There are two reasons.
First, railroads compete with the trucking industry. Their rivalry goes back to the 50s when the Eisenhower administration pulled railroad subsidies and poured resources into the Interstate network.
The Interstate network turned out to be the most successful public works project since the aqueducts in Rome. The highways helped make America the richest country in the world.
Meanwhile, the railroads got crushed. Profits – and stock prices – fell off a cliff. The truckers stole all the railroads’ business. One day the railroads controlled the transport industry like a monopoly, the next day their business was gone.
In order to survive for the last forty years, the freight railroads have had to consolidate like crazy and abandon hundreds of routes.
By the late 90s, the railroad business was lean and mean, oil prices had bottomed to around $10 a barrel, and railroad shipping was the cheapest option around.
You already know what happened next. An explosion in demand for natural resources and a boom in international trade deluged both truckers and railroads with new business.
Between 2002 and 2004, the stock prices of both industries flourished. But in 2005 their paths diverge. Check out the chart below:
The culprit is oil.
Railroads are three times more fuel-efficient than trucks. Here are some stats I found in a research report:
- U.S. trucks now use about 20% of all fuel the U.S. consumes.
- Last year the U.S. trucking industry fuel costs increased 33%.
- For many motor carriers, fuel accounts for as much as 25% of total operating costs.
Each time the cost of diesel fuel goes up ten cents per gallon, 10,000 U.S. truck companies go out of business.
Bottom line: high oil prices hurt the truckers much more than they hurt the railroads. As the trucking industry contracts, profits flow back to the railroads.
Coal is the second reason to love railroad stocks in an oil crisis.
Most people think a spike in oil prices will hurt all transport companies, railroads included. High oil is a drag on the economy, they say, so international trade’ll slow down.
I think they’re right about the truckers but wrong about the railroads.
In terms of volume, railroads ship more coal than any other material. The USA has the largest coal deposits in the world… enough for 250 years of supply. If oil spikes, demand for coal grows and the railroads stay busy. Simple as that.
With the chronic shortage of railroad capacity at the moment, I just can’t see a scenario where railroads don’t stay busy.
High oil prices are good news for railroad companies and few people realize it. DailyWealth’s advice is to load up on the following railroad stocks: BNSF (BNI) and Norfolk Southern (NSC) especially if there’s a spike in energy prices.
Good investing,
Tom
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
Sign up today to read more investment ideas from Tom Dyson.
