Tag: crude oil

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Inflation fears threaten higher interest rates

Markets are hesitant ahead of December CPI data due for release in a few hours.

Fearful of a resurgence in inflation, Treasury investors are driving up long-term interest rates, with the 10-year yield headed for a test of 5.0%.

10-Year Treasury Yield

Long-term inflation expectations are rising, with the University of Michigan 5-year outlook climbing to 3.3%.

University of Michigan: 5-Year Inflation Expectations

Producer prices are also rebounding, with services PPI recovering to 4.02% in December.

PPI Services

We do not anticipate a significant hike in CPI, but there are warning signs of a rebound.

Brent Crude

Brent crude climbed to $80 per barrel on the threat of new sanctions on Russian shipping impacting supply. Retracement that respects support at $76 would warn of another advance.

Brent Crude

Energy prices are a key vector for inflation. The chart below shows how energy CPI (orange) rose ahead of headline CPI (red) in 2021, and its fall in 2022 – 23 was instrumental in inflation’s subsequent decline.

Energy CPI & Headline CPI

Stocks

Mega-cap technology stocks are dragging the S&P 500 down, with former frontrunner Nvidia (NVDA) falling 7.2% over the past two months. Tesla (TSLA) has also shed almost half its December gains.

Top 7 Technology Stocks

The S&P 500 index is retracing to test resistance at 5850. Respect would warn of a further decline to 5700.

S&P 500

Large caps enjoy more support, with the equal-weighted index ($IQX) respecting key support at 7000.

S&P 500 Equal-Weighted Index

Rising long-term interest rates have set off a migration from high-multiple growth stocks to more defensive value sectors, with the Russell 1000 Large Cap Value ETF (IWD) outperforming the Russell 1000 Large Cap Growth ETF (IWF) in the past few weeks.

Russell 1000 Large Cap Value ETF (IWD) & Russell 1000 Large Cap Growth ETF (IWF)

Financial Markets

Bitcoin struggles to break resistance at $100K as financial market liquidity tightens. A reversal below $90K would warn of a liquidity contraction likely to affect stocks and bonds.

Bitcoin (BTC)

Gold

Fears of persistent inflation drive gold and geopolitical tensions fuel further demand. A higher Trend Index trough indicates rising buying pressure and a breakout above $2,725 per ounce would signal another test of $2,800.

Spot Gold

The monthly chart below shows the long-term view, where breakout above $2,800 would offer a target of $3,600.

Spot Gold

Conclusion

Rising long-term Treasury yields reflect the growing risk of long-term inflation.

The outlook is bearish for growth stocks trading at high earnings multiples and financial instruments with a duration longer than two years.

We remain bullish on gold and defensive stocks.

Acknowledgments

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Stabilizing crude oil prices

Volatile crude oil prices damage production capacity and economic growth and cause volatile consumer price inflation.

At the height of the 2020 pandemic, Nymex WTI crude oil prices fell to an unprecedented low of -$13.10 per barrel as demand dried up and oil storage facilities reached capacity. Producers faced a dilemma: either shut down wells or sell at a loss, effectively paying end users to consume their oil.

Nymex WTI Crude

The Department of Energy failed to capitalize on this opportunity to replenish the Strategic Petroleum Reserve (SPR), buying only 21 million barrels of crude over four months. US field production fell from 13 million to below 10 million barrels per day as shale producers shut wells rather than produce at below cost. The damage done to balance sheets meant that it took several years to restore production as prices recovered.

US Crude Oil Production

Russia’s invasion of Ukraine in February 2022 caused a spike in crude oil prices, with WTI crude peaking at close to $125 per barrel. In response, the Biden administration released 290 million barrels from the SPR. This tipped the oil market into surplus despite OPEC+ production cuts, with Nymex crude prices falling below $75 per barrel.

Strategic Petroleum Reserve (SPR)

Shrinking demand from China and rising non-OPEC production, led by the US, has maintained prices at close to $75 per barrel. Now, hostilities between Israel and Iran threaten to escalate to the point that crude oil supplies from the Middle East could be affected.

Joseph Webster from the Atlantic Council argues that the DoE should not hesitate to make further releases from the SPR to stabilize prices in the event of a supply threat. Net crude imports to the US (blue below) have shrunk to 2 million barrels daily from 8 million in 2017, meaning the SPR provides more than 23 weeks of cover if all imports were to be terminated.

US Crude Net Imports

Further releases from the SPR would not only help to keep prices low but also stabilize them, which can be highly profitable for the US government. SPR releases under the Biden administration, at an average of close to $90 per barrel, will net about $20 per barrel if the SPR is replenished at current prices—a profit of nearly $600 million.

Conclusion

Releases from the Strategic Petroleum Reserve (SPR) should be used to stabilize crude oil prices in case of an interruption to crude oil imports. This would likely have four benefits:

First, SPR releases would ensure an interrupted supply to industry and minimize the impact on the economy.

