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Rig count reductions are the big reason cited by many oil analysts for a supposed coming contraction in oil supply. Yet over the past two days earnings from two energy companies offered anecdotal insight into why I am skeptical of the theory that rig count reductions will ease the growing oil supply glut. On Tuesday, oil giant BHP Billiton Limited (BHP) said it would reduce its US shale drilling rig count to 16 from 26, nearly a 30% reduction.
However, that reduction in rig count would not impact 2015 financial year production guidance. BHP said expected shale liquids volumes (shale oil and NGLs) to rise by approximately 50% in the period—despite the falling rig count.
Then Wednesday, Chesapeake Energy Corporation (CHK) said they were slashing capex for 2015 and reducing their rig count to the lowest level since 2001. The rig count will fall to between 35-45, down from an average rig count of 64 in 2014.
Yet despite these rig count cuts, production growth still is expected to increase by 3%-5%.
I realize this is a sample of only two companies, but they help make my point that energy company share prices (especially Exploration and Production companies) live and die by production growth—not rig count.
It’s pretty simple: E&Ps need to show growth by either 1) producing more of their commodity to boost revenues, or 2) selling current production at a higher price. Obviously, #2 isn’t happening, so unless these energy companies want to see their stocks annihilated, they have to show some incremental production growth even with a falling rig count.
Shutting in production to try and support the price of your commodity is something that these companies simply will not do (nor should they). So, again, the declining rig count isn’t quite the bullish indicator that everyone thinks it is.
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The market was focused on Greece last week, and because of that traders basically ignored the more-than-3% weekly decline in oil prices (the biggest decline in nearly a month). Yet, as we originally pointed out in late November/early December, oil prices and the Dollar Index remain the near-term drivers of stocks, and it’s no coincidence that the bottom in stock prices in January came two days after the bottom in oil prices (1/29 bottom in oil prices, 2/2 bottom in the S&P 500).
The main fundamental catalyst for the recent rebound in oil prices (aside from last week) has been the plunging rig count and the reduction in exploratory capex from oil producers. And, I totally acknowledge those are bullish influences longer term for oil prices. Yet the key question now is whether the price action for oil is 1) a bottom or 2) a large oversold bounce in a still downward trending market. I am leaning towards #2, because that’s what the fundamentals and technicals are starting to point to.
The way I see it, there are three bearish influences on oil prices right now.
Bearish Oil Prices Influence #1: Inventories
We know that US inventories are at 80-year highs. Some of that recent build has been because of the refinery strikes (so, less demand to refine raw crude). The refineries participating in the strikes account for 13% of refined product production. But, if we look at the weekend inventory data, it’s not like we’ve seen a huge collapse in production from levels earlier this year. So, inventories at an 80-year high is bearish for oil prices.
Bearish Oil Prices Influence #2: Falling Rig Counts Don’t Mean Less Production
I’ve talked about this for the last month, but if we use natural gas as a potential blueprint, it shows us that reduced rig count and capex budgets don’t result in less production. Since April 2011, the natural gas rig count dropped from 885 to 289 as of last week’s report, yet during that same period natural gas production rose over 20% to 2.37MMcf from 1.9MMcf. Point being, while the sticker shock of the rig declines was substantial, it doesn’t necessarily mean we’re going to see less production. Oh, and over that same time period (April 2011 to last Friday) natural gas prices dropped 38%!
Bearish Oil Prices Influence #3: Market Structure
I don’t want to get too much in the weeds here, but contango (the difference between front month crude and back month crude) is widening. Markets in contango are usually in a downtrend, and that point is further exemplified when the contango is widening like it has been in WTI crude oil prices recently.
Technically speaking, the recent countertrend rally has run out of steam as the uptrend line was broken late last week. And, although that is not outright bearish, at the very least it suggests that oil prices will remain suppressed in range-bound trade between $45 and $55 with a bias to the downside over the medium term, as the primary trend is a bearish one.
Guessing the near-term direction of oil prices is a loser’s game, but we get paid for opinions here, and the fundamentals and technicals imply this rally in crude may just be one, massive, oversold bounce.
