Thursday Oct 16 2014

Word Count 782

Crash !

Social mood has moved to more extreme positions which has taken markets down around the world. We have been warning of such an event for the last couple of years in this space. It is here, now. Let’s examine the various topics in a quick over view of what has happened in the last sixty days and the implications that holds.

The Price of Oil and Gas

The price of West Texas Intermediate has fallen from $107 to $80.  It rebounded Thursday and Friday morning as I write. That is a 25% drop which has or will affect economies all over the world..  Many economists are taking the position that this will spur the economy. This makes driving cheaper. More people will drive to stores (retail is the basis of the economy) and spend their now extra disposable income.

I don’t think so. I believe the drop in the price of oil and natural gas, is indicative of a weakening economy that simply cannot afford higher energy prices.  Compounding the difficulty is there are few oil producing regions that which can afford the option of a lower cash flow.  This will affect numerous players in the oil market.

Russia

Vladimir Putin has fashioned Russia to be a commodity economy rather than a consumer economy. With Russia 50% dependent on oil revenue, this puts Putin much more in charge than if say some Russian version of Facebook had a say in what is going on. As long as Putin can bluster his way through various energy deals, as in the Ukraine, things are just fine. But if the price of oil drops 25%, the income to Russia drops 12.5%.

OPEC

Fractured as always, OPEC is doing anything but maintaining stability for the price of oil. The Saudis told the world this past weekend to get used to lower oil prices. They are lowering price to dissuade Western Countries from fracking and producing more oil. This makes sense from their standpoint. But, it is hardly an  assurance for cash strapped Venezuela or Nigeria. None of the  OPEC members seem interested in lowering oil  production.

Panic – Headlines

Stocks Swoon  in Frenzied Day, down 415 points

New Push to Check Ebola

Risk of Deflation

HBO  Plans Web Service, Netflix drops 25% in After Hours Trading

Wal Mart, McDonalds warn of Rough Spots Ahead

EU Central Bank Balks, Wondering What to Do

What It Means

There are various marginal economies (Kuwait, Iran, Nigeria) that have nothing other than oil to sell. To maintain cash flow they are more likely to increase production for cash, than raise prices. The result will be more supply in a world already awash in oil.

One can read various predictions that oil can be produced in the Balkan, Eagle Ford, or Permian with prices as low as $60. This assumes that bankers who lend on energy exploration or deaf, blind, and dumb. They are not. As fears of ever lower oil prices spread, the lending spigot will be cut off.  I have no idea at exactly what price that happens. But it will happen. 

Local governments in  the Permian Basin and the Eagle Ford have been wondering how they would cope with the demand for services. Careful what you wish for. Now imagine all those new residents are still here, but the without the foundation of ever higher oil prices. Suddenly property and sales tax revenue falls. But demand for services  is as high as ever. This is a real problem.

Meanwhile in Austin, the severance tax revenue will shrink. That means lower property taxes for the State of Texas and Texas Counties. Higher Education never saw this coming. State Universities should expect to be rebuffed at the Legislature when asking for more money, in capital and operating budgets.

Stock prices for companies drilling in the Eagle Ford and the Permian Basin have been hit hard. Sanchez Energy for example is down 50% in four months. In the 1973-74 bear market I termed this the black hole of the bear market. Stock capitalization, wealth in the stock market, vanishes as investors panic out of troubled sectors.

Finally, we have expected a top in the five year bull stock market this Fall of  2014. It is 40 years from the 1974 Dow low at 577. With the European Central Bank out of ideas on stimulating its double digit unemployment, China slowing, and Argentina and Venezuela already looking like deadbeat borrowers, the fundamental news is negative.

October has a reputation for the roughest month on Wall Street.  And as usual the economists never saw it coming.

Follow Professor Elam on the markets at

http://www.themarketperspective.com

 

Friday October 10, 2014

Word Count 829

A Social Mood Shift for The  Fall

Wednesday and Thursday marked the biggest one day rally and worst one day drop for the Dow Jones Industrial average (^DJI) for all of 2014. That’s the first time those extremes have been hit on back to back days in nearly 17 years.

Jeff Macke, Yahoo Finance

Taken together, oil and stock prices are more likely to fall in tandem than for falling oil prices to stimulate stock prices. That is my minority view for what it is worth. This December will mark the 40^th year anniversary of the low in the Dow Industrials at 577. I suggest this might be a good time to be watching stock and oil prices, from the sidelines.

Dennis Elam in One on One, Sept 9, 2014

You can’t say I didn’t warn you….

