Oil


Please read new post:

The last bubble in the investment desert

Today I want to post something completely different. 75 years ago there was the biggest battle in history of humanity – the Battle of Stalingrad. A rough estimate is for 2 million of total military deaths, maybe a bit less. For 199 days of fighting it would be about 10,000 soldiers killed daily, i.e. if you take our total losses in Iraq since 2003 of 3,923 soldiers – back then that kind of casualties would happen from morning till noon of one day.

I think I saw about 50 different movies about WWII, but if you want to get a complete feeling about that war I would recommend to see “Enemy at the Gates“. No other movie I saw would give that much of understanding of that war, in my opinion.

Essentially the battle of Stalingrad was all about oil (the same Greenspan said about Iraq war – that’s oil, stