Posts by The Trend Letter

markets

A must see chart

It is said that in the markets as in life, history provides great insight for the future. If so, the following charts offer a compelling argument that the S&P 500 will have a strong run into the first quarter of 2016.

We compared these charts about 6 weeks ago, showing the uncanny similarity of the performance of the S&P 500 in 2015 to the performance of 2011. Here are those original charts.

S&P2011vers2015

Today  we updated the charts…take a look.

S&P2012vs2016

If this pattern continues, then you can expect the equity markets to have a solid 1st quarter in 2016. From December 2011 to April 2012, the S&P 500 rallied almost 20%.

Stay tuned!

fedbuilding

Fed raises rates – what it means

For the first time in more than nine years, the Federal Reserve (Fed) voted unanimously to raise its benchmark interest rates by 25 basis points to a range of 0.25% – 0.50%.

“With the economy performing well and expected to continue to do so, the committee judges that a modest increase in the federal funds rate is appropriate,” Fed Chair Janet Yellen said in a press conference after the rate decision was announced. “The economic recovery has clearly come a long way.”

The central bank made it clear that the rate hike was a tentative beginning to a “gradual” tightening cycle.

In addition to raising the benchmark Fed Fund Rate, the Fed also voted to raise the discount rate, which is charged on loans directly from the Fed to banks, by 25 points to 1%. Fed members also increased their outlook for GDP growth in 2016 to 2.4% from 2.3%. In addition, they lowered their estimate of the unemployment rate from 4.8% to 4.7%.

So what does this all mean? One of the things you will be seeing in the mass media will be how rising rates are bad for stocks. As we have noted many times over the past few years, this is simply not true.

Below is a chart showing how when the Fed lowered rates, the stock market benefited. It is true that when the Fed started all of its QE programs, the only sector to benefit was the equity markets.

fedvsS&P

What the mass media fails to realize is that if we see real interest rates rise, not just the Fed rates, but long-term bond yields rise, then that will signal that the bond market is starting to decline, & when that happens we will see capital flow into equities.

We have shown the following chart a number of times & it appears that none of the mass media or mainstream newsletters have ever looked at the real correlation between the equities & interest rates, they never bother to dig past the sound bites.. The correlation is not exact, but we can clearly see that over the past 15 years, that when the yield on the 10 year US bond rises or falls, the S&P 500 tends to trend in the same direction.

Remember, that the interest rates we pay for loans, mortgages etc, are driven by the long-term bond yields, not the Fed rate. It is really only from early 2014 to 2015 (red box) that there was a large divergence where the S&P 500 continued to rise, while the yield (interest rates) contracted.

That divergence relates to the global flow of capital that poured into the US equity markets from investors who were moving their capital out of the Euro & Yen, into the $US  via US equities & US bonds.

S&Pvsbonds

Here is a chart of those three currencies, & note the clear flow of capital into the $US, & out of the Euro & Yen during that one year time frame (red box).

USEuroYen

As we move forward in the coming tsunami of a Sovereign Debt Crisis,  you need to be on your toes. Understand how ALL markets are interconnected & that this crisis will impact EVERYONE.

The good new is, if you understand the global flow of capital you will be in a position to realize massive gains in the next few years, & if you don’t, you will likely suffer massive losses, worse than during the Financial Crisis in 2008.

The coming crisis is a Bond Market Crisis, NOT an equity crisis, Timing is the key.

Stay tuned!

Junkpic

Major High Yield Mutual Fund collapses…what does it mean?

Major Junk bond fund shuts down

In our November 17th issue of Market Musings, we gave our final warning on high-yield bonds. In that report we stated…

“Understand that Mutual Funds have loaded up on this high-risk debt & today they own 20% of ALL outstanding Corporate debt. As these debts are starting  to go bad, investors holding these mutual funds will want to redeem their shares & this will cause further panic, as everyone runs for the exits.”

