Oil Will Drop to $40 Before Rising to $50

Oil has dropped about 13% since its high of $51.67 in early June. On Friday NYMEX September crude fell 56 cents at $44.19/b. ICE September Brent settled down 51 cents at $45.69/b. The US Dollar Index reached 97.5 Friday, its highest level since March 10. A stronger dollar makes fuel imports more expensive for holders of other currencies. The Brexit vote raised concerns about European economic strength.

My last report on oil occurred in early June as futures prices broke the $50 mark for the first time in a rally driven by a US decrease in production and a weakening dollar. I claimed that it was highly unlikely for oil to rise to $60 because of three reasons: Middle Eastern production, temporary outages, and the Bullwhip Effect. Saudi Arabia, who is very capable of operating in a low price scenario, showed no signs of slowing down and Iran is determined to rapidly ramp up their production. Nigeria and Canada’s outages helped spark a rise in oil prices, but the effect of those short-term catastrophes is waning. All eyes have been on US production, gasoline inventories and demand, and the overall economic outlook. And sure enough as oil prices rose US energy companies eagerly watched the futures ticker, salivating over the idea of $60/b. Cautiously optimistic, production has continued to decrease, but the opposite is true for active rigs revealing that US companies are more adept at operating in a low-cost environment and are tempted to revamp operations.

Nigeria and Canada

The outlook for these two past market movers is split. The Nigerian oil industry risks sinking deeper into crisis in the months ahead with more disruptions to oil output and exports as the government’s dialogue with militant groups has failed to curb violence in the Niger Delta. Some 700,000 b/d of Nigerian oil output is currently shut-in due to the latest wave of attacks on pipelines and other production facilities in the Niger Delta region, the state oil firm NNPC said Thursday, taking production to around 1.5 million b/d. Nigerian officials hope that production will normalize soon but these seems increasingly unlikely.

Canadian companies are slowly showing signs of life after the wildfires that plagued multiple oil sites abated. The number of oil and natural gas wells drilled in the second quarter of 2016 in Canada fell 58% but there are some signs of resurrection. Three leading oil sands producers — Cenovus Energy, Canadian Natural Resources and a joint venture between ConocoPhillips and Total E&P Canada — have remained on track to add a combined raw bitumen production capacity of over 300,000 b/d by late 2017. Drilling activity is also expected to be maintained in the Montney and Duvernay. According to the CEO of Canadian drilling company Precision “We have started off [Q3] with 29 rigs each in Canada and the US and our hope will be for the rig fleets to remain in service. With a few more dollars of increase in [the] oil price, we will move up nicely, and in the WTI $60/b to $65/b range, we can expect all our 200 rigs to be contracted”.

US Production

Falling US crude production and inventories have offered support for the market despite the recent drop below $50.

The July Short-Term Energy Outlook (STEO) forecasts crude oil production from the Lower 48 states to continue to decline through the rest of 2016, then level off in the first and second quarters of 2017. This production forecast is predicated on the WTI price forecast in STEO, which rises from an average of $47/b in third-quarter 2016 to an average of $50/b in second-quarter 2017. Crude inventories fell 2.34 MMbbl last week, according to the Energy Information Administration.

Despite decreasing production drilling rigs targeting crude in the U.S. rose by 14 to 371, after 27 were added since the start of the month, Baker Hughes Inc. said on its website Friday. While declines from existing wells are expected to result in a net decrease in production, increased drilling and higher well productivity are expected to soften the decline. The new-well oil production per rig through July 2016 averaged 796 b/d in the Bakken region (within the Williston Basin), 983 b/d in the Eagle Ford, and 470 b/d in the Permian, according to EIA’s latest Drilling Productivity Report.

 

Also US gasoline inventories stood at 241 million barrels the week ended July 15, a 12.1% surplus to the five-year average for the same time of year, according to Energy Information Administration data.

 

So What Does All of This Mean?

