Oil subsides but is still potent for upside

Oil continues to strength against massive supplies in the US.

"Oil inventories at Cushing reached 34.1 million barrels in the week ended April 16, less than one million barrels shy of a record, the U.S. Energy Information Administration said Wednesday. The extra oil has few outlets, with stockpiles across the Midwest at their highest in at least 20 years and refiners already producing enough fuel to further inflate gasoline and distillate inventories."

Supplies at the highest level in 20 years and oil is still above $80/barrell. Wow.

'"Oil prices have managed to remain above $80 a barrel largely due to strong demand out of China, which has exceeded expectations for economic growth over the last 18 months, even as U.S. oil demand has underperformed.

"The shift in the epicenter for demand continues to shift east of the Suez," wrote analysts with Barclays Capital.'

Yet this may not be the end of it. If the Chinese yuan increases, then oil could go even higher if their stimulus is maintained while the currency appreciates and thus the buying power of China increases.

Oil: Another China play

Some said it was the USD holding up the oil price. Now the USD has retraced to pre-crisis levels vs. other major currencies and the price of oil has not fallen.

As it turns out, China imports are a large catalyst in demand for crude oil.

“China’s growing reliance on seaborne crude oil imports will set the tone of the tanker market for the coming decade,” Poten said in a report to clients, quoted by Bloomberg. “China’s expanding middle class, strategic stockpiling and complex refining capacity ensure that it will continue to be a large ship, crude oil story.”

What is strange is that overall world demand is down, but since China is buying, prices are up. This is somewhat understandable because 50% of the oil futures contracts traded are for speculation. So it is a self feeding machine.

In any case, based on this information I will be looking for an acceptable exit point for my SCO position. I cannot invest with 80% confidence when I see I am fighting the Chinese stimulus investment in oil consumption. I will need to wait to see lending decline prior to taking such a position again.

"China’s crude oil imports may reach an all-time high this year as an economic recovery spurs demand for fuels, data from China National Petroleum Corp. showed on Feb. 4. The Chinese economy, which expanded at the fastest pace in the fourth quarter since 2007, will grow four times faster than the U.S. in 2010, the United Nations said in December.

Chinese charterers accounted for about 30 percent of VLCC spot fixture activity this year, up from below 5 percent a decade earlier, Poten said."

Is it time for the USD to show some muscle?

The US dollar has been kicked, spit on, and left for dead in 2009. Gold bugs, fiscal conservatives, and doomsayers all have abandoned the US currency in anticipation of economic meltdown due to the massive amount of debt spending to slow the crisis.

But have USD critics gotten ahead of themselves?

* Oil has overshot against the USD

Since March, USD has fallen less than 20% vs the Euro, but oil futures have increased 40% in anticipation of a collapse in the purchasing power of the USD. Yet that has not happened...

...and as time ticks by, the disparity between the increasing inventory of oil in the market and the demand on the exchanges becomes more and more peculiar.

* Even weaker currencies have gained 30% vs USD

Emerging market currencies such as the Colombian Peso, Brazilian Real, and Turkish Lira all have gained over 25% vs the USD in a just six months. Although their futures are bright, there are still significant political risk to emerging countries that is now disregarded in the purchase price.

* Lots of deflation on the horizon

The market has been bearish on the USD since March. But considering the wind down of stimulus in the next few months (Treasury purchases, MBS purchases, Cash for Clunkers) and also housing programs (HAMP, Housing Tax Credit), the deflation of reduced economic activity should be significantly bullish for the USD.

* USD is reaching historical support levels

Emerging economies need the USD propped up to maintain exports and keep the flow of hard currency into their country. This historical chart underscores the importance of the US economy to the world.



* Traders have moved to a net long position on the USD

In fact, it has been noted recently that traders have switched to a net bullish dollar position.(1)

* USD reversal could cause market mayhem

Many journalists remark on how the investment banks borrow from the Fed for free and invest in other currencies to obtain a spread. This is called a carry trade and it has helped banks such as Goldman Sachs, Morgan Stanley and JP Morgan book billions during this year. Roubini thinks an uptick in the US dollar will lead to a massive carry trade unwind.

“Everybody’s playing the same game and this game is becoming dangerous.”

