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News - January 2010

As the Oil Turns

Jan 8th, 2010

Ok, the easy way to start today's report is to say that oil hit a 15 month high in yesterday's trade. Yet how we got there and why we are pulling back has more subplots than a daily television soap opera. There were so many stories pulling at the heart strings of the oil trader it is hard for anyone to keep them all straight. Some happy and some sad and some just plain freaky. Over night oil is pulling back on news that China's central bank raised interest rates on its three-month bills for the first time since August, a day after it promised to keep credit growth in check. This slowdown helped end some bullish momentum that was achieved in yesterday's session.

Of course any good energy report should start with an analysis of the weekly inventories from the Energy Information Agency which is always a factor in the decisions of both the buyers and the sellers. This inventory report, like some of the others before it, was supposed to be all about the impact of colder weather. Heating oil bulls were hoping that this recent cold snap would lead to another large drawdown in overall distillate supply. Yet the EIA reported that distillate inventories fell only by a mere 300,000 barrels. This was a disappointment to the bulls that were hoping supplies had melted away faster than the polar ice caps. When they failed to live up to expectations, the entire petroleum complex that had rallied in anticipation of this report, broke hard in an instant.

Adding the initial bearishness of the report was a larger than anticipated increase in crude supply to the tune of 1.3 million barrels. A number that saw oil break from the 8247 high hit right before the report only to plunge to as low as 8085 after the report. Traders seemed to fall like it got a sucker punch but after being stunned a bit came back up fighting like Rocky Balboa. The EIA confirmed weak demand for gas over the holiday weekend when they reported an increase of 3.7 million barrels. Despite these anemic numbers the complex came back and was led by oil.

If it wasn't inventories driving the market it had to be macro economics. In that past when we talked about macro economics some of that talk centered the carry trade and the weak dollar. Today's Wall Street Journal has an article about how recently, "the link between the dollar and commodities prices has snapped." The Journal says that, "The greenback and prices of raw materials like oil and copper often move in opposite directions. But since the end of November, both the dollar and commodity prices have been gaining ground." The Journal says that, "Behind the unusual trading: signs of an economic rebound and the belief that a recovery will both fuel demand for commodities and help underpin the dollar. Some investors are betting this phenomenon may continue for some time as economies around the globe strengthen." The Journal continued, "The trading is a break from patterns seen through most of last year, when prices for key commodities rose while the dollar was flagging. Commodities are priced in dollars, so a falling dollar means it takes more of them to buy the same things. Demand from emerging markets is getting particular attention, because they are the fastest-growing consumers of such materials." "Things look very robust in those areas to us," said Joe Foster, a senior analyst for the Van Eck Global Hard Assets Fund, which has about $2.3 billion in assets. Mr. Foster called the current dynamic, "almost a no-lose kind of a situation" for commodities prices, because they could also get a boost if the dollar starts to weaken again relative to other currencies. That could reassert the link that's fallen apart recently. At the same time, commodities prices are vulnerable to any hiccups in the broader global economic recovery. While economic conditions are trumping dollar considerations right now, if the world's economies dipped again, that could severely crimp demand once more."

The Journal says that" prices for many materials fell sharply amid the darkest days of the financial crisis and some have yet to fully rebound, even with the current rallies. Since November, the dollar is up 4.3%, oil 7.6% and copper 10.4%.Copper, used widely in construction, has surged 12% in the past 12 trading days alone and is up nearly 133% over the past year. But it's still almost 15% below the peak closing price it hit in July 2008. Copper closed Wednesday up 2.4%, to $3.4775 a pound. Oil, meanwhile, is still 43% below its July 2008 record close, but up 95% over the past year. It closed Wednesday at $83.18 a barrel, up 1.72%, its 10th straight day of gains. The dollar traded down slightly on Wednesday. Any signs of inflation or a sharp rise in interest rates could also affect the relationship between the dollar and commodities prices. The dollar played a central role in boosting commodity prices last year, as investors took advantage of U.S. interest rates near zero to borrow money cheaply and invest it. But they've been unwinding that trade amid signs of economic recovery, and any signs of inflation that spurred an increase in interest rates could come into play, as well. As a result, rising demand for commodities may not continue to be the overriding factor for investors."

And I think there is another reason for the recent disconnect between the dollar commodity link and that is the changing of the finance minister.

Oil Price Rises Above 80 on Better Macro Outlook but Fundamentals will Play a Key Role in 2010

by Oil N' Gold | ONG Focus - Insights
Jan 4th, 2010

WTI crude oil extends the 8th day of rally above 80 on speculations for growth in energy demand as US weather remains below-normal. The February contract surged to as high as 81.16, the highest level since October 26, in European session. While macro-economic outlook and equity market performance will continue to play a role in driving crude oil price, a stronger emphasis will be placed on fundamentals this year than in 2009.

Crude oil price advanced +78% in 2009. However, US oil inventory reached the highest level in almost 2 decade. Look at timespreads, the steep contangoes also suggest severe oversupply in the market. At the same time, the correlation between oil price and stock market rose to 45% in 2009, almost doubling that in the prior year. These evidenced that the strong performance of crude oil last year was driven by macroeconomic outlook and market anticipation of better fundamentals in the future.

As we enter 2010, investors should focus on demand growth. Again, it's widely expected that China will remain the locomotive for growth. According to the US Energy Department, crude oil demand should rise +1.1M bpd to 85.219M bpd in 2010. Of the 1.1M bpd increase in demand, 0.405M bpd will come from China while only 0.09M bpd from OECD economies.

In 2009, the inverse correlation between USD and crude was prominent. However, this pattern may fade this year. The impact of the dollar's movement on crude oil depends on its cause. For instance, if USD rises as the US economy improves rapidly and outpaces other countries. This would benefit commodities.

Gold price rebounds strongly to 1118 in European session. Having traded below 1100 for most of the time in the last 2 weeks, the yellow metal appears 'cheap' to buyers. Unlike crude oil, we expect strength in USD will continue to pressure gold. In fact, the pile-up of huge short USD/long gold positions in 2009 remains an overhang on gold's outlook.