US data remained the key driver in oil prices for the past month or so. The lower production provided optimism for both investors and companies alike. The ambiance surrounding the black-gold elites improved to be less depressing and more forward-looking. Halliburton CEO Dave Lesar said Wednesday, “Today our customers are thinking about growing their business again rather than being focused on survival.” It only seems logical that while US production helped ignite the rally, any signs of weakness or supply gluts will drastically lower prices. Ceterus Paribus, in a best case scenario, with Russia, Iran, Nigeria, and Canada’s storages remaining the same then that leaves the US to decrease production. Rig counts, gasoline inventories, and increased optimism show that the US may not be so aggressive in curbing output. With the peak driving season considered to be ending in September look for a glut either on the crude or refined sides leading to $40 prices.

 

 

http://www.platts.com/news-feature/2016/oil/african-energy-outlook/index

http://www.platts.com/latest-news/oil/calgary/canadian-q2-oil-gas-drilling-falls-57-signs-of-21050812

http://www.eia.gov/petroleum/weekly/

http://www.bloomberg.com/news/articles/2016-07-21/oil-heads-for-weekly-loss-amid-ample-u-s-crude-fuel-stockpiles

Please Don’t Become a Magikarp

These past few weeks are a testament to the average person’s 7-second attention span or however short it is… I was too distracted to read the whole article. Apparently our attention span loses in length even to that of a goldfish. Undoubtedly, the increased dependence on digital processing, social media, and smartphones have allowed us to no longer need to sustain focus for a long period of time. Why commit things to memory when you can look information up in a matter of seconds? Many people get their news from Twitter, short articles, or horrifyingly enough from Facebook. This inability to retain bits and pieces of fact or fiction gathered from various media sources has proved very resourceful recently. Because if humanity were able to maintain a grasp on current events then surely they would go mad. Shootings in Orlando, bombings in Iraq, five police officers dead in Dallas, the massacre in Nice, a military coup in Turkey. If any sane man or women had the capacity to dwell on our world’s reality then they would be crushed by the burdens of human emotion: Surprise, empathy, grief, animosity, and anger. But posting a quick blurb on Facebook is perfect for relieving your conscious while creating the perception that you give a shit. Maybe it’s a blessing. What other choice do we have than to get on with our own lives?

Current events aside let’s turn this goldfish into a Magikarp. For those of you who aren’t avid Pokemon fans a Magikarp is a Pokémon resembling an orange fish. It is about as useless as the Federal Reserve’s monetary policy. I’m assuming that this Magikarp also has a longer attention span than humans and embodies so many of the faults of this digital age. Because while we choose not to remember the atrocities committed, the victims that need our help, or the political and economic instability ravaging our countries at least we can focus what little attention that we have on PokemonGo. According to Wikipedia, “The game allows players to capture, battle, and train virtual creatures, called Pokémon, who appear on device screens as though in the real world. It makes use of GPS and the camera of compatible devices.”  In the two weeks since PokemonGo has been released it has acquired more users than Twitter, sucked up more Smartphone time than Facebook, with the system briefly shutting down because of the high amount of users. People are roaming the streets staring down at their Smartphones looking to catch the next big Pokémon. The amount of time and energy going into this game are astounding and they provide the perfect escape for people who just can’t handle real life. In some instances it is just plain cowardly.

The Nintendo stock price is flourishing, almost doubling in the past two weeks. They are about to launch a $35 wristband to notify when Pokémon are near. With just $273 million in earnings in 2015, if 5% of users bought this wristband they would generate $1.75 billion in revenue. This is just the tip of the iceberg as Nintendo plans on expanding into other gaming worlds such as Mario and Zelda.

The “Magikarps” of the investing world seem to have even shorter memories then the millions of Smartphone users. This week was capped off by good news in the retail sector.  Sales rose 0.6% in June from May, which was far above the 0.1% consensus from the Street. Sales rose in virtually every category, even department stores. The only categories to see sales drop were clothing stores and restaurants and bars.