Second, replenishing reserves when prices are low would help to maintain a floor under prices and support shale producers, avoiding the shut-down of wells when prices fall too low to cover operating costs.

Third, stabilizing energy prices can be achieved at no cost to the taxpayer. Selling when prices are high and buying when prices are low will likely show a profit.

Lastly, SPR releases would help to keep a lid on inflation. Energy prices impact the consumer price index directly through gasoline and heating prices to the consumer but more significantly through the energy cost component of goods and services. The chart below shows how energy CPI (orange) increased ahead of headline CPI in 2021 and similarly led the decrease in 2022-2023.

CPI & CPI Energy

Acknowledgments

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Crude oil: Opportunities and value traps

On the weekend we wrote that the bottom had fallen out of the oil market after Nymex crude broke support at $20 per barrel.

Now, the previously unimaginable has occurred, with Nymex Light Crude falling below zero for the first time in history, closing at -$13.10 per barrel with reports of intra-day lows at -$37.63.

WTI Crude

From The Age:

“Traders are still paying $US20.43 for a barrel of US oil to be delivered in June, which analysts consider to be closer to the “true” price of oil. Crude to be delivered next month, meanwhile, is running up against a stark problem: traders are running out of places to keep it, with storage tanks close to full amid a collapse in demand as factories, automobiles and airplanes sit idled around the world.

Tanks at a key energy hub in Oklahoma could hit their limits within three weeks, according to Chris Midgley, head of analytics at S&P Global Platts. Because of that, traders are willing to pay others to take that oil for delivery in May off their hands, so long as they also take the burden of figuring out where to keep it.”

Cushing Storage

Brent Crude is trading at $25.57 per barrel but a Trend Index peak deep below zero warns of similar strong selling pressure.

Brent Crude

Outlook

Crude oil production is still in a long-term up-trend. Low prices may present opportunities to buy cyclical stocks at historically low prices.

IEA Oil Production

The Oil & Gas sector has plunged as expected.

DJ US Oil & Gas

Oil infrastructure is also suffering from low activity levels.

DJ US Pipelines

Energy-consuming industries, however, may benefit from lower oil prices.

EIA: Industrial Sectors

Transport

Transport is the biggest consumer of crude oil products.

IEA Oil Sectors

If we break usage down by fuel types, the largest is diesel/gas, followed closely by motor gasoline, with jet kerosene significantly smaller.

Products from Crude

Airlines which have suffered from a massive drop in air travel.

DJ US Airlines

While delivery services (formerly air freight) are suffering from the collapse of global trade.

DJ US Delivery Services

So is marine transport.

DJ US Marine Transport
But trucking is holding up well.

DJ US Trucking

Construction Materials

Crude oil runs a distant second to coal as the chief energy source for cement production.

IEA Cement - Energy Usage

But the industry is a heavy transport user and should benefit from lower oil prices.

DJ US Construction Materials

Mining

Mining is also likely to benefit from lower extraction and transport costs.

DJ US Basic Materials

Forestry & Paper

Forestry is another heavy fuel user.

DJ US Forestry & Paper

Chemicals & Plastics

Basic chemicals (including fertilizers) are the largest industrial consumer of crude oil.

DJ US Chemicals

Specialty chemicals are also largely oil-based.

DJ US Specialty Chemicals

Aerospace & Automobiles

Aerospace, laid low by problems at Boeing (BA), has been floored by a massive downturn in the airline industry and will take a long time to recover.

DJ US Aerospace

Automobiles have so far stood up well because of stellar performance from the likes of Tesla (TSLA).

DJ US Automobiles

But the sting is in the tail. Light vehicle sales have plummeted.

Light Vehicle Sales

Low vehicle sales and less travel also means lower tire sales.

DJ US Tires

Oil Producers in Affected Regions

The IEA graph below shows producing regions that are uneconomic at varying prices/barrel (x-axis). If we take $25/barrel as the average over the next two years, North American producers would suffer the most, followed by Asia-Pacific and Latin America.

Uneconomic Crude Production by Country

Middle-Eastern producers enjoy the lowest extraction costs and are mostly still profitable at lower prices.

Avoiding Value Traps

Value opportunities abound in industries that are badly affected by the economic contraction and falling crude prices — as well as by those industries that stand to benefit from low oil prices. Some affected industries, however, are going to struggle to survive without state assistance.

The problem with value stocks is that, although they may seem cheap, prices can fall a lot further. That is why we use both technical and fundamental analysis to evaluate opportunities.

There are many stocks that are trading well below our assessment of fair value at present but we will not buy until the technical outlook turns bullish. It takes plenty of patience. But helps to avoid value traps.

The stock market remains an exceptionally efficient mechanism
for the transfer of wealth from the impatient to the patient.