If oil prices close below $48/barrel, that will likely result in a test of the recent lows at $43.58.
This is important, because we believe oil prices are still a leading indicator for the stock market, and if oil rolls over form here, stocks very well could decline along with it.
As was the case with most of the financial markets Wednesday, commodities’ traders were largely focused on the release of the FOMC minutes. The general reading on the back and forth inside the Fed was rather “dovish,” primarily because FOMC officials seemed particularly focused on wanting to make sure the economic recovery was truly “sticking” before they raise interest rates. The Fed’s release had an immediate effect on gold prices, both before and after the actual minutes came out. Meanwhile, copper prices were heavily influenced by what has been one of the biggest influences on the market today, Greece and its deal with the Eurogroup.
Gold prices were the big story in the commodities space yesterday, as futures collapsed through $1,200/oz. to a six-week low as traders positioned for a potentially “hawkish” FOMC announcement. But, upon the “dovish” release, there was an algo-driven, short-covering rally that took gold prices back to flat, and comfortably above the closely watched $1,200 level. The rally in gold prices continued overnight as gold prices now are sitting just under $1,220 per ounce.
Yesterday’s rally in gold prices was mostly an algo-driven short-covering rally and fundamentally, the case remains bearish for gold prices. Looking at the near term, futures did become oversold ahead of the Fed minutes, so a bounce back/consolidation rally may be ahead of us. However, such a move in gold prices should be seen as a selling opportunity once the short covering subsides.
Meanwhile, copper prices, the benchmark industrial commodity, rallied 1.41% Wednesday, making some bullish technical progress on the charts as optimism surrounding Greece helped support the market.
The Eurozone is the second-largest consumer of the industrial metal after China, so progress in the Greek/EU negotiations that ultimately leads to a better EU economy (without the overhang of Greek uncertainty) is an underlying bullish influence for copper prices.
Technically speaking, copper prices closed at the highest level since January 16, and was able to break back through a nearly three-month old downtrend resistance line. The technical “progress” is obviously near-term bullish, and could see futures rally to as high as a broad resistance band between $2.75 and $2.85.
However, Europe will remain in focus, and if the Greece-EU deal deteriorates (which will increase the threat of EU “contagion”), then copper prices likely will come back under pressure.
The bottom line here is that volatile gold prices and shiny copper prices have largely been news-driven events. Now the question is what will happen once the news is in, and once traders turn back to fundamentals and technicals when making buy and sell decisions.
In Tuesday’s Stock Market Today post, we broadly covered that the FOMC minutes released today will be examined for signs of when the Fed may first hike interest rates. To that end, the hawks will be looking for extensive mention of the term “patient,” while the doves will be looking for a discussion regarding, “NAIRU.” How the market interprets the minutes will go a long way toward determining the fate of the stock market today, and for the rest of the financial markets today—and well beyond.
Given that the S&P 500 Index recently rose to a new all-time high, it’s hard to think that the market is too worried about a pending rise in interest rates, but that could all change today with the reading of the FOMC minutes.
Starting with the hawks, “patient” is thought to mean three months. So, if “patient” were to be removed from the March meeting then it means a June rate hike is on the table. For the minutes, if there is evidence of an extensive discussion about whether “patient” should have been included in the January statement, or how many more statements should contain “patient,” then that will be taken as hawkish. More broadly, if “patient’ was just merely discussed, it’s slightly hawkish.
One the dovish side, one area of focus for the minutes will be the “NAIRU,” a term you may have heard already but definitely will be hearing more of in the coming months.
The “NAIRU” is the “Non-Accelerating Inflation Rate of Unemployment.” Basically, NAIRU is the lowest the unemployment rate can get before it starts to produce significant inflation. From a practical standpoint, it’s the unemployment rate at which the Fed will have to start to raise interest rates.