Now we have a respected value investing firm Third Avenue Management  shuttering its once top-performing credit fund Third Avenue Focused Credit Fund amid poor performance & unmanageable redemption requests.

From Forbes…

“The fund’s strategy of buying debts in America’s most financially leveraged companies during a time of uncharacteristically loose monetary policy worked at first, but then it backfired.”

“Holding these debts, often the least liquid in the market, can be extremely painful if a corporation is unable to manage its debt load through earnings growth or refinancing activity. The strategy can also test investors’ patience before a thesis plays out, or a cycle turns.”

“Third Avenue will liquidate its fund, but in order to do so, it will freeze redemptions. CEO Barse said the move will allow the firm to manage thin liquidity and avert fire sales. Barse also said firm remained confident in its investment strategy,  but was overwhelmed by redemptions.”

This is huge & is exactly what we have been warning about. This is the first time that a mutual fund has ever halted redemptions without an order from the Securities & Exchange Commission directing it to do so.

As we noted in previous posts, when trouble starts in the bond market, contagion spreads. As we have been warning, there has been a dangerously large amount of money pour into the junk bond funds trying to gain the much sought after yield. Now as we showed last month this market is turning down & in fact, every High Yield fund is in the red this year.

As more & more investors seek to get out of these mutual funds, more & more funds will have the same trouble that Third Avenue Management had with an unmanageable flood of redemption requests, hitting this market even harder.

Why is this happening?

As a reminder, High Yield or Junk bonds are low-grade bonds that may be issued by companies without long track records, or with questionable ability to meet their debt obligations.

As we highlighted in that November 17th Market Musings, since 2007, global corporations have increased their debt from $38 trillion to $56 trillion, an $18 trillion increase.

While many financial advisers point to the attractive yields these bonds offer, they do not always explain the high risk that comes with these bonds. These low grade bonds are the most sensitive to problems in the credit markets.

Oil companies are big players in the credit markets & with oil prices continuing to decline (oil closed today under $36), producers are seeing their revenues slashed.

Crude

These oil producers are scrambling to simply survive. They also have over $500 billion in debt & what is more dangerous is the fact that over 80% of their operating cash flow is being used to service this debt. That is over double the amount than in 2014.

Most US oil producers need oil at $55-$60 to break even. What is giving some of these companies some breathing room is that they have approximately 35% of their production hedged at $60+ prices. That is helping off set the $20 per barrel losses they are incurring at today’s prices.

But if oil prices remain below $55-$60 next year, then it gets real ugly for these producers because next year the average producer has only 10%-15% of their oil production hedged at $60+ prices, so their losses will really ramp up.

As these hedges come off, many US producers will not be able to generate enough cash to meet their debt obligations. According to Bloomberg, the total debt for half of the 60 producers in its Oil Index has risen to a level that represents 40% of their enterprise value. It’s a sign of distress that shows equity values falling in the face of oil’s crash.

Haynes & Boone’s latest Oil Patch Bankruptcy Monitor shows there are now 36 oil producers who have filed for bankruptcy in 2015. Combined they have a total of over $13 billion in debt outstanding.

As more & more companies have their debt rating dropped from “Investment” grade to “Speculative” grade, it means large institutions can no longer hold those bonds, so they must sell them.

This is exactly what is happening today, & it is going to get worse. As we have noted many times, when companies holding huge amounts of debt go bankrupt, it creates contagion.

The following chart is from Bloomberg & it shows the distress levels & the default rate for Speculative grade bonds. We can see how the distressed level has now risen to over 20%. We can also see that the distressed rate is a forerunner to the default rate.

distress ratio

As we noted in November, Wall St keeps packaging up bad debt & selling it to unsuspecting investors. Banks keep loaning Emerging Market companies  $ trillions. Automobile companies keep giving out 7 year loans to anyone with a driver’s license.

With the Junk bonds, we are seeing the first shoe drop, as bond holders are starting to rush to the exits.

