This stock is just waiting to explode. He recommends you take advantage of this investing opportunity and says, “because of its strong dividend policies, investors will be well compensated while they wait for that oil-price rebound.”

This from Horacio:

In the face of the global financial meltdown, the price of oil has plummeted from a record high of almost $150 a barrel in July to less than $40 recently. And now it seems to be bottoming.

Clearly, this isn’t the precise moment to call a market bottom, but it is reasonable to think about a bottom around this range for a few reasons.

For starters, the forward curve of oil futures prices is showing a very marked upward slope, known in the commodities business as a forward curve in “contango.”  This means that – the farther out we go – the higher and higher oil futures prices climb. To see what we mean, let’s take a look at the projected price of oil as depicted by this graph.

A futures curve as upwardly skewed as this one provides a great opportunity for profits:  One can just buy oil today, sell it forward and hold it until December 2016 and make a guaranteed rate of return of about 62%.  In a year, you can make about 11% by just buying now, holding it and delivering in a year.  If you add some leverage to the transaction, you can make a nice return.

Some sophisticated players are doing just that: They’re buying oil, and are holding it in a tanker in port – with the obvious intent of capturing these profits.

However, this very favorable contango arbitrage is not going to last for long, as more players have been jumping into it, thus flattening the futures curve with time.  It is easy to see that, at some point, as oil gets absorbed into storage, and the curve gets inverted, the speculative players that shorted oil by selling futures long ago without having production or physical oil will be squeezed into covering at much higher spot prices.  This spike in spot prices situation will develop in less than a year, as demand recovers.

The slope of the curve also indicates widespread expectations for inflation.

From Stimulus to Inflation

The U.S. government has launched a huge stimulus package and its plan for a $3.6 trillion budget for fiscal 2010 will elevate the fiscal deficit to a staggering $1.75 trillion this year – a numbing 12.3% of gross domestic product (GDP).

And we have yet to deal with the massive social-security and health-care entitlement programs, which pose a huge fiscal threat ahead.

The financing of the announced deficits will come through issuance of U.S. Treasuries, which means that the U.S. Federal Reserve will have to monetize the debt. That is, the U.S. central bank will have to print money in order to make it available to buy the debt, since the level of issuance is so high that foreign buyers will not be able to purchase all the debt.

In addition, the Fed has already been very busy expanding its balance sheet in order to pump liquidity into the markets to buy mortgages and other assets. And it has already lowered its benchmark Federal Funds rate to a range of 0.00%-0.25%.

Why are the Fed and the government so intent in stimulating the economy?

The nightmare scenario for any central bank is falling into the so-called “liquidity trap” – a situation that exists when an economy’s asset prices enter a deflationary spiral and people reach the conclusion that by merely sitting in cash, even at a zero interest rate, they are getting richer by the day.  In that situation, monetary policy becomes ineffective, since rates are already at zero, and since it is very difficult to get out of that deflationary spiral.

That is precisely what happened in Japan during its “Lost Decade.” By the time the Japanese figured out that they needed to do something very dramatic in terms of stimulus, it was too late. The drop in prices had already created too many losses in the banking system and taken the entire system into bankruptcy.

Therefore, the theory goes, very aggressive monetary and fiscal action is needed right at the outset, in order to prevent the deflationary spiral and to actually generate some inflation.  At the same time that the United States, at the epicenter of the global crisis, is acting in this manner, countries around the rest of the world, which have been affected to different degrees, have launched their own stimulus initiatives.

China’s Stimulus Points to Strong Global Demand

China, which is at the forefront of global commodities demand, is of particular interest.  China needs to grow its economy at a minimum rate of 8% a year in order to employ the 18 million workers that join the labor force annually.  This is an imperative for a country that has dictatorial government, in order to avoid massive unrest.  That’s why in November, Beijing announced a $585 billion (4 trillion yuan) stimulus plan. It’s also why the country is taking such aggressive steps to assure access to supplies of key commodities.
Since then, the government has been aggressively buying long term access to commodities in such countries as Brazil and Australia.

Aluminum Corp. of China (NYSE ADR: ACH), otherwise known as Chinalco, has invested $19.5 billion in Rio Tinto PLC (NYSE ADR: RTP) to acquire stakes of up to 50% in nine of Rio’s mining assets.

