Professor Elam

Friday Aug 5 2011

$85 Oil

Now we have another ominous sell signal. I take these very seriously; everyone in Andrews should do likewise.

One on One, Andrews County News, July 28, 2011

That was our lead in comment last week. We went on to postulate a potential scenario of a world-wide meltdown in stock and commodity prices. Now one week later that scenario is already coming true. For those of you just joining us, we noted that a monthly sell signal in our timing model occurred in crude oil. This is exactly how the world-wide melt down in the markets began in the summer of 2008. We have been warning of such a top for several weeks in this space. We hope that those of you in the energy service business have taken note, raised cash, and paid off debt. We also noted the anecdotal signs of frantic activity all over Andrews from fancy pickups to folks living in motel rooms. So, let’s look at both the fundamental and technical side of what has happened in the last week.

As I write Friday morning August 5, crude has fallen to $85. Oil Market Fundamentals News sources around the world are broadcasting photos of Egypt’s Mubarak in his 'cage' on a gurney with cancer (we are told) on trial for his life. It is a sure bet the meaning of this photo is not lost on other Arab leaders. The only possible result is that either the current leaders will pump more oil to create programs to calm the protesting masses or those that replace the current leaders will do the same thing. Either way there can only be more oil produced in the face of falling demand. Unemployment is on the rise and people are driving less. Oil prices and demand for oil is falling as Manufacturing and Purchasing Manager Indices fall around the world. Real estate prices world-wide are floating on the sea of speculative money still sloshing around from government stimulus schemes.

The next marker to fall will be commercial and residential real estate, particularly in over heated commodity based economies like Australia and Canada. By the way, even in conservative San Antonio, the downtown office vacancy rate is 28%! Already cotton, coffee, and now crude oil prices are falling.

The next phase of the bear market, which is likely to last into 2013 will destroy the remaining existing pollyana assumptions about positive stock market returns. This will put existing pension and teacher retirement plans even further under water. All defined benefit plans make an assumption about annual returns from their investments. If the investments come up short, the provider is supposed to add to the plan to make up the difference. But, few to no providers do this! The only possible result will be to roll back existing retirement ages as well as promised benefits. More people will just continue working. This will mean fewer openings for those coming into the work force. This is ALREADY happening which is why so many college grads are moving back home. Hence the unemployment levels will continue to rise with less take home pay and therefore fewer purchases of hard goods like washing machines and automobiles.

The European reality is that it is not merely the small countries but the too big to fails like Spain and Italy that have too much debt. The Italy ETF which is EWI has lost one third of its value since May 1. This will eventually weaken the Euro resulting in demand for the US Dollar. The Dollar rallied 1.5% Thursday. Since oil prices are denominated in dollars, a stronger dollar is likely to further dampen oil prices. Patterson hit $35 in 2008; that has been our warning signal. Patterson PTEN made it to $34 and has fallen 19% in just five days. In the energy service industry, cut backs are on the way. And, the apparent salvation of the industry, natural gas, has dropped 20% since the first week of June to less than $4 an mcf. Price drops will make it difficult to support the expensive fracturing and related services that have been driving the shale gas boom.

Will gold and silver be the last refuge of safety? Yesterday GDX a bell weather gold mining holding company dropped 5.57%. Mining stocks have stubbornly refused to confirm the run up in the price of gold. So far gold is the last commodity refuge of speculators. Crude has fallen $30 or 26% from its high of $115. Yes it is oversold but trying to catch the proverbial falling knife or predict a near term price support level in a panic is a fool’s game. But frankly the absolute price level will not be driving the activity level in the Permian Basin. Expectations drive activity levels. And now the expectations, have dramatically changed from $145 oil to how low might it go.

So, once again, as was the case in 2008, we prepared you for what has happened. We hope that all in the energy service (including the bankers…) industry have taken precautionary, defensive steps to protect their business.