Most investors holding these high yield mutual funds have no idea that these High Yield Mutual funds & Exchange Traded funds hold debt from very marginal companies, & many of those companies are oil fracking companies which are being bleed dry with low oil prices.

Understand that mutual funds have loaded up on this high-risk debt & today they own 20% of ALL outstanding Corporate debt. As these debts are starting  to go bad, investors holding these mutual funds will want to redeem their shares & this will cause further panic, as everyone runs for the exits.

As we noted in November, we have seen this story play out before & it always ends the same way. While the JNK ETF has already lost over 12%, there is a long way to go if oil prices remain below $55-$60.

jnk

What should I do?

If you still own low grade investment bonds, you are probably already in the red. As noted on the previous chart, this sector has a lot of room to the downside, losses could be huge.

If you didn’t follow our advise & unload these bonds last month, look to do so now.

There will be a time to buy back into this sector, but this is not it.

Stay tuned!

oil

Oil closes at $37.63, what next?

West Texas Crude Oil closed Monday at $37.63, breaking below $38.00 for the first time in six years. The price of oil has declined almost 65% from its peak in June’14.

OilDec715

Prior to last week’s meeting of the Organization of Petroleum Exporting Countries (OPEC) oil cartel, there were strong rumors that OPEC would finally cut its production target.  Unfortunately for those who were banking on an OPEC cut, the OPEC decision was to not cut its production targets, which sent the price of oil plunging to less than $40 a barrel on Friday.

In previous years OPEC nations would normally agree to reduce their production when oil prices got too low. With an OPEC production cut, supply declines, & prices push higher. The result would then allow OPEC producers to earn higher profits.

OPEC is becoming split, with poor countries such as Angola, Nigeria, & Venezuela desperately wanting production cuts & higher prices, while the richer countries led by Saudi Arabia  can withstand lower prices & are wanting to continue to put the squeeze on the US shale producers.

Saudi Arabia knows that many US shale producers borrowed heavily when the price of oil was over $100. They did this to ramp up exploration & production to take advantage of those high oil prices.

All sectors move in cycles, & no sector is more affected by cycles than oil. We show this Oil Cycle chart often as it helps illustrate how the cure for high oil prices is high oil prices, & the cure for low oil prices is low oil prices.

As US shale producers borrowed hundreds of $Billions to reinvest in exploration & production, it increased supply to the point where supply now far outweighs demand. Prices then declined & now we are at the point where, with a 65% slash in prices, these producers are seriously short of cash flow to service their massive debt loads.

Oilcycle

According to Bloomberg, the total debt for half of the 60 producers in its Oil Index has risen to a level that represents 40% of their enterprise value. It’s a sign of distress that shows equity values falling in the face of oil’s crash.

Haynes & Boone’s latest Oil Patch Bankruptcy Monitor shows there are now 36 oil producers who have filed for bankruptcy in 2015. Combined they have a total of over $13 billion in debt outstanding.

With more & more bankruptcies in the sector, we are seeing a huge drop in exploration as the following chart of US rig count shows.  Since June’14, the total rig count has dropped from 1600 to under 600.

Rig count

But even with such a massive drop in exploration, technological advancements have allowed US shale producers to be extremely more productive with their current rigs. In addition, many industries, such as the auto industry are producing much more fuel efficient products, reducing consumption.

So while low oil prices have hammered investors trying to catch a falling knife, buying every dip, for the consumers it has been a boon. If you & your family are not relying on oil revenues, like so many countries are, you are saving a great deal on your energy costs.

As the Oil Cycle chart above shows, these low oil prices will be the cure for low oil prices. As more & more debt indebted companies go bankrupt, we will soon start to see a decrease in production due to the heavy decrease in exploration.

Our model’s original target for oil’s low was $32, with a potential of down to $20. During oil’s decline those who followed our recommendations have already booked gains of 115%, & 74%.