China also struck a deal with Brazil’s Petrobras (NYSE ADR: PBR) for a long-term supply of oil.

China Development Bank, one of China’s largest state-owned enterprises, agreed to lend $10 billion to Petrobras for its ambitious deepwater-development program in order to ensure a long-term daily supply of 160,000 barrels oil. That followed a similar deal with two Russian giants. China Development Bank lent $15 billion to OAO Rosneft Oil Co., Russia’s state-owned oil company, and $10 billion to the Russian state pipeline monopoly Transneft (PINK: TRNFF). In return for the needed financing, Russia agreed to supply China with 15 million tons of oil annually for 20 years.

Hence, the outlook for commodities – given easy global monetary and fiscal policies, and a reflationary bias – is very favorable, and we are going to take advantage of it.

Enter Diamond Offshore Drilling Inc. (NYSE: DO).

Drilling for Profit

Diamond Offshore is the world’s second-largest driller by market capitalization, right after Transocean Ltd. (NYSE: RIG).  It has 31 floating rigs: nine sophisticated deepwater semi-submersibles, one drill ship for very deep water, and 21 other semi-submersibles.  In addition the firm owns only 13 jack-up rigs, of which only seven are in the Gulf of Mexico.

What I like about Diamond Offshore is its conservative, shrewd management and its commitment to shareholders.  The latter is especially ensured because of the situation of its controlling company, the New York conglomerate Loews Corp. (NYSE: L), which owns 54% of the Diamond Offshore’s stock.

Loews, run for half a century by the Tisch family, initially acquired Diamond Offshore’s assets in an opportunistic transaction in 1992.  It then sold 30% of the company to the public in 1995 and later acquired Arethusa (Offshore) Ltd. in 1996, using stock, a move that reduced its participation to the current 54%. Since that time, Diamond Offshore has been using its ample cash flow to repurchase shares from public hands.

Diamond Offshore, also referred to as DO, has been managed very wisely.  As the world’s No. 2 contract driller, DO has concentrated on the higher-priced equipment, that is, the semi-submersible rigs, which operate in deep waters.  And deep water, which require that higher-priced equipment, is where the biggest action is.

And since the specialized deepwater equipment is all taken, DO’s mid-depth equipment benefits because it can be adapted for use on bigger projects.

DO has minimized its exposure to jack-up rigs (those that rest on the ocean floor) and especially to work in the Gulf of Mexico, which has more competition and lower daily rates.

No wonder that DO’s fourth-quarter results handily beat analysts’ consensus estimates of $2.34 per share by posting operating earnings per share of $2.53.  Revenue also beat expectations, showing a 1% increase over the prior quarter.  The company also realized higher day rates and higher utilization rates.

These are all indications of strong management execution.  What is impressive about DO is that the company used the run-up in oil prices last year to enter into long-term contracts at very high prices, registering an impressive $10.3 billion backlog.  That gives Diamond Offshore a great earnings visibility going forward.

But the upside does not stop there.

There is a special situation in the making, because the Loews Group owns CNA Financial Corp. (NYSE: CNA), an insurance company that is trading at half of its book value.  You see, insurance companies have been hit hard financially by markdowns in their fixed-income and hedge-fund holdings, but Loews invested $1.25 billion in CNA last fall in a move to improve the company’s balance sheet.

And in order to be ready to defend debt ratings, a conservative management like Tisch has all the incentive in the world to keep maximizing Diamond Offshore profits to support CNA – should it be needed despite CNA’s current strong liquidity and financial flexibility.

DO recently paid one of its regular special dividends of $1.85 a share, bringing the dividend yield to almost 13%.  If this dividend is safe – and we believe that it is – this is a winning strategy for the group, given the current financial environment, and it will greatly help to maximize profits and cash flow from Diamond Offshore.

Mark Urness, a friend of mine at Calyon Financial, one of the leading energy research specialists on Wall Street, concurs with our assessment of this sky-high dividend. He estimates that DO will continue to offer the 12.5% dividend yield, which is unparalleled in the oilfield-services segment. We, like Mark, expect the company to distribute $8 a share in 2009 in the form of both the regular and the special dividends that DO has been using.

DO has been extremely disciplined with costs and with new investments, maximizing free-cash flow to almost $900 million last year.  In fact, with the ample backlog at higher prices of the contracts signed, DO should increase its free cash flow and net income to about $1.4 billion to $1.5 billion in 2009.