While people are claiming this bodes well for the economy they forget that May’s initial report was revised down significantly, from a gain of 0.5% to only 0.2%. So the June number, assuming it too isn’t revised, is just an offset of what now appears to be a mediocre May.

The other recent good news came from the June jobs report. The consensus was for 180,000 jobs to be created and the range went from a low of 130,000 to as high as 235,000. The actual number came in at 287,000, over 100,000 jobs above the average consensus. While great numbers I would advise investors to remain cautiously optimistic. Don’t just shrug off the downward revision for the already bad number from May, making it even worse. Initially that number was 38,000 jobs and now it’s just 11,000 jobs. So about 70% of the jobs disappeared.

Euphoria set in this week as US stock markets reached record highs. The Dow Jones ended at 18,513 at the closing bells on Friday. There was a quote in the WSJ that made me cringe. Some analyst claimed that “the market is solid, which means the economy is solid”.  We are in the midst of the second longest bull run in US history spanning seven and a half years. Easy monetary policy was the solution to the Great Recession in 2008 and has continued despite the Feds claims that they will raise rates. The flow of money from central banks in Japan and Europe has resulted in a selloff of Treasury Bills all over the world creating inflated assets, most notably stocks in bonds. With negative yields investors were actually paying to lend money to Berlin on the 10-yr German Bund. With such low returns where else can you put your money but the stock market? The Federal Reserve has been inflating their balance sheet for so long now while experiencing diminishing returns in economic growth. It seems obvious that this money that they’ve been injecting into the markets is not stimulating the working class but is going right back into equities creating a nice big bubble. No matter what the Fed says they can’t raise rates because they realize that the natural brain chemistry of our economy is now wired around easy money; it’s not so easy to quit this type of heroin. The reason the stock market went up this week is because people realize that the strong jobs number does not mean the Fed will raise rates. This paradox of record low interest rates and record high stocks is here to stay.

With a desperate search for adequate returns in this environment there are still places to go. A good place to start would be to protect against inflation through commodities, high-yield bonds, REITs, emerging market equities, and Munis.

This week’s rally did result in a selloff of T-bills with yields rising from 1.547% from 1.366%. With low yields, Treasuries may still not be a bad buy.

Even though a $10,000 investment produces a paltry $158 in annual interest income, returns of bonds have been higher than they were in the past. While many investors focus on the nominal yield they don’t take into account the “real yield” or the yield less the CPI. Currently with low inflation there may be some money to be made. Would you rather have a bond that is yield 1.55% with 1% inflation which equals .55% (Pretty bad I know) or a bond that yields 3% with 4% inflation providing negative returns.

This misperception is known as the “money illusion.” According to Barrons, “The term was coined by Irving Fisher, an economist at Yale University, in his 1928 book of the same name. Fisher defined it as “the failure to perceive that the dollar, or any other unit of money, expands or shrinks in value.”” In the money illusion, nominal figures jump out more vividly than real numbers.

We live in a world where very few people are willing to forgive but are very skilled at forgetting. People can barely predict the direction of the market in a year’s time, much less a week, or even seven seconds. Don’t be a Magikarp, keep your head up, and explore the data from all angles to succeed in today’s market.

On Compromise: My grandfather’s take on the polarization of America

Bob Natiello WG56

On Compromise

When asked, “Just exactly what are your politics,” I always answer with a unique expression of neutrality. “I’m a member of the Algebra Party,” I state. “Whatever you do to one side of the equation, you have to do to the other.”

Though my words are nothing more than a personal refusal to commit to one particular party, they seldom fail to draw looks of suspicion. You can’t be neutral, their eyes say. You have to choose one side or the other. Yet recent Gallup polls show that the percentage of voters who call themselves Independents has grown to 43%. In the same time frame, the percentage who say they’re Democrats has dropped from 36% to 30%. The percentage of voters defining themselves as Republicans has also fallen, but by a more modest two points: 28% to 26%.