The reason I’m bringing this up is because the Fed consensus NAIRU may be about to be lowered, which means the Fed could, theoretically, keep interest rates lower for longer. The NAIRU currently is estimated between 5.2% and 5.5%, so a little bit lower than the current unemployment rate. The growing expectation is that NAIRU will be lowered to 5.0%.
If that happens it means the Fed could take more time raising rates, and making the increase more gradual once the first hike has occurred (so, 25 basis points every two meetings vs. every meeting, for example).
Bottom line: If NAIRU is discussed extensively in the minutes today, look for a dovish response from markets (bonds up, dollar down, gold up, stocks up).
Traders are back from the President’s Day holiday and ready to begin the business of moving the stock market today. Now that the S&P 500 Index is at all-time highs, the direction of the stock market today, and for the rest of the week, will likely be an important harbinger of things to come for the near-term future of financial markets. This week, we get a look at several important insights into the mindset of the Federal Reserve via the release of the FOMC minutes today. WE also get data on the current state of the global economy.
By far the most important event in the stock market today, and for the week, comes Tuesday via the release of the FOMC minutes. Keep in mind the January FOMC meeting was slightly more “hawkish” than expected because 1) the FOMC minimized the recent drop in CPI and other statistic inflation measures, 2) did not cite international policy or stagnant growth materially, and 3) upgraded the economy.
The minutes are obviously important because it’s not known just how committed the FOMC is to raising rates in June, July or September—but the minutes might provide a clue. Remember, even with this “stealth” backup in yields over the past few weeks, there remains a large gap between market expectations for rates and Fed expectations for rates at year-end 2015—and that gap remains at the top of our list of potential “correction catalysts.”
The FOMC minutes are the economic release with the biggest potential to disappoint the market in that they may be “hawkish,” and if that’s the case look for bonds to decline further and for stocks to sell-off.
The next most important events this week are the global February Flash PMIs due Friday. European numbers come early Friday morning, while the US number comes later, shortly before the open. Obviously, given the slight moderation in growth in the US and potential stabilization in Europe, this first look at the February data will be important.
Although overshadowed in importance by the flash PMIs, in the US we do get the official first look at February data via the Empire Manufacturing Survey (Tuesday) and Philly Fed Survey (Thursday). Finally, we also get the first look at the housing market in January via the Housing Market Index (Tuesday) and Housing Starts (Wednesday).
With regards to the US and international economic data, it would take some significant disappointment via the flash PMIs to weigh on global stock markets, so unless the data is really bad it shouldn’t negatively alter current economic outlooks (and as a result shouldn’t cause too much market volatility).
Bottom line: As Greece inches towards some resolution, focus is shifting more and more to the outlook for Fed policy, so the FOMC minutes are the key event to watch this week regardless of asset class.
The real story in the stock market today is Greece. In fact, Greece and its pending deal with the EU is one of the biggest unknowns for the markets today, and until this issue is resolved, stocks, bonds, commodities and just about every other financial market today is going to be in a state of unease.
Unfortunately, the headline noise regarding Greece is deafening, so I wanted to take a moment and spell out what really matters to the markets today, as hysterical headlines are going to get more numerous as we enter the second half of February.
As a broad point, Greece matters because of contagion, both financial and political. First, Greece owes so much money; the concern is that a default or conversion to Drachmas would result in significant stress to European financial institutions, which could cause a panic (remember Lehman?).
Second, if Greece leaves the Eurozone there is concern nationalistic parties in Spain and Portugal will feel emboldened—and then we could have a total fracturing of the EU (which would create massive uncertainty). Bottom line, it may seem like it’s no big deal if Greece leaves the EU, but the potential of contagion (again, remember Lehman) is why markets are watching this so fretfully.
We still do not think this is a major fundamental influence on stocks, but there is so much coverage and confusion we thought this would be a value as a “guide” to Greece. To that end, we want to provide a succinct guide of “what’s next” now that we are starting to get closer to “crunch time.”