When our model gives a BUY signal we will send out a Flash Report to our paid subscribers. This could be a buying opportunity of a lifetime.

Stay tuned!

FBICyberforce

Feds collecting hoards of personal Internet data

From the Washington Examiner

The FBI has been collecting information about U.S. residents such as friends, political activities and online shopping for more than a decade, the former owner of an Internet company revealed.

The agency has been collecting the personal Internet data through so-called “National Security Letters.”

“For more than a decade, the FBI has been demanding extremely sensitive personal information about private citizens just by issuing letters to online companies like mine,” said Nicholas Merrill, who owned the New York-based Calyx Internet Access.

“The FBI has interpreted its NSL authority to encompass the websites we read, the web searches we conduct, the people we contact, and the places we go. This kind of data reveals the most intimate details of our lives, including our political activities, religious affiliations, private relationships, and even our private thoughts and beliefs,” Merrill said.

Through the letters, which do not require a warrant, the FBI has the right to demand “electronic communications transactional records” from Internet companies. Its power to do so expanded under the Patriot Act of 2001, but the agency has kept complete details of the program a secret.

According to Merrill, some of the information the agency obtains through the letters includes complete web browsing histories; the IP addresses of all those with whom a subject corresponds; and the records of online purchases. A report from the Justice Department’s inspector general indicates the FBI issued more than 400,000 such requests between 2003 and 2011.

Merrill’s announcement came after the federal district court in Manhattan lifted a 2004 gag order that prevented him from divulging the details of National Security Letter requests made of his company.

“Courts cannot, consistent with the First Amendment, simply accept the government’s assertions that disclosure would implicate and create a risk,” Judge Victor Merrero wrote in the Nov. 30 decision.

Following the decision’s release, Merrill added on Twitter, “The FBI should not be able to silence innocent critics like myself — or hide abuses — simply by saying the magic words ‘National Security.'”

Carlin

Saving the Planet

Instead of sending thousands of politicians & bureaucrats to Paris in their private jets to get their picture taken with other politicians, maybe we need to step back & determine what our real role here is on this planet. This link was sent to us from a subscriber on the late George Carlin’s view on “Saving the Planet.”

Note: it is not for those who are close minded or offended by a few f-bombs.

 

interconnected

It’s all connected

Everyone it appears is aware how central banks manipulate their currencies in order to try & stimulate their economies. While central banks can influence the currency markets, often more with talk than action, global currency markets are massive, & the market will always have the final say.

According to the Bank for International Settlements (BIS), in 2014 the Foreign Exchange or Forex market traded an average of $5.3 trillion per day.This dwarfs the global equity market trading volume of approximately $90 billion per day.

So while central banks do manipulate their local currency to some degree, it is the markets that dictate the value of each currency, & the market determines each currency’s value based on a number of factors:

1. Risk
2. Yield on bonds denominated in that currency
3. Supply of that currency in the global markets
4. Capital flows in & out of that currency
5. Assets of the domestic country

Wealthy investors assess what the perceived risk is of a given currency. For example, when Putin invaded Ukraine, over $60 billion worth of Rubles quickly moved into the US dollar in the form of bonds, stocks & cash.

In the past 18 months we have seen a great deal of big European investors move their capital out of the Euro & into the US dollar to avoid losing wealth holding a declining currency.

With energy prices at multi-year lows, countries such as Russia, Venezuela, Saudi Arabia, Libya, Nigeria & even Canada, all saw deep declines in the value of their currency. It all adds up, if your main source of revenue is oil, & the price of oil declines 50%, you can be pretty sure the value of your currency will decline.

Is it any wonder that countries that rely heavily on commodity exports to drive their economy are seeing their currency decline with commodity prices trading at multi-year lows? Below is a chart of the Reuters CRB Commodity Index, & as we can clearly see today’s price is at the lowest level since 2002, & is down 60% from its 2008 high.