DO’s profit margins are impressive – and exorbitant – thanks to the shortage in rigs: Gross margins are 64% and operating margins are 54%.

These margins are likely to keep growing as management continues to execute thoroughly and oil prices rebound.  This strong growth in revenue and earnings – driven by DO’s savvy positioning in deepwater and mid-water rigs, and bolstered by rebounding oil prices thanks to global monetary and fiscal conditions – will surely help deliver much higher multiples than the meager six times earnings that Diamond Offshore’s shares are currently trading around these days.

Diamond Offshore’s shares closed Friday at $55.58. They are down 62% from their 52-week high of $147.77.

This cash-rich, profit-fountain company is a resounding “Strong Buy,” as its stock is waiting to explode to the upside.

Recommendation: Buy Diamond Offshore Drilling Inc. (NYSE: DO), a top player in its sector, and a company that is poised to capitalize on a projected resurgence in oil prices. Because of its strong dividend policies, investors will be well compensated while they wait for that oil-price rebound (**).

(**)  Special Note of Disclosure: Horacio Marquez holds no interest in Diamond Offshore Drilling Inc. (NYSE: DO).

Source: Buy, Sell, or Hold: Profit From the Projected Oil-Price Rebound With Diamond Offshore

Money Morning first reported in January, that China was building stakes in some of the world’s largest natural-resource companies, which have been made vulnerable by depressed commodities prices, tumbling profits and falling stock prices. In the scant few weeks since that Money Morning report was published, Aluminum Corp. of China Ltd. (ADR: ACH), or Chinalco, has invested $19.5 billion in Australian/British mining giant Rio Tinto PLC (ADR: RTP), and China Minmetals Corp. acquired Australian zinc miner Oz Minerals Ltd.

China Development Bank has been particularly active. Earlier this week, the bank lent $15 billion to OAO Rosneft Oil Co., Russia’s state-owned oil company, and $10 billion to the Russian state pipeline monopoly Transneft (PINK: TRNFF). In return for the needed financing, Russia agreed to supply China with 15 million tons of oil annually for 20 years.

China Development Bank struck a similar deal with Petrobras Friday, agreeing to loan the Latin American energy giant $10 billion to help finance deepwater oil exploration off the coast of Brazil.

Oil exploration will be carried out with the participation of Sinopec (ADR: SHI), the Chinese state oil company, the Macauhub reported.

The contract will be finalized within the next two months so it can be signed when Brazilian President Luiz Inácio Lula da Silva visits China in May, according to Petrobras Chief Executive Officer Sergio Gabrielli.

In addition to the exploration partnership, the deal signed between Petrobras and Sinopec includes the supply of 60,000 to 100,000 barrels of oil per day in the current year. Petrobras also signed a memorandum of understanding with state company China National Petroleum Corporation (CNPC) for the supply of 40,000 to 60,000 barrels per day.

Brazil is necessarily the country that comes to mind when taking inventory of the world’s top oil producers. It currently has about 12 billion barrels of proven reserves, but that figure could grow substantially now that a number of very rich deposits have been found off Brazil’s shores.

Petrobras happened across the second-largest oil find in two decades last year when it found between 5 billion and 8 billion barrels of untapped light oil in the Tupi basin. Even more impressive are the unofficial figures from a new reservoir, known as Carioca. That field could hold 33 billion barrels of oil and gas, which would make it the world’s largest discovery in at least 32 years.

With discoveries like these Brazil, currently ranked 13th on the list of the world’s top oil producers could, could easily move into the top ten.

The only problem with the Tupi and Caricoa oil fields is production costs. The Carioca discovery, for instance, is located 170 miles offshore, more than 6,000 feet under the surface of the water, and is trapped beneath a shelf of salt 500 miles long and 125 miles wide.

Developing oil fields such as these will be very costly and with crude oil trading below $40 a barrel financing is imperative. In that sense China couldn’t have timed its investment in Petrobras any better.

Petrobras said it plans to invest $174.4 billion from 2009 through 2013, compared with the $112.4 billion planned for investment for 2008-12. The company will invest $28.6 billion in 2009 alone.

In 2008, trade between China and Brazil totaled $36 billion making China Brazil’s second largest trading partner.

Source: China Continues its Commodities Binge with Brazilian Oil Deal