The dollar has dropped 12 percent in the past year against a basket of six major currencies as the Federal Reserve, led by Chairman Ben S. Bernanke, cut interest rates to near zero in an effort to lift the U.S. economy out of its worst recession since the 1930s. Roubini said the dollar will eventually “bottom out” as the Fed raises borrowing costs and withdraws stimulus measures including purchases of government debt. That may force investors to reverse carry trades and “rush to the exit,” he said.

“The risk is that we are planting the seeds of the next financial crisis,” said Roubini, chairman of New York-based research and advisory service Roubini Global Economics. “This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals.”(2)

The author of this blog thinks it is time for the USD to correct, but that it is too risky to play for a major spike in the USD. In the case there were unforeseen banking issues in Europe or in a significant emerging market, a run to the USD could be damaging to US banks who are leveraging USD.

The author recommends buying SCO under $13 and exiting above $15.5

(1) Forbes.com, "Stronger Buck Threatens Stocks And Commodities", Ryan Campbell, Nov 3, 2009

(2) Bloomberg.com, "Roubini Says Carry Trades Fueling ‘Huge’ Asset Bubble", Michael Patterson, Oct 27, 2009

If this is a recovery...

If this is a "recovery", then I need to take high school english again. Recovery from an injury means regaining health and mobility. I see little health in the following stats considering the massive stimulus it took us to get there.

First of all, how do job loss trends like this...

...translate into increasing home prices?

It must be this...

...since I don't see a rebound in Buffet's favorit metric...



...or here in US daily oil consumption (even though the reported numbers are only until July)...


Bottom line. All I see is a little prop up, not recovery. Remember, my previous blog mentioned that we are now at the peak effect of the stimulus and that it will wear off from here. At least the headlines have toned down from the cheery "That was easy!" messages of two months ago. Let's see if they turn into "This is kinda hard?" in March when the Treasury stops buying agency debt.

Stimulus Watch: China stimulus effect declining

Commodities are the key sign for watching the effect of the stimulus program in China. Across the board, signs are starting to show that the largest stimulus program (as a percentage of GDP) is already starting to wane in effect. In the comments, let me know what other factors you are watching to track China's stimulus progress through the system.


(1) Oil consumption


Even though China recently became the #1 consumer of automobiles, oil consumption peaked in July and has been declining. "August seems to have brought a reality check for refiners in China," said Vandana Hari, Asia news director at Platts. "Domestic fuel demand has clearly been lagging their high processing rates, and storage space is finite."


(2) Copper demand


The large state sponsored infrastructure projects drove tremendous demand for copper and semi finished products. There were even reports of pig farmers stockpiling the metal as a speculative investment. But there is cracks in this demand too... "Traders say the market was worried that China, the world'slargest consumer of copper, may have overdone the stock building,which boosted prices in the first half of this year. Chinese copper and semi-fabricated imports fell 20 percent in August from July at just over 325,000 tonnes, and off 30 percent
from a record 476,000 tonnes in June."




(3) Iron Ore

Even iron ore, like copper, linked to China's massive development projects. "Cash prices for iron ore delivered to China from India have fallen 26 percent to $82 a ton since August, according to Metal Bulletin prices for the week ended Sept. 4. Iron ore from Australia has fallen 28 percent since Aug. 13 to $76.1 a ton yesterday, according to the Steel Index. Iron ore inventories at China’s major ports reached 76.5 million tons for the week ended Sept. 4, the highest level this year, according to data provided by Beijing Antaike Information Development Co."

(4) Lending

"The drop in new bank lending -- to an average of 383 billion yuan ($56 billion) in July and August compared with a monthly average of over 1.2 trillion yuan in the first half -- will also pull down transactions in the coming months, said Gao Shanwen, chief economist at Essence Securities."

(5) Constrained Lending -> Real Estate Asset Price Declines by End of Year

Policy tweaks and slower lending will probably be enough for now, analysts say, allowing Beijing to stop short of declaring a full-fledged campaign to stamp out property speculation similar to one in 2007. Ge projected that housing prices would drop toward the end of 2009 or early next year, by about 10 percent, much less than a 20-30 percent fall witnessed last year."

Clearly the world economy would suffer greatly if the program disapated in effect so quickly.

Let me know how you are preparing for the stimulus to wear off and when you expect the timing to occur.