These declines in party allegiance show a distinct change in the body politic. Today, more voters identify themselves as Independent than as Democrat or as Republican. A nagging discomfort with government is behind this shift, political scientists say—an obvious failure of our leaders to get something done.

In her recent book, Penn president, Amy Gutmann offers her insight into the root cause of these feelings. With co-author, Dennis Thompson, she cites failure to compromise as the culprit that prevents us from moving ahead. Even when compromise might favor a common good—improved education or a fairer tax code, for example—politicians on both sides seem unwilling to yield their cherished beliefs in favor of cooperation. In an interview on CBS’s 60 Minutes, John Boehner, the former Speaker of the House, gave this answer to Lesley Stahl’s question about compromise, “I reject the word.” I believe this unyielding partisan mindset keeps our nation from reaching consensus.

A major reason behind this intransigence is the media. They’ve taken the simple act of changing one’s mind, redubbed it “flip-flopping” and virtually criminalized it. In such an adversarial atmosphere, what politician—of either stripe—would dare compromise? Concede a point to your opposition by backing off, and the media will skewer you for backing down.

In the coming 10-day stretch from July 18th to 28th, both parties will have completed their quadrennial conventions in Cleveland and Philadelphia. Before the delegates settle down to contemplate their sweeping November victory, they might seriously consider this Gutmann/Thompson advice: partisan dominance is not the way to eliminate gridlock. Compromise is. Politicians can extricate our nation from the mire of the status quo if they see compromise not as defeat, but as victory for both sides. The below sonnet uses poetry to make the point. When both sides compromise, both sides can claim victory.

 

On Compromise

I fear our leaders and their rigid minds

Unbending, taut and loath to compromise.

I dread the mindset that so often blinds

Their thinking—and their rush to polarize.

Can they not join to seek the common good?

No crime exists in seeing eye-to-eye.

Why can’t they fuse their aims as leaders should?

And to their endless combat bid goodbye.

When prized beliefs can yield to middle ground

The dry-rot status quo can be dismissed.

When seeds of conflict find no fertile mound

Then progress can take root and growth persist.

When leaders meet halfway, their journey’s done

And then both sides can claim their victory’s won.

Fireworks on the 4th… But not in America

The 4th of July is a remarkable holiday where we celebrate the traditions inspired by our Founding Fathers. The values inculcated from an early age include economic prosperity, democracy, hard-work, and equality. Unfortunately we haven’t really had time to celebrate many of these traditions especially in the financial markets. In the past two weeks all eyes have been on Britain and their referendum to leave the European Union. While there are many possibilities that the UK are considering taking, including establishing another referendum, the uncertainty has decimated the British pound and the more risky assets. But I’m not here to discuss Britain because honestly I find the excessive coverage to be quite vexing. With people so focused on what’s happening overseas there has been little reaction to the United States economic data recently released. While there were very few positive or negative shocks embedded in the data in the month of June, the results seem to be pointing toward a somewhat disappointing second quarter.

GDP:

June 28th

The real GDP was adjusted for a third price estimate with an annual rate of 1.1 percent in the first quarter of 2016, according to the Bureau of Economic Analysis. This was an increase from the second estimate of 0.8 percent.

Originally the GDP numbers reflected more spending on household services, notably on health care and on housing and utilities. The upward revision to real GDP growth moved due to upward revisions to exports and to business investment which was countered by downwards revisions in consumer spending.

 

Corporate Profits:

June 28th

Corporate profits increased 1.8 percent at a quarterly rate in the first quarter of 2016 after decreasing 7.8 percent in the fourth quarter of 2015.

Profits of domestic financial corporations decreased $11.3 billion in the first quarter, compared with a decrease of $24.0 billion in the fourth. Over the last 4 quarters, corporate profits decreased 4.3 percent.