The “Positive” Solution the Market is Looking For: A 3-6 month “bridge agreement” between the Troika of the ECB, EU and IMF and Greece. This “bridge” agreement won’t mean a solution to the Greece problem, but it does remove the potential of a Greek default in the near term. This is what is currently being negotiated at the various EU meetings this week and next. If this agreement is made, it will be a positive for European stocks.
Key Terms to Watch For: ELA (Emergency Liquidity Assistance). The ELA is a credit line the ECB gives to the Greek National Bank, and the Greek National Bank then provides that money to Greek banks. The ELA matters because since the ECB no longer accepts Greek debt as collateral for normal financing operations, the ELA is the only source of liquidity for Greek banks. Why does this matter? If we get to the end of February and there is no “bridge agreement” in place on Greece, then the ECB may with-draw the ELA. If that happens, Greece will default. The ELA can be removed by a 2/3 majority of the ECB–so if things get bad enough then it is possible.
Capital Controls & Bank Runs: The more heated the rhetoric gets between Greece and the Troika the more money leaves Greek banks, which is definitely a potentially complicating factor. Generally it is estimated that Greece has enough cash to get to early March, although tax receipts (not surprisingly) fell precipitously once elections were called, as people (correctly) assumed they may not have to pay all these taxes.
One idea that has been talked about is Greece instituting capital controls to stem the flow of deposits out of Greece (which will increase meaningfully the closer we get to March). If you see Greece institute capital controls that will represent a material negative shift in this crisis and risk assets will suffer, with Europe taking the hardest hit. Capital controls never work. They spook investors and can turn what was a small problem into an enormous crisis for the markets today. If we see capital controls being seriously considered in Greece over the next two weeks it will make me much more cautious on Europe.
Key Upcoming Events:
Feb 16: EU Finance Ministers Meeting. Unlike yesterday’s meeting there may actually be some progress on the bridge agreement. If nothing comes from this meeting, expect a legitimate uptick in the level of concern regarding Greece.
Feb 18: ECB Meeting. This isn’t a policy meeting so there’s no rate decision or anything, but still, Greece will be discussed and there’s potential for some further progress in negotiations. If the two sides are no closer to a bridge agreement after this meeting, look for an even bigger uptick in concern.
Feb 28: Greek bailout expires & ELA is removed. If there is no agreement by the Feb. 28 then things get very interesting, very quickly. Most estimates think Greece will have enough cash to make it into early March, but if no “bridge” agreement is set by the 28th, risk of a Greek default or “Grexit” will rise significantly.
March 6: “Drop Dead” Date. If no deal is done by this date (it’s the end of the week following the 28th) then a Greek default will almost be a certainty.
It was an ugly day in the commodity space Tuesday, and the financial markets today are preparing for more of the same. Consider that we saw a big sell-off oil patch, crude oil futures leading the way lower, falling over 5% while the rest of the space saw losses of at least 1%. The sole outperformer in the space Tuesday was natural gas, which bounced on weather forecasts. The primary commodity tracking ETF, PowerShares DB Commodity Tracking ETF (DBC), slumped 1.26%.
For DBC, and for the entire commodity space, the markets today are riddled with bearishness, and that’s been particularly true over the past six months. In fact, a 52-week chart here of DBC clearly illustrates the descent in the space since July. The move lower, led chiefly by crude oil prices, has caused this ETF to plunge nearly 30% in the past six months. For the financial markets today, including the stock market today, one of the biggest drivers has been the commodity plunge in general, and in particular those plunging crude prices.
This week, once again crude oil prices remain the clear focus of the commodity space, as the recent short-lived rally now has fizzled out at key resistance in the mid-$50s. Futures fell 5.09% Tuesday to finish just above the $50 per barrel level. Fundamentally, nothing has changed and the recent price action has been primarily driven by technical trading.
The two big technical resisting forces are again, the four-plus month old downtrend line ($51.90) and the 50-day moving average at $53.47. Going forward those two levels (which are both moving lower) will remain very important to watch. Bottom line, the short squeeze in crude oil prices seems to have run its course and now it appears we are poised for some consolidation in oil between roughly the mid $40s and the mid $50s in WTI. Today, focus will turn to weekly supply data as the EIA numbers are released at 10:30 a.m.
