Dear Reader,
A few readers have inquired, “Why not publish more articles on the market lately; isn’t there a lot going on?” There’s a good reason, and it can be summed up in one word: volatility. We haven’t seen a period of sustained volatility of this magnitude in years. Usually the VIX Index likes to take a jump, followed by a rather sudden drop downward. Today we’re in a completely different situation, with a sustained high VIX and a market that has taken a beating but certainly hasn’t crashed.
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In this environment, many forecasters have already swallowed their own words a dozen times. The market jumps 250 points one day, and they predict the start of a rally. The next day, the market crashes 300 points, and the bears hit the headlines. In my opinion, it’s borderline foolish to draw massive multimonth or multiyear implications from the moves of a single day in a highly volatile environment.
Furthermore, the majority of these swings have been caused by fear – or even the fear of fear – in the market. We still don’t know what’s going to happen in Europe. It’s quite possible that one of the PIIGS will default sometime in the next month, but kicking the can down the road another year isn’t outside the realm of possibility either. Check the last major spike in volatility in mid-2010. We’ve been in this exact spot before – only now it’s more serious. Still, it’s difficult to say if we’re approaching the moment of truth for Europe.
What do we know, and what can we say for sure? The eurozone and in particular the PIIGS are doomed. We didn’t wake up to this fact last month, like the majority of the market did. You’ve been reading about it for years in our newsletters. Second, gold continues to be a major trend. Even if we see a sell-off similar to 2008, the fundamentals for gold will not change. In fact, such an event would mean a big-time shopping season. Since the last market crash, gold has had an incredible performance. If the market takes another major dive, I would expect a prolonging of the long-term gold bull market, even if prices have a temporary setback. The governments of the world will be in even worse shape, and they will react like they always do… by printing more money.
Sure, interest rates are low, but world central banks can take them lower. Consider that the Swiss National Bank recently lowered its short-term rate from 0.25% to zero. If another crisis comes, you can bet that the European Central Bank is going to take rates from 1.5% to nada in a heartbeat; that’s going to be good news for gold.
In short, don’t let volatile numbers guide your decisions. Volatility necessarily occurs from competing visions in the market. If you’re comfortable with your idea of the market and the state of the US government, stay the course and don’t let the confusion of others drive your investments.
By the Casey Research Energy Team
What a year it has been for oil prices. It was only in April that US-benchmark WTI crude reached a peak of almost US$114 per barrel. Now – not six months later – prices have fallen to a new 2011 low: On Tuesday the spot price of WTI crude dropped as low as $74.95 a barrel, before recovering slightly to close at $75.67. The price has not been this low since September 2010.
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Forward prices provide no indication of a pick-up. European-benchmark Brent crude for December 2013 delivery is trading near $90 a barrel, compared to a current spot price of $102.18. The December 2013 price for WTI is near $82, pretty much on par with the average spot price over the last few weeks.
In addition, on Tuesday the average price of a basket of OPEC crudes fell to $99.65, the lowest price for the basket since mid-February. The OPEC basket is made up of the average price of one major crude grade from each member country.
Volatility is standard practice in the oil markets, but for prices to drop more than 30% in less than six months is more erratic than usual. As for where prices will go from here, that depends on whether one thinks the world is entering a significant recession or not. A serious recession is not a certainty, but the markets are acting as though it is, in part because current economic conditions differ so dramatically from those of just eight months ago.
Crude prices roses to three-year highs early in the year, driven by instability in the Middle East and North Africa, rising Chinese demand, bullish views from investment banks, and expectations of an aggressive US stimulus plan. Confidence was high that the recovery from the 2008 recession was real. However, those reasons for confidence are fading one by one.
The Arab Spring is still very much in action, but the most significant uprisings are now occurring in Syria and Bahrain, both unimportant oil producers. On top of that, Libyan oil production is set to resume over the next 12 months. As such, the riots and revolutions still rocking the Arab world have less bearing on the price of oil than they did a few months ago.
Chinese demand, always cited as the backstop for sliding oil prices, is weakening. For three straight months now, China’s manufacturing sector has contracted… and the country is struggling to contain inflation.
The United States, of course, did not implement an aggressive stimulus plan, though Federal Reserve Chairman Ben Bernanke recently reminded a Europe-focused world that America is still facing significant economic issues when he said the central bank stands ready to take additional steps to boost growth. With recent data showing American incomes falling and prices climbing – both in the face of stubbornly persistent unemployment – growth remains a serious concern.
And one by one, investment banks are reining in their bullish forecasts for oil demand and global economic growth, no longer able to argue that demand from China and India can compensate for stagnant growth or recessions in Europe and the US.
Goldman Sachs, nicknamed the “permabull” for its relatively high commodity price outlooks, was the latest investment bank to join the movement and lower its oil price forecasts. Goldman now expects WTI to average $109 per barrel over 2012 – down from $123.50 – and foresees Brent crude averaging $120 per barrel instead of $130. Goldman also cut its expectations for economic growth in China, as the US and Europe order fewer Chinese-made products.
Interestingly, a recent survey found that Goldman’s analysts were the most accurate price forecasters in 2011. And while Goldman’s analysts cut their price forecasts, they also noted that the market has seen heavy destocking ahead of a potential crisis. As such, “If a crisis does not occur, the oil market risks running into pressing supply constraints, requiring sharply higher prices to force demand in line with supplies,” the bank said.
