NORW: Krone falls as oil price unable to support it

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2020, 2022, torn apart by the coronavirus, has been a particularly difficult year for global equities, with Nordic equities being no exception. For example, the negative price return of around 13% of the Global X MSCI Norway ETF (NYSEARCA: NORWAY) a book this year perfectly encapsulates how betting on the sharp rise in oil prices and its tailwinds for commodity-correlated currencies (and ETFs) and relying on what is sometimes seen as “Nordic stability” could result in pure disappointment. Another way of putting it, it’s a classic example of how a macro-focused thesis can fail.

Surprisingly, ETF Norway is in the red even despite Equinor (EQNR), its valuable holding from the energy sector, appreciating nearly 38% in New York and more than 55% in Oslo.

Data by YCharts

This supermajor has delivered a great story of multiple expansion and solid improvement in underlying fundamentals (including growth rates). To better situate the context, its 2021 Enterprise Value/Proven Reserves ratio now stands at ~19.8x compared to ~17.2x on January 1st. This is not the consequence of increased proven oil and gas reserves (they are updated once a year) or higher net debt. On the contrary, the latter has even fallen sharply, as the company is literally printing money this year thanks to the price of Brent teetering near decade highs, with a phenomenal year-over-year FCF margin of 28% and a whopping 44 $.6 billion in cash and cash equivalents on the balance sheet, 1.46x greater than total debt. Consequently, multiple expansion was driven solely by capital appreciation supported by the energy crisis and the historic rise in crude prices. Surprisingly, EQNR remains even underrated from a benchmarking perspective.

We see a completely similar story in the case of Aker BP (OTCPK: DETNF), another major oil and gas company on the Norwegian continental shelf, previously absent from the NORW portfolio but now the third largest holding (~5.9%) . However, it should be noted that other NORW investments, mainly non-energy, have not been as successful, even stocks in the financial sector which are supposed to benefit from higher interest rates, such as DNB ASA (OTCPK: DNBHF ), the the biggest financial services group, which is down around 7.4% in Oslo since the start of the year.

Anyway, why has 2022 been so slow for NORW despite its core investment (nearly 20% of net assets), perfectly functioning EQNR, and oil so expensive and supportive of the stronger krone? It’s not because the Norwegian economy is heading for a recession. This is a time when monetary policy contrasts across the world meet the demand for energy in the foreign exchange market. And the energy bulls lose.

Dig Deeper: Recap of NORW Essentials

NORW is a passively managed exchange traded fund that tracks the MSCI Norway IMI 25/50 Index. In the current iteration, NORW is 68 shares long, with the top ten holding over 63%.

In November 2021, when I first covered this fund, the portfolio also contained 68 stocks, implying that it has remained consistent this year, but on closer inspection some differences could still be seen. For example, he added the aforementioned Aker BP as rising oil prices catapulted his float-adjusted market value. Meanwhile, Sbanken ASA (weighting around 0.5% as of Nov 11) is no longer part of the holdings as it was acquired by DNB ASA earlier this year.

Soaring oil prices boost government cash flow, but do little to support the struggling krone

In my previous ETF article published in November 2021, I reported that two factors need to be watched closely to understand what returns NORW might be able to deliver. It’s about Norges Bank policy and the price of oil. Both could have a big impact on the NOK/USD rate and push the ETF’s net asset value south, even if the prices of its underlying holdings rise. And while acknowledging that key rate hikes were in the cards, I opted for a neutral view, in part due to my conservative outlook for the price of crude (which, as we all know, looked far too conservative ).

But what now? Norges Bank seems resolutely hawkish. In June he recognized that faster rate increases are needed to deal with emerging economic headwinds that are adding to inflationary pressures. Higher rates that weigh on consumer spending and inflict pain on over-indebted households are concerning. But inflation getting out of hand is a much bigger danger, and so I have no doubt that the central bank will follow suit. More importantly, recession is barely in the cards, so the central bank has the luxury of gradually pushing borrowing costs higher without risking shattering the economy.

The most recent Data according to Statistics Norway presented earlier in July, inflation reached its highest level in 33 years, with consumer prices increasing by 6.3% compared to the previous year; something similar was only seen in October 1988. And that’s noticeably above the 2% target. Digging deeper into the overall CPI, we see a few even higher rates, as transportation recorded the fastest increase at 11.7%, followed by restaurants and hotels at 9.2%.

Norges Bank began raising interest rates as early as 2021, when most developed players, including the United States, were still considering whether raising too early would hurt economic growth; it was an implicitly bullish factor for the crown.

Additionally, geopolitics has pushed the price of oil into the stratosphere. As a result, not only are exploration and production companies literally printing money (I see a 30% increase in Aker BP’s FCF in 2022 as likely; Equinor could generate a 43% growth rate), but the Norwegian government is also reaping the benefits. The State’s net cash from oil activities (taxes, SGFI’s net cash, etc.) is provide to reach an all-time high of NOK 933 billion this year (as of May 12 estimates), about 3.2 times the 2021 level.

A seemingly unambiguous bullish backdrop for the krone? Alas. With the Fed even more hawkish assuming the inflation problem is rooted in the US, and with the terminal rate likely to go as high as 4%, the crown bulls’ arguments look somewhat bleak. As a result, the NOK depreciated by around 10.5%, along with other much less oil-dependent Nordic currencies and the euro, contributing roughly to the negative returns of NORW and ENOR this year.

Data by YCharts

Final Thoughts

In summary, the silver lining is that even though its 2022 year-to-date performance is negative, the Norwegian ETF has performed much better than its Nordic peers, the European equity basket (IEUR) and the flagship US fund iShares Core S&P. 500 ETF (IVV) this year.

Data by YCharts

For context, the iShares MSCI Denmark ETF (EDEN) was beaten by the historic fall in the euro (the Danish krone is pegged to the euro) as well as an exodus of investors from multiple stocks which affected disproportionately renewables, while the iShares MSCI Sweden ETF (EWD) suffered from the weakness of the Swedish krona, the problem I discussed in my May article, when it has no exposure significant contribution to oil producers to support it in a context of soaring crude prices.

Admittedly, the comparatively better performance of NORW was guaranteed by the dizzying rally in oil and gas stocks, which still was not enough to prevent the crown from falling, and even a meager positive return was not achieved. by the fund.

Looking again at the Norwegian thesis, further hikes in key rates seem almost certain, (at least) until they reach 3% in the summer of 2023, as mentioned in the June monetary policy. Evaluation. This should support the appreciation of the krone against the USD or at least save it from a deeper decline. However, I think this is insufficient for a bullish view on NORW. There will be no upgrade, it remains a Hold.