This past week has seen volatility in stock prices reaching multi-year extremes. Moves, which used to take three days, now occur in one day. No doubt high frequency trading is the root of some of the up 250 Dow points up one day and then down the next.  But October has a deserved reputation as a crash month.  The meltdowns of 1929, 1987, and 9/11 all occurred in October. So here we are again.

Today we address the real question, what happened?  Oil prices were triple digit just weeks ago. Stock prices were on a tear amid cries of a new bull market from even long term observers. Now oil prices are down $20 and headlines report energy stocks are being crushed. The change is not so much in the market fundamentals but in the social mood of investors. Social Mood finally caught up with the reality of sky-high markets.  Let’s examine this phenomenon.

Social mood motivates social actions. Conventional wisdom has it that individuals are acted upon by the news, and then make decisions. But social mood is unconscious and internally regulated. For example, the price of oil in the spring of 2013 was $87.50. By August it hit $112.50. That is an amazing 28% increase. Did world demand increase 28% or did the supply fall by 28% in those few months?  No, but the social mood of the participants certainly expanded that much. If I have learned anything writing these columns, it is that the price of oil has little relation to supply and demand.

Last week I remarked on attending a conference on the Eagle Ford Shale play. I noted no one discussed the falling price of oil. Another large conference is slated for next month in Midland on the Permian Basin play.  Regardless of a string of correct predictions in this space, my telephone is not ringing with an invitation to speak. The reason is that my views do not fit the social mood of the organizers.

The S & P 500 soared from 1920 to 2020 in less than two months since August. Then, like Wiley Coyote chasing the Roadrunner over the cliff, social mood went in reverse. The S & P index is now testing the exact it low it up in during August. But by the headlines one might think it was Black Tuesday in 1929.  The explanation is that social mood moves in fractals. The mood can be massive compared to the actual price change.

Finally headlines are reflecting my long-standing skepticism over the durability of triple digit oil prices. One analysts reports that ‘if ‘prices drop another5 $4 or $5, companies will be forced to trim their capital budgets.’ (Emphasis added) I find the prediction of Robert Baird and Company intriguing  that ‘prices could drop to $53 in certain parts of the Permian and Eagle Ford and still be profitable to drill. ‘

To which a student of social mood can only reply, fat chance of that. Rather the more reliable prediction is that at some point on the way down, the social mood switch will be thrown from wild optimism to just plain fear. Capital budgets will not be trimmed; they will be slashed.  No one really knows the minimum price at which frocking enjoys price support. But I will bet few to no industry players will hang around to find out just where that break-even point may be.

And why is that?  Finally, social mood arises when humans interact socially. The process appears to be related to the herding impulse. It is all so typical that joyous celebrations, billed as conferences, on the Permian and Eagle Ford would be planned just two months apart. And it is just as likely they would be planned at the very pinnacle of positive social mood on the topic, After all extreme expression of social mood tends to occur near the end of a trend, not at the beginning.

Learn more about social mood and its outcomes at http://www.themarketperspective.com.

Dennis Elam is an Associate Professor at Tx A & M SanAntonio.

 

 

Friday Oct 3 2014

Word Count 789

Oil Prices Slide Amid Massive  Supply

 

Taken together, oil and stock prices are more likely to fall in tandem than for falling oil prices to stimulate stock prices. That is my minority view for what it is worth. This December will mark the 40^th year anniversary of the low in the Dow Industrials at 577. I suggest this might be a good time to be watching stock and oil prices, from the sidelines.

Dennis Elam in One on One, Sept 9, 2014

That prediction has certainly come true a month later, as have all my concerns expressed in this space over the last year. Those specific concerns are that   supply will eventually trump demand resulting in lower oil prices.  This is part of a larger deflationary trend fueled by cheap money from Central Banks. As in 2007, the result is massive debt and higher asset prices for stocks and real estate, but little for job creation. Some Hedge Funds are now leveraged eight to one in their bets on higher markets.

The illusory light switch of social mood flicked to positive March 9, 2009. A 1932-1937 like stock and real estate rally ensued. But evidence mounts that social mood switches around the world are now turning down. Let’ s connect the news dots of social mood for the real explanation of what is happening.

As the price of oil fell from 1982 into January of 1986, the Saudis were the ‘swing producer of OPEC.’ The Saudis would limit production which kept prices then above $20. By 1986 the Saudis tired of being the balance. World production soared and the price fell to $12.  Wednesday this past week Saudi Arabia lowered its official selling price for oil. The message is market share rather than an attempt to shore up price. And so prices plunged to $8.18 Thursday before recovering to $91.40.