~ Warren Buffett

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S&P 500: Upside limited, while downside risks grow

Corporate profits (before tax) ticked up slightly in the second quarter of 2019 but remain below 2006 levels in real terms. The chart below shows corporate profits adjusted for inflation using the GDP implicit price deflator.

Real GDP and Hours Worked

Growth in production of durable consumer goods remains week, reflecting poor consumer confidence.

Durable Goods Production

The chart below shows growth in bank credit and the broad money supply (MZM plus time deposits). Credit growth (blue) remains steady at around 5%, slightly ahead of nominal GDP growth (4.04% for 12 months ending June); a healthy sign. Broad money (green) surged upwards in the first three quarters of this year. Not an encouraging sign when there were similar surges in broad money before the last two recessions.

Broad Money & Credit Growth

The S&P 500 is testing resistance at 3000. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure. Expect a test of support at 2800. Breach would flag a reversal, with a target of 2400.

S&P 500

The cyclical Retailing Index displays a similar pattern, with resistance between 2450 and 2500.

Retail

Our view is that upside is limited, while downside risks are growing.

On the global front, the outlook is still dominated by the prospect of a prolonged US-China trade war. More great insights from Trivium China:

Tariff delays may be aimed at creating warm, fuzzy feelings before the next round of talks in early October, but……These small gestures do nothing to resolve the underlying trade conflict. We’re still pessimistic on prospects for a deal.

Zhou Xiaoming – China’s former top diplomat in Geneva – expressed the same view in a recent interview (Guancha):
“The two sides disagree too much on the objectives of the negotiations……It is almost impossible to reach an agreement in the short term.”

Zhou urged Chinese officials to be clear on the US’s objective:
“Economic and technological decoupling is the objective of the entire US government.”

Zhou said that officials must prepare for that potentiality, even if it is not their desired outcome.

So should we.

Dow Jones – UBS Commodity Index found support at 76 before rallying to 79. Rising troughs on the Trend Index reflect increased support. Consolidation between 76 and 81 is likely but we maintain our bearish long-term outlook for commodities.

DJ-UBS Commodities Index

On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Trend Index peaks below zero indicate selling pressure. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.

Nymex Light Crude

We maintain our investment in quality growth stocks but have reduced equity exposure to 40% of (International Growth) portfolio value.

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Gold rallies but so does the Dollar

A long-term (monthly) chart shows Crude Oil (WTI Light Crude) has broken below its trend channel and is testing support at $45/barrel.

Crude Oil

Weak crude tends to coincide with a strong Dollar. Breakout of the Dollar index above 97 is likely. Rising Trend index troughs indicate buying pressure.

Dollar Index

Gold is headed for another test of resistance at $1350/ounce but a strong Dollar is likely to undermine a primary advance.

Spot Gold in USD

The All Ordinaries Gold Index broke resistance at 5400/5500, signaling a primary advance with a target of 7000. That will depend on further weakness in the Aussie Dollar and/or a stronger gold price.

All Ordinaries Gold Index

Conclusion: We are witnessing a rally in Gold due to global uncertainty but the LT outlook, with declining crude and a stronger Dollar, is still bearish.

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Gold: Bull or bear?

Gold is testing resistance at $1300/ounce and is likely to follow-through to the long-term (LT) ceiling at $1350. Trend Index  on the LT  monthly chart displays a large triangular consolidation, indicating uncertainty. Upward breakout would signal a primary up-trend but this is unlikely, for three reasons. First, this is a bear market. A decline is more likely for that reason alone. Target for a decline is the 2015 low at $1050/ounce.

Spot Gold in USD

Second, a strengthening Dollar is likely to weaken Gold. I have inverted the LT chart of the Dollar Index (and Trend Index) below so that it is easier to relate to gold. As the Dollar strengthened, denoted by a LT fall on the inverted chart, Gold has weakened. The Dollar index shows a broadening consolidation since 2015, with bull and bear traps, again indicating uncertainty. At present, the Dollar is testing resistance at 97 but is likely to follow through to test LT resistance at 100. Rising Trend Index troughs above zero (remember the scale is inverted) signal buying pressure.

Dollar Index inverted

Third, falling Crude Oil prices are bearish for Gold. The LT chart below compares spot crude  to  spot gold, both adjusted for inflation to bring earlier peaks into proper perspective. The LT relationship is clear: gold and crude tend to rise and fall together. Crude prices have recently tumbled, exerting downward pressure on Gold.

Gold and Crude Oil, adjusted by CPI

Conclusion: We are witnessing a rally in Gold because of global uncertainty but the LT outlook is bearish.

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Significant divergence

Market commentators are sifting through the data, looking for reasons to explain the sharp sell-off in stocks over the last two months. But everything they examine is likely to be shaded by their bear-tinted spectacles after the S&P 500 broke primary support at 2550.