Click to access gdp1q16_3rd_fax.pdf

Markit Manufacturing PMI:

July 1st

U.S. manufacturers indicated a slight rebound in production volumes during June, helped by the fastest rise in new work since March. However, the latest survey signaled that growth momentum remained relatively subdued in comparison to its post-crisis trend, which the PMI Index registered to be 51.3 in June, up from 50.7 in May and the highest reading for three months.

A rebound in export sales provided a boost to manufacturers’ workloads in June. Moreover, the increase in new orders from abroad was the fastest since September 2014.

The latest reading rounds off the worst quarter for goods producers for six years and with the continuing uncertainty throughout the global markets the outlook for Q2 doesn’t seem to bode well for exporters.

Producers are struggling in the face of the strong dollar, the energy sector decline and
presidential election jitters. With companies searching for any type of stability amid a volatile market, heightened tensions between the UK and the European Union are likely to unsettle the global business environment further in coming months.

https://www.markiteconomics.com/Survey//PressRelease.mvc/6af4890597674e268079c8acfd3446e7

 

Markit US Services PMI

July 6th

The US Services PMI index increased to 51.4 in June, up fractionally from 51.3 in May. The seasonally adjusted Markit U.S. Services Business Activity Index signaled a further marginal expansion of service sector output.

While rising, the PMI index was hit hard in May and still borders contraction levels (under 50.0). The service levels for the month of June continue to corroborate poor economic prospects in the second quarter. The deflated business confidence and heightened economic uncertainty had acted as a brake on growth in June. Furthermore, the balance of service providers expecting a rise in business activity during the next 12 months reached a fresh survey-record low in June.

Commenting on the PMI data, Chris Williamson, Chief Economist at Markit said:
“Rebound, what rebound? The final PMI numbers confirm the earlier flash PMI signal that the pace of US economic growth remained subdued in the second quarter. While volatile official GDP numbers are widely expected to show a rebound from a lacklustre start to the year, the PMIs suggest the underlying malaise has not gone away. The surveys point to an annualized pace of economic growth of just 1% in the second quarter.”

One piece of good news: New work received by service providers expanded at a moderate pace in June, and the latest upturn was the fastest since January. Much of this was due to an increase in orders that needed to be filled. However, the rate of expansion remained weaker than its post-crisis trend.

https://www.markiteconomics.com/Survey//PressRelease.mvc/bb8b2e3e686e4869894f8c7ac6ab4108

 

UK PMI Services Index:

July 5th

Growth over the second quarter as a whole was the weakest since the first quarter of 2013 when the current upturn began. Moreover, the 12-month outlook was the darkest since December 2012. Companies often reported that uncertainty linked to the EU referendum had weighed on workloads and incoming new business. The data collection window for the June survey was 13-28 June, with 89% of responses received before 24 June.

The Business Activity Index fell from 53.5 in May to 52.3 in June, matching April’s 38-month low and signaling a relatively weak rate of growth in UK services output.
Economic growth slowed to just 0.2% in the second quarter, with a further loss of momentum in June as Brexit anxiety intensified.

With this anxiety so prevalent before the referendum, I can’t imagine what the service index results are going to be like for July. It is unlikely that policymakers will wait for more data before unleashing additional monetary stimulus. There will definitely be more policy action taken in the next few weeks, as investors fear holding volatile positions in the market and as UK continues to search for new leadership.

https://www.markiteconomics.com/Survey//PressRelease.mvc/b93210b9d29a440383344176b79696c2

 

US Trade Deficit:

July 6th

The trade gap rose 10.1% from April, the largest rise since August, to a seasonally adjusted $41.14 billion, the Commerce Department said Wednesday. Exports of goods and services fell 0.2% while imports rose 1.6%. However, there is some optimism for Q2 as some economists believe that the headwinds of the strong dollar and the damaged energy sector are behind us.

http://www.wsj.com/articles/u-s-trade-gap-widened-in-may-1467808606