And remember, most of the prominent oil producing nations like Nigeria  for example, have nothing else to sell, but oil.

And, US refineries are set to undergo seasonal fall maintenance. This means fewer purchases of crude oil.  The perfect storm ensues as   excess supply is  met with lower demand.

The myth that Central Bankers actually control an economy is dying hard as EU  President Mario Draghi is learning. Inflation has weakened to a five year low. Translated, there is less and less demand for goods and services amid double-digit unemployment. The ECB is now waiting to see if ‘stimulus will lift the weak economy.’

Mario can check out the Paris Auto Show for an answer. Optimism for a turn in Europe’s log suffering car business that was evident a few months ago is dropping like autumn leaves.

Deflation is on display in both gasoline prices and gasoline components. A spike in supplies has sent US Ethanol prices tumbling to four-year lows. Ethanol futures slid 28% last month as falling domestic demand left US producers with the largest inventories of this year.  Note the existence of falling demand in the last two paragraphs.

And just to keep things on edge, the latest cyber attack affected about 76 million of J. P. Morgan Chase’ customers this summer.

Meanwhile positive social mood continues among the promoters of energy conferences. We spotted this promo for the Permian Basin Conference slated for November.

I attended an upbeat presentation on the Eagle Ford Shale by UTSA’s Economic Development Group. It can be viewed on line at http://ccbr.iedtexas.org/.

West Texas' Permian Basin is shattering records and expectations. And all signs point to continued growth. Oil production has surged from a low of 850,000 bpd in 2007 to 1.35 million bpd in 2013. And in May 2014 Permian Basin averaged a record 460 rigs — up 16% from the previous year to a level not seen since at least 1980.

The point here is that one could read the same headlines in this newspaper in 1981. What could go wrong?  The answer is that in 1981 we had a record number of rigs running nationally.  And that number kept expanding as the price fell. Are we now witnessing a repeat of that same scenario?  Indeed we have a 34-year anniversary of record rig count. This is cause for concern, rather than celebration.

September and October are living up to their reputation for exciting, downbeat months in the markets. And to be fair as I write Friday, stocks are rebounding. Volatility is back. But the deflationary forces we have written about for the last year are here in earnest.  It would be best to temper enthusiasm for production with a cautionary eye on prices.

Dennis Elam PhD CPA teaches at Texas A & M University San Antonio and blogs on markets at http://www.themarketperspective.com

Friday September 19 2014 6:11 AM CST

Word Count 689

Trading Paper Barrels

Energy service companies toil to bring in the real Texas Tea, barrel by barrel in the Permian Basin and the Eagle Ford. Traders in New York are a bit more clever; they simply create paper barrels and start trading. Today we look at various aspects of the paper trade and the new reality in Texas.

The Butter and Cheese Exchange of New York began trading in 1872. Later the Exchange did business in potato futures. These trades were subject to such outright manipulation that the Commodity Futures Trading Commission CFTC was created in the early 1970s to ride herd on such frauds. Today it is known as the New York Mercantile Exchange where billions of dollars of energy contracts are traded.

Arbitrage is the process of taking advantage of price differentials in the same commodity in different markets or at different time intervals. We have tracked the drop in the price of West Texas Intermediate to Thursday’s close at $92.03.  However the October 2015 contract is trading for $100.55.  So traders can buy the near term contract at $92.03 and sell one year forward at $100.55. The trader pockets the $8.52 difference. Even if the price of oil futures is higher when October 2015 arrives, since the trader is ‘long the spot market, he is able to ‘cover’ or close out the trade and provide product to the seller.

This has resulted in a phenomenon not seen since the price collapse of 2008. Then oil plummeted to $35. Sensing this could not continues, firms began leasing tankers to store the cheap oil, hoping to profit from and eventual price rise.  For example Sinopec has leased the 3.2 million barrel supertanker TI Europe. Sinopec is storing oil there. Speculation has it that there are now some 25-50 million barrels in tanker storage.

Two weeks ago in this space I reported that supply was simply outpacing demand. The result was lower oil prices, a prediction that has come true. While storing oil to take advantage of higher future prices may be a clever trade, it is hard to see how this will eventually raise oil prices.  When there is more and more of a commodity in storage but less demand the price usually has to fall for the market to absorb the supply.

In a related development we have the latest report form the Commitment of Traders COT regarding gasoline futures. This group has been betting on lower gasoline prices since 2005. Commercial traders are seen as the ‘smart money’ as opposed to the public. The commercials are now down to one of the lowest short positions since 2010. This means fewer and fewer of the sophisticated crowd are expecting lower gasoline prices. In the past this has been a precursor to higher gasoline prices.