Natural gas was the sole commodity to finish in the green Tuesday, adding 3.27% on the session as forecasts for cold temperatures spurred short covering off recent multi-year lows. Also, initial forecasts for Wednesday’s EIA report at –176Bcf are materially higher than the recent average, and that also contributed to Tuesday’s rally. The price action, however, was not very encouraging for the bulls as futures closed well off the highs of the day, showing a clear lack of any follow through buying. The outlook for natural gas remains rather bearish as prices are in a well-defined downtrend and there is material resistance up towards $2.80.
Moving to the metals, gold continued to consolidate Friday’s sharp losses, but did finish lower by 0.58%. The fundamentals remain bearish for gold as the broader markets are beginning to trade with a more hawkish tone since Friday’s solid employment report. The jobs number served as a bit of a wake up call to many investors who remained under the impression the Fed was going to stay dovish forever. But just as many FOMC members continue to emphasize they are not, we are seeing the markets begin to price in the reality, evident by the recent declines in bonds and gold as well as the rally in the dollar.
Looking to industrial metals, copper fell 1.20% Tuesday, but remained comfortably within the recent, broad trading range between $2.45 and $2.65. Near term, further sideways trade can be expected; however, on a longer time frame, the trend remains bearish as low production costs (thanks to low energy prices) paired with lackluster demand forecasts are far from encouraging fundamentals while the technicals also strongly favor the bears.
So, the bottom line for commodities in the markets today is: more weakness ahead, until such time as both the fundamental and technical prognosis improves.
The World Bank thinks global growth will be slower than originally estimated. On Tuesday, the lender issued its semiannual Global Economic Prospects report, and for global growth bulls the outlook wasn’t very encouraging.
For 2015, the global economy is estimated to expand by 3%, which is down from a projected 3.4% growth rate in June. In 2016, the World Bank thinks growth will come in at 3.3%, which is down from the prior estimate for 3.5% growth.
While most investors would be well served to take the World Bank’s estimates with the proverbial grain of salt, one thing we do know is that traders often take these data projections serious—at least in the short-term. We saw just that in Tuesday trade, as growth concerns weighed on commodities, most notably copper, which traded down nearly 5% in the session.
It is often said that copper has a Ph.D. in global economics, which just means that copper prices are a good indicator of the health of an economy. When the economy is trending lower, then usually we’ll see that reflected in copper prices—and that’s precisely what happened Tuesday, and what’s happened in copper via the iPath DJ-UBS Copper SubTR ETN (JJC). This copper exchange-traded note is down some 17.2% over the past three months, a move that betrays just how fearful traders have become about the prospects for global growth.
More broadly, the spot price of copper has been in a bearish downtrend now really since the spring 2011 highs, but most recently lower energy costs and weak demand specifically out of China, the world’s largest consumer of the industrial metal, have pushed prices down to near six-year lows.
The collapse in “Dr. Copper,” has been somewhat lost in the oil declines, but clearly this is not a good sign for global growth.
Chinese demand for copper is expected to fall again this year, and that presents a very troubling backdrop for the future of copper prices going forward. The bottom line is clear; copper is falling victim to a combination of low production costs (oversupply) and soft demand expectations, which is resulting in a sharp slide to the downside that we think has room to continue going even lower.
So, if you are long this industrial commodity (and I hope you’re not) then now is the time to rethink the “Dr. Copper” bull trade.
I briefly mentioned last week the high level trade talks that occurred between China and Canada in Beijing. The net result of those talks, the most material and fruitful in years, was the signing of a declaration of intent to agree to a “Foreign Investment Promotion and Protection Agreement.” (FIPA).
The lengthy name aside, it’s an important step in further Canadian/Chinese trade, as it sets a broad frame work for ensuring equitable treatment for foreign investors in both countries. Basically, it removes a large degree of risk for Chinese or Canadian firms investing with the other country by providing a legal framework and set of laws that protect foreign investors . . .
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