CRB

US dollar denominated debt

The US was the front runner in the Quantitative Easing (QE) game, & as they were  heavily pumping out their various QE programs, the interest rates in the US dropped to near 0%. Many Emerging Market companies & governments decided to take advantage of those low US rates & issued debt denominated in $US.

But now as the US rises in value, these companies & countries must pay out yields  & principle on maturing bonds in $US. For many of these countries, their local currency is now 20%-30% lower than the $US than it was when they issued the debt.

Basically, these foreign entities that issued $US denominated debt were shorting the $US. Now that the dollar has been on a tear means Emerging Market companies & countries must pay a much higher cost to cover their debt obligations.

Since our BUY signal to subscribers in early 2014, the $US has appreciated almost 25%, which is a huge move for a major currency.

$US

When big money (wealthy & institutional investors) begins to foresee a risk of holding a depreciating currency, they do not hesitate to move their capital out of these perceived riskier currencies (bonds). Once the big money moves, it often turns in to panic sell.

Emerging Markets in big trouble

For Emerging Markets, as their currencies decline, the cost to service their $US denominated debt rises. But because their revenues are so dependent on commodity prices, as commodity prices hover near multi-year lows, their revenue streams also decline. The market participants see this lose-lose scenario, & capital flees the country & its currency, pushing the value of the currency down even further. It is a viscous cycle

Today there is an estimated $9 trillion in emerging market debt denominated in the $US. No central bank can stop this bubble.

We continue to advise our subscribers to stay long the $US, & short the Euro & Yen. If you are a non-US resident, then look to use any correction (decline) in the $US & exchange your domestic currency for $US.

Note that in time, the $US will come under similar scrutiny, as the US debt situation is about as ugly as it gets.. But Europe is collapsing before our eyes, & so is the Euro. Japan is the next ticking time-bomb, & the Yen will see serious devaluation over the next 1-1.5 years. It is all about timing, first Europe & Japan, then the US.

We are on the verge of global Sovereign Debt Default…it will be the biggest financial crisis in history. It will affect everyone, no matter where you live.

Investment opportunity of a lifetime

This coming crisis will be frightening for most, but those who understand how the global flow of capital dictates the direction of ALL markets will be in a position to profit significantly in this most turbulent time.

As the Sovereign Debt Crisis moves from Europe, to Japan, & then to the US, we will have some enormous buying opportunities. We will be issuing BUY & SELL signals to subscribers over the next 4-5 years that will move in & out of various currencies, precious metals, commodities, & bond markets. We will use many instruments such a shares, & Exchange Traded Funds (ETF).

This coming crisis is going to be a wild rise, but it will also present a once in a lifetime investment opportunity.

If you understand how ALL markets are interconnected, you will have a great opportunity to prosper…if you don’t, you won’t.

Stay tuned!

 

isis

Rising tensions, what does it mean for investors?

Unfortunately, our forecast over the past couple of years for increased geopolitical tensions is coming true.. We have stated a number of times that when ruling governments are in dire financial shape, the politicians realize that they have no solution to solve the financial problems, so they often look for diversions to take the focus away from them.

Certainly Russian President Putin has been a master of these diversions, first invading Ukraine & now with his move in Syria. We are also very suspicious of why Turkey shot down a lone Russian jet. Seriously, there is no way they would have thought that if Russia wanted to attack them, Russia would only send one jet.

Turkey is in horrible shape financially, so we have to wonder if they want to use this incident to unite the people against Russia & divert their attention away from their domestic problems. As more & more countries fall deeper in debt, watch for more of these provocations against other foreign countries.

These politicians feel trapped & they are very dangerous as their main goal is to maintain power at any cost.

This shooting down of a Russian fighter jet follows the ISIS-led attacks in France & the downing of a Russian airliner, & likely the hotel strike in Mali.What we are seeing is a rapidly spreading of attacks, no longer isolated to just the Middle East. .

Who is ISIS?