A raft of other investment banks have also cut their forecasts – Goldman’s numbers are now fairly representative of the predictions from most major banks. And OPEC leaders are also warning of the potential for oil demand to fall. The OPEC governor for the United Arab Emirates, Ali Obaid al-Yabhouni, said that while oil supply and demand appear to be largely in balance at the moment, “… there are ominous clouds on the horizon that represent a major downside risk.”
So are prices going to continue to fall? Let’s take a broader look at the situation. One way to describe the year in oil would be as a wild swing from irrational exuberance in the first half of the year to increasingly irrational pessimism now. The current dread about recessions and plunging oil prices is a perfect mirror of the panic in February, March, and April over the potential for supply disruptions in the Middle East to cause price spikes. At that point, the market exaggerated the risk of supply disruptions, confusing a possibility with something closer to a certainty. Now the markets are doing the same thing, but in the other direction – exaggerating the risk of a deep recession and a large drop in oil consumption.
The threat of outright recession has risen, to be sure, and in response investors are becoming more and more risk averse. However, a recession is not yet a certainty. Current indicators are mixed, generally suggesting the economies of the United States, the United Kingdom, and the eurozone are struggling for traction rather than shrinking. Nevertheless, the more the markets fall, the more investors seem to be fearing an even deeper pullback. The markets are extrapolating recent movements rather than making a calm assessment of what is likely to happen in the future.
Well, any investor who expects markets to react calmly and rationally is in the wrong game. Markets portray human emotions as much as economic realities, and people are rightly very nervous right now.
The answer to all this instability lies first with Europe. Investors need to see a broad solution advanced for the eurozone crisis, including a plan for orderly defaults for Greece (now considered almost a certainty), a plan for bank recapitalization, and a plan for how the contagion will be contained. A comprehensive solution of this sort would provide markets with some confidence that Europe, while hobbled, can in time recover. With more politicians, analysts, and bankers now accepting that a Greek default and the nationalization of debt-laden major banks are probably necessary parts of this solution, there is a dim light on the horizon. It will take a long time for that light to brighten, but it is at least visible now.
If Europe can stabilize, attention will shift back to America. As other Casey writers have discussed in great detail, the problems here run even deeper than those in Europe. But a rising tide lifts all ships, so a recovering Europe would help America work through the painful changes that are necessary to sail our storm-ravaged ship to calmer waters.
That’s the rational argument. The markets, however, may yet drag oil prices further down in the coming days. Then again, a single instance of positive data from Germany or China could send prices the other way, because at present emotions are the dominant force. And we all know how erratic those can be.
[Sifting through the fear pervading markets is an arduous task, which isn’t helped by the flip-flopping some analysts have been doing. In contrast, Casey Energy Report is a steady source of sound information and specific recommendations, which will help every energy investor sleep better. Try it risk-free for three months.]
More Euro Nations Face Downgrade After Italy, Moody’s Says (Bloomberg)
The ratings agencies are in a desperate game of catch-up. I can’t think of a time where they were more irrelevant and behind the curve. The markets are a few steps ahead of them at every turn. The article notes that the market values Italian bonds at a BBB rating (Baa2 in Moody’s system). Moody’s still has the country at A2. That’s three ratings above the market’s pricing – hardly a calculation error. At least in 2008, the ratings agencies were wrong, but almost everyone else was wrong with them.
Occupy Wall Street: A Story Without Heroes (Ludwig von Mises Institute)
Anthony Gregory makes some astute observations about the Occupy Wall Street protests. He notes that these protestors aren’t exactly a threat to Washington. In fact, they demand more government and hence will likely be useful puppets in the expansion of the state. Ultimately, their cries for additional government intervention will only deliver more of the same actions that brought the world economy to its knees. Gregory lists a few of their demands:
Although there is no single ideology uniting the movement, it does seem to have a general philosophical thrust, and not a very good one at that. OccupyWallStreet.org has a list of demands, and while the website does not represent all of the protesters, one could safely bet that it lines up with the views of most of them: A “living-wage” guarantee for workers and the unemployed, universal healthcare, free college for everyone, a ban on fossil fuels, a trillion dollars in new infrastructure, another trillion in “ecological restoration,” racial and gender “rights,” election reform, universal debt forgiveness, a ban on credit reporting agencies, and more power for the unions. Out of over a dozen demands there is only one I agree with – open borders – and, ironically, many on Wall Street probably favor that as well.
In my opinion, what’s really sad is the distance from reality underlying some of these requests. For example, the “living wage” issue – right now, people are willing to accept almost any wage. At the moment, any job is a blessing. It’s a bit ridiculous to talk about a living wage with over 9% unemployment. How exactly is anyone to bring about this desired living wage under the current circumstances?
Four Arrested in Alleged Government Bribery Scheme (Associated Press)
Earlier in the year, the press released a story of millions in cash missing in Iraq. A few weeks ago, I reported on the billions wasted from overpriced and now abandoned bases in Iraq. Now, we have a domestic $20 million bribery case involving two members of the Army Corps of Engineers. I wonder why the usual route wasn’t used here: give donations to a congressman that pay for his visits to the Four Seasons Hotel, his lobster lunches, and private jets on the campaign trail. If the wars themselves aren’t a good enough reason to cut off the money spigot to the military, the mishandling of the money is enough reason to curtail some of those funds.
That’s it for today. Thank you for reading and subscribing to Casey Daily Dispatch.
Vedran Vuk
Casey Daily Dispatch Editor