One reason for covering their short positions is the recent rapid rise of the US Dollar. With uncertainty all around the world, traders have flocked to the US buck. The Russian ruble, the Australian Dollar, the Euro, and the British pound have all been pummeled to the downside. Now that 55% of the Scotts have voted to stay in the UK, it is likely we will see a bounce in some European currencies, and a correction in the US Dollar.  Since September 8, the British pound has risen from 161 to 164 apparently anticipating the Scottish vote.  The US Dollar is over extended on a short term basis and could certainly correct. Oil priced in dollars might bounce to the upside for the duration of a Dollar correction.

Meanwhile the US stock market is still on a tear.  It looks like the NASD is poised to re-visit its March 2000 high at  5,000. My hesitation on stocks is simply that the wild ride up can reverse in similar fashion. It has been several years since we had even a 10% correction  in the stock market . But for now the ever-reliable New York Stock Exchange Advance Decline line is still headed up.

Dennis Elam PhD CPA blogs on markets at http://www.themarketpersepctive.com

 

Sept 9 2014

Word Count   767

Too Much of a Good Thing

Two weeks ago in this space I was able to state that the price of crude oil was able to hold its uptrend line. Today that is not the case. Crude oil prices are breaking down and are apparently a good deal weaker in real West Texas Intermediate Crude WTIC prices than what we read on the New York Mercantile Exchange. There are two schools of thought on whether this is good or bad for the overall economy. For sure it is a warning shot in the Permian Basin and the Eagle Ford Shale producing areas.

The spot price of WTIC has dropped from its June high at $107 to just under $93. Price fell through a ‘triple support area’ at $99. This past week witnessed huge intra day swings of over $2.50.  I would expect a rebound to perhaps the $97 area and then a resumption of the decline. We have seen similar declines in other commodities such as gold, falling from its July high at $1340 to below $1270. The silver chart is even weaker.  The Commodity Research Bureau Index representing a basket of commodity prices including energy continues to fall. It is now trading under the 200 day moving average of 295.

One school of thought is that falling energy prices will. boost the economy. Some department store stocks were up this week on the idea that consumers would be more likely to drive to the store.  Personally I am not so sure it will work out that way. Perhaps we are seeing the return of the 2007 start of a deflationary wave. The fortunes of oil exporting states provide an interesting window on this debate.

Saudi Arabia exported 878,000 barrels of oil to the US each in August. It sold for 48 cents less a barrel than Louisiana Sweet. This is the narrowest discount since Bloomberg started keeping data back in 1991. Here is the rub. THE Saudi Oil Minister Ali al-Naimi predicted last December Saudi shipments would average 1.4-1.5 million barrels a day. So real exports are 500,000 barrels a day less, which at $100 is a $50 million dollar a day, drop!  The reason of course is the expanded output of US oil production.

In researching this article I note some experts are discounting this as a short-term event, don’t read too much into it. But we keep getting rosy scenario reports of ever expanding US production. Reports of substituting gas for water in fracking or at least reducing the amount of water required lend credence to this view.

As noted some believe lower energy prices will stimulate the economy with all kinds of cheaper energy.  But as I connect the dots it looks more and more like the start of a race to the bottom or for energy prices. The OPEC countries have little to sell other than oil. Other players like Russia have bet the future of their country on strong energy prices. With fixed commitments and entitlements to citizens totally dependent on oil revenue, my guess is that such exporters are likely to sell more and more oil at ever lower prices to keep their revenue streams going. As noted, commodity prices are down across the board, not just in the energy sector.

This is also being driven by a stronger dollar. The world is wondering what Mario Draghi, the head of the European Central Bank, will do. Already he is lowering rates and in some European countries, some very short-term rates are already negative. That does not lave much room for further reduction. France’s Prime Minister Hollande re shuffled his cabinet for a second time in six months still attempting to counter 10% unemployment. Meanwhile the Middle East seethes with civil war. Whoever is in charge will need more money to fight, and surely that means higher production.

Stock prices are dizzyingly high and now down four days in a raw. Monthly volume has been decreasing from the highs seen in March 2009. We have had a more and more narrow focused rally in a few large stocks the last few months.

Taken together, oil and stock prices are more likely to fall in tandem than for falling oil prices to stimulate stock prices. That is my minority view for what it is worth. This December will mark the 40^th year anniversary of the low in the Dow Industrials at 577. I suggest this might be a good time to be watching stock and oil prices, from the sidelines.

Dennis Elam blogs at http://www.themarketperspective.com