We hate to use the term ‘terrorist’ to describe the Islamic State of Iraq & Syria (ISIS) because ISIS is far more than some terrorist group, we must think of ISIS as a country. It has a functional government, complete with Ministries of Education, Culture, Justice, Transportation, Energy & military.

ISIS controls a territory almost as large as Britain, lying between eastern Syria and western Iraq. Its headquarters are in  the city of Mosul, a modern, bustling metropolis larger than Philadelphia.

The Islamic State is a well-run organization that combines bureaucratic efficiency & military expertise with a sophisticated use of information technology.  ISIS claims to be the new caliphate & that its leader, Abu Bakr al-Baghdadi, is the caliph.

A Caliphate is a form of Islamic government led by a caliph – a person considered to be the political & religious successor to the prophet Mohammed, & therefore the leader of all Muslims worldwide.

So ISIS is not some terrorist cell that hides in the mountains, it is a very sophisticated organization & it is spreading its reach worldwide.

The rise of ISIS is tearing Europe apart

With its attack on Paris, downing of the Russian jet, & many more attacks to come, ISIS is putting Western countries on alert. Nowhere are the effects being felt more than in Europe.

In addition to the heavily fatalities, of which there no doubt will be more, the financial impact to Europe is going to be massive. With an already declining economy, & high unemployment, Europe is now being swarmed by over 1 million migrants & refugees fleeing the war-torn Syria.  The total numbers could ultimately be several million.

The future of Europe’s Schengen free travel zone was cast into doubt on Friday after France declared that it would impose border controls indefinitely. Germany, Austria, Denmark & other states resurrected long-abandoned border controls in a bid to control the influx of hundreds of thousands of migrants this summer.

As Jean-Claude Jonker, President of the European Union stated, the single currency cannot survive if the free movement of people granted by the passport-free travel zone ends.

“If the spirit leaves our hearts, we will lose more than Schengen. A single currency does not exist if Schengen fails. It is not a neutral concept. It is not banal. It is one of the pillars of the construction of Europe.”

What should investors do?

Typically during during volatile times investors seek out safe havens, such as cash & government bonds. But what happens when it is government that is the problem?

After decades of running massive deficit budgets in virtually every major country, the world is drowning in more than $200 trillion of debt that can never be repaid. So while ISIS & global tensions are contributing to the demise of Europe, it is the level of debt that will be the root cause of the coming Economic Crisis.

Very soon we will see the first of many Sovereign Debt Defaults globally. The first domino will likely be Greece, or Hungary, or Poland or?? It doesn’t really matter who the first one will be. But as soon as the first one declares that it is bankrupt, investors will look around & ask ‘who’s next’?

When people no longer trust the state, the monetary system collapses. It is the result of the collapse in confidence in government.That is when contagion will ramp up, & that is when investors will stampede out of public investments (government bonds) & into private investments (equities, collectibles, fine art, commodities, & precious metals).

To survive & even prosper during volatile economic times we need to follow the global flow of capital. We keep hearing & reading analysts declaring that the US Dollar is going to collapse. Sure the US Dollar will EVENTUALLY collapse, but it is not the problem today. It is all about timing.

Think about it. If you were a well off European where would you want your cash? Would you leave it in a European bank, in Euros, or would you want it in a safer place? In times of trouble, capital flees the area where the trouble exists & flows to areas perceived to be safe. Right now, Europe is collapsing before our eyes, as is the Euro.

Yes, we will see corrections as nothing goes straight to the bottom, but Europe & the Euro are in serious trouble. This is why the US Dollar has been on such a strong run, foreign capital is buying US bonds, US stocks, & US real estate. To do that they need US Dollars. It is nothing more complicated than that.

As an investor, you want to have cash & the cash you want is US Dollars. We have advised non US subscribers for over 18 months now to move a good portion of their cash out of their local currency, & into US Dollars. In Canada, all we had to do was open a $US account in our Canadian bank.

