"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, June 25, 2014

Volatile Crude Oil Impacting Commodity Indices

Hold onto your hat for the wild ride currently taking place in the WTI crude oil market. Yesterday afternoon, the front month soared nearly $1.50/barrel when news hit the wires of a Wall Street Journal "scoop" story that the Obama Administration was supposedly going to relax the export rules to allow two firms to export ultra-light crude. The firms are Pioneer Natural Resources and Enterprise Products Partners. This was regarded as a big deal because the US has not exported oil in nearly 40 years. We can export refined products just not the raw stuff.

Oil spread traders are having a field day on this news.

After being down for the previous two sessions, the price shot up, completely erasing those losses. However, and this is key, the market could not extend past the overhead chart resistance centered near the $107.50 level. It did manage to keep its footing near $107 but as more data hit, this time the storage or stocks number, the market began to slowly retreat.

The EIA showed crude oil stocks rose 1.7 million barrels to 388.09 million. The market was actually looking for a drop of 1.2 million barrels for that week. Both gasoline and distillate stocks rose.

The market however bounced higher mid-morning continuing its extreme volatility. What we are witnessing is the result of the massive speculative long side positioning with hedge fund longs in particular attempting to defend those positions.

The problem however in crude is what we were reminded of by both the EIA data and the bigger news, the incredible downward revision to Q1 GDP. To say that it was lousy, would be a disservice to the word, "lousy". It was abysmal! The number was revised to a nearly 3% shrinkage.

So here is the question - what in the world is crude oil doing up at these levels when the economy is seemingly going backward? Yes, I understand the Q1 number is backward looking and that markets are inherently forward looking, but given this sharp rate of contraction in the economy, we are going to have to have seen some quite rapid improvements in the economy during Q2 to get the number up near even 2.0 -  2.5% GDP growth. Even at a number like that, it is certainly not indicative of an economy roaring full spread ahead and it certainly is not one that would seem to be burning through crude oil at a rate to justify these rather lofty oil prices.

As I wrote previously, just how much of the crude oil price is due to geopolitical premium ( speculative demand ) and just how much is due to actual demand for the product itself? That is the mystery. This is why that big overhang of speculative long positions in this market makes me extremely nervous. At what point has the market fully factored in geopolitical unrest?

Another question - have these speculative players been buying crude as an inflation hedge? If so, how much of that buying is related to this?

I am raising questions that I have no answer for but am doing so to illustrate the complex factors going into the pricing of the black gold. But here is one big question - with an economy limping along, how can inflation pressures be a concern? Or are we witnessing the dreaded stagflation scenario? That the TIPS spread is increasing shows investors are worried about budding inflation pressures yet the economy is going nowhere fast it would seem. Food for thought is it not?

But let me come full circle and actually move towards the headline I chose. The commodity indices that we are now left with are too heavily weighted towards energy in my opinion but they are the only ones we have to work with. As such, energy prices have an unduly disproportional impact on the price levels of these various indices. Thus, I do not believe that they are truly indicative of what is happening across the broader commodity complex. Volatile crude oil prices can disproportionally drive the commodity indices higher when energy is moving higher and can also disproportionally sink the commodity indices lower when energy prices are falling.  

While these commodity indices are always helpful, one has to step back and consider some of the various sectors of the commodity markets, especially those with a lesser weighting in the various indices. Take a look at grains, such as corn and wheat for example. Corn prices, as well as wheat prices are both near a 4 month low. Soybean prices are near a three month low. Natural gas prices are essentially flat and have been for 4 months now. And while both cattle and hog prices have been soaring, they should be moderating later this year and especially into winter and spring of next year.

Then one has to consider whether or not rising energy prices are inflationary in this current economic climate, or deflationary.

The point I am making here is that there is still a great deal of uncertainty out there. Equities move sharply lower one day and then reverse course the next. Interest rates move higher only to retreat. The signals are all mixed up and that is what is leading to lack of clearly defined trends in many markets with the resultant sharp reversals in price from one day to the next.

It does sometimes feel as if we are living in some sort of weird parallel universe where everything is a mirror image of this one. In that universe, a near 3.0% contraction in the US economy for Q1 is greeted with equity buying and strength in crude oil making the stuff even more expensive and further dampening consumer disposable income.

What appears to be at work in equities, at least for today, is that some buyers are still considering that Q1 number an aberration and that growth is going to pick up for the remainder of this year. That may be the case; it may not be the case. No one really knows for sure. All it leads to each piece of economic data being scrutinized ever more closely to see how each piece of the pie comes together.

One brief point here - you hog producers out there - we have a Quarterly Hogs and Pigs Report coming up Friday so be careful. I hope some of you have secured some hedges in expected Q4 production and Q1 2015 production along with long side feed coverage.

More later as time permits.