S&P 500

The Nasdaq 100 also broke primary support, confirming the bear market.

Nasdaq 100

Of the big five tech stocks, Apple and Google are both testing primary support, threatening to follow Facebook into a primary down-trend. If the two break primary support, that would further strengthen the bear signal.

Big Five tech stocks

Volatility (21-day) is now close to 2% but the key is how volatility behaves on the next multi-week rally. If volatility forms a trough above 1% that would confirm the elevated risk.

S&P 500

Divergence? What Divergence?

Why do I say there is a significant divergence? Look at the fundamentals.

Fedex has just released stats for its most recent quarter, ended November 30. Package volumes are rising, not falling.

Fedex Stats

Supported by a very bullish Freight Transportation Index.

Freight Transportation Index

Consumption is strong, with Services and Non-durable goods rebounding. No sign of a recession here.

Consumption

Light vehicle sales are at a robust annual rate of 17.5 million.

Light Vehicle Sales

Retail sales growth (ex motor vehicles and parts) weakened in the last month but is still in an up-trend.

Retail

Housing starts and authorizations are still climbing.

Housing

Real construction spending (adjusted by CPI) is strong.

Construction

Manufacturers new orders (ex defense and aircraft) have rebounded after a weak 2015 – 2016.

Manufacturers New Orders

Corporate investment is growing at a faster rate than the economy, with rising new capital formation over GDP.

New Capital Formation

The Fed is shrinking its balance sheet which is expected to impact on liquidity. But commercial banks are running down excess reserves on deposit at the Fed at a faster rate, so that Fed assets net of excess reserves (green line) is actually rising. Hardly a drain on liquidity.

Fed Balance Sheet

Market pundits are watching the yield curve with bated breath, waiting for the 10-year to cross below the 2-year yield.

Yield Differential 10-Year minus 2-Year

In the past this has served as a reliable early warning, normally 12 to 24 months ahead of a recession. But the St Louis Fed Financial Stress Index is well below zero, signaling an accommodative financial environment.

Financial Stress Index

Why the mismatch? Fed actions — QE, Operation Twist, and even steps to shrink its balance sheet — have all suppressed long-term interest rates. We need to be wary of taking signals from a distorted yield curve.

Why have stocks reacted?

This is not a Pollyanna outlook. Never argue with the tape — we are clearly in a bear market. So why are stocks diverging from the economy?

The answer is China.

The impact of a trade war with the US would most likely cause a recession in China. Oil prices are already plunging in anticipation of falling demand.

Nymex Light Crude and Brent Crude

Commodities are likely to follow.

DJ UBS Commodities Index

The impact of a Chinese recession would be felt around the globe. Europe has its own problems and could easily follow.

DJ Europe Financial Index

The US is likely to emerge relatively unscathed but Wall Street is going to be exceedingly cautious until some semblance of normality is restored.

I do not suggest selling all your stocks but make sure that there is enough cash in the portfolio to take advantage of opportunities when they arise.

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Aussie Gold stocks continue strong run

The Dollar rally is slowing, with the Dollar Index running into resistance at 93, ahead of the anticipated 95. Penetration of the descending trendline suggests that a bottom is forming. Bullish divergence on the Trend Index indicates buying pressure. Retracement that respects the new support level at 91 would be a bullish sign. Breach of 88.50 is unlikely but would warn of another primary decline.

Dollar Index

Rising crude prices weaken Dollar demand.

WTI Light Crude

Spot Gold continues to test support at $1300. The declining Trend Index indicates selling pressure and a peak below zero would warn of another test of primary support at $1250/ounce.

Spot Gold

Australian gold stocks continue their strong run. Retracement of the All Ordinaries Gold Index that respects the new support level at 5000/5100 would confirm a fresh advance and long-term target of 6000.

All Ordinaries Gold Index

A weakening Aussie Dollar, testing support at 75 US cents, is driving local gold prices. Breach of support would offer a long-term target of 69/70 US cents.

AUDUSD

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OPEC extends output cuts but “caught in a pincer”

From Stanley Reed at The Age:

The Organisation of the Petroleum Exporting Countries extended oil production cuts through March 2018, Khalid A. al-Falih, the Saudi energy minister, said in Vienna overnight. The move follows a decision this month by Saudi Arabia and Russia to do so.

The earlier announcement helped lift prices from a low of $US46. But on Thursday, prices shed more than 4 per cent with more than a billion barrels traded….

“Opec is being caught in a pincer movement of technology and policy that will, over time, erode oil use,” said Bill Farren-Price, chief executive of Petroleum Policy Intelligence, an advisory firm for hedge funds and other investors. “This meeting is more about forestalling an oil price collapse than driving prices higher.”

Read more at: OPEC agrees to extend output cuts through March 2018

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