The $US will ultimately decline, but not until after the Yen & Euro see significant declines. Two years ago, we predicted that the Euro may not survive this coming Economic Crisis.  As time passes, that prediction is becoming more & more valid.

While we are about to see the largest Economic Crisis in history, for those who understand what is happening & who follow the global flow of capital, this will be an investment opportunity of a lifetime.

Stay tuned!

tanker

Goldman eyes $20 oil as glut overwhelms storage sites

From , Telegraph

The world is running out of storage facilities for surging supplies of oil and may soon exhaust tanker space offshore, raising the chances of a violent plunge in crude prices over coming weeks, experts have warned.

Goldman Sachs told clients that the increasing glut of oil on the global market has combined with mild weather from a freak El Nino this winter. The twin-effect could send prices plummeting to $20 a barrel, the so-called ‘cash cost’ that forces drillers to abandon production. “Risks of a sharp leg lower remain elevated,” it said.

Oil has fallen from $110 a barrel early last year and is hovering near $40 for US crude, and $44 for Brent in Europe.

The US investment bank said the overall glut in the commodity markets may take another twelve months to clear. It cited ‘red flag’ signals on the Shanghai Future Exchange over recent days. Copper contracts point to “imminent weakening” in China’s ‘old economy’ of heavy industry and construction, it said.

wtivsbrent

The warnings came as OPEC producers and Russian companies fight a cut-throat battle for market share in Europe and Asia. Saudi Arabia is shipping crude to Poland and Sweden for the first time, poaching new customers in the Kremlin’s traditional backyard.

Iraq is selling its low grade ‘Basra heavy’ crude on global markets for as little as $30 a barrel as the country runs out of operating cash and is forced to cut funding for anti-ISIS militias. Iraq is seeking a large rescue loan from the International Monetary Fund. “The drop in oil prices is a difficult test for us,” said premier Haider al-Abadi.

It is estimated that at least 100m barrels are now being stored on tankers offshore, waiting for better prices. A queue of 39 vessels carrying 28m barrels is laid up outside the Texas port of Galveston, while the Iranians have a further 30m barrels offshore ready to sell as soon as sanctions are lifted.

“The world is floating in oil, and commercial stocks on land are at a record high,” said David Hufton, head of oil brokers PVM Group. “The numbers we are facing now are dreadful. Stocks have been building continuously for two years. This is unprecedented.”

“What has saved us so far is that China has been buying 200,000 to 300,000 barrels a day (b/d) for their strategic reserve,” he said.

oil_stocks

It is unclear exactly how much more space China may have. The Chinese authorities certainly want to keep building stocks – and do so at bargain prices – since reserves cover just 50 days demand, far short of the 90-day minimum recommended by the International Energy Agency. But the new storage depots in Gansu and Xinjiang will not be ready until the end of the year, at the earliest.

Data from the US Energy Department shows that America’s storage sites are 70pc full, in theory leaving room for another 150m barrels. But this is already tight enough to create regional bottlenecks. It will not be sufficient if OPEC continues to flood the global market in a bid to drive out rivals. Excess supply is running near 2m b/d.

Saudi Arabia and its key Gulf allies are staying the course for now, convinced that their strategy is paying off as the fall in the US rig-count leads – with a lag of several months – to a significant drop in shale output. Some $200bn of long-term projects have been cancelled around the world, notably in deep waters, the Arctic, and the Canadian tar sands, but most of this has no immediate effect on prices.

oil rig count

Ali al-Naimi, Saudi Arabia’s oil minister, said global demand is recovering and prices will rebound next year as the market comes back into balance. The greater risk is a lack investment in future supply as the ‘decline rate’ on existing fields accelerates to 4pc a year or even higher. “We need billions of dollars to continue exploration and producing oil,” he said.

The IEA said in its World Energy Outlook last week that it takes $650bn of fresh investment each year just to stand still.

It is an open question whether Mr al-Naimi’s soothing words will assuage Algeria, Venezuela, Libya, Nigeria, Iran, and others when they gather for a fractious OPEC meeting in Vienna on December 4. Saudi assurances that prices would soon rebound have proved wrong time and again over recent months.

The majority of the cartel favours an output cut to stop the pain. The mood is now so tense that OPEC has had to suspend publication of its long-term strategy report, ostensibly due to a dispute over what constitutes a “fair” price but in reality due to a deeper clash over the likely future of the oil industry as renewable technology advances by leaps and bounds, and world leaders commit to sweeping curbs on carbon emissions.

Views are deeply polarized over whether it is even possible to stop the US shale juggernaut in any meaningful sense. Paul Horsnell from Standard Chartered expects oil output in the US to fall by 900,000 barrels next year: enough to clear the glut, given that global demand is rising by roughly 1m b/d.

In stark contrast, Seth Kleinman from Citigroup said US production is likely to remain steady at around 9m b/d next year, so long as prices remain near $50. Output will rise by roughly 300,000 b/d for each $5 increase in price above that.

If so, this is a meagre result for the cartel, which has lost half a trillion dollars of revenue since the oil crash kicked off in mid-2014. Several OPEC states are in dire straits. Even the Saudis have been downgraded by Standard & Poor’s and are facing a budget crunch.

US weekly oil supply

OPEC was slow to understand the rising threat posed by the US shale industry. It may now have misjudged its resilience. Frackers have been quick to cut costs with multiple pad-drilling, and they can revive production relatively quickly as soon as prices recover.

Goldman Sachs said the deeper the fall in oil prices over coming months, the sharper the rebound later, comparing it to the cycles after 1986, 1988, and 1998.

OPEC needs a higher price to fund the social welfare nets and defence spending of its members. The great question is whether US shale will snap back within months and regain its market share as soon as OPEC tries to test the waters again`. This strategic showdown may end in an inconclusive draw.

 

oiltanker

Good indicator why Oil prices continue to decline

We get quite a bit of email questioning our bearish stand with oil. Today oil is trading just above $40, & yes we still expect yo see low $30 oil before we will see $60 oil.

Oil is a classic ‘boom & bust’ sector, & is driven by supply & demand. While every sector experiences bullish & bearish extremes, none experience them more than oil.

pendulum

There is a saying… “the cure for low oil prices is low oil prices.”  Oil price move in distinct cycles, where as prices rise, produces open up the spigots, wanting to capitalize on those higher prices. From January 2011 to November 2015, the price of oil traded between $80 & $115…for oil producers, that’s when they want to ramp up production to reap the gains.

oil4yr

As the prices increased so did production, until starting in November 2014, when the supply of oil started to outpace the demand. It is as simple as that. Historically, when prices declined too quickly, OPEC would step in & slow down production. But this time they didn’t. Because it was the American shale producers who were adding the biggest net production volumes, OPEC, particularly the Saudis, decided to play a game of chicken, keeping the spigots open.

Today we are at a point where all of the storage facilities are full, & we now have an estimated 100 million barrels of oil sitting in tankers at sea, waiting for storage space on land to free up. Much of this oil was owned by speculators who were hoping to profit on the August price decline to under $40. Now they are having to pay for storage on these ships, & you know some of these speculators are sweating bullets as the price flirts with setting new lows.

flotila

While production is still far outpacing demand,  things will change, as the cycle works its way through. We showed this chart a week ago & it clearly demonstrates that US oil producers  have been shutting down capital expenditure (CapEx). They are still pumping out as much oil as they can from current sources, but they are not spending money looking for new sources. We can see here that rig counts have dropped from 1600 a year ago to less than 600 today.

Rig count

On the oil cycle we are now at the level where low prices will force these producers to cut production. Once we get there, then supplies will decline & the pendulum will reach an bearish extreme. But in order to get there, we need to see lower prices. Ultimately, lower pirces will lead to under supply & then we will see prices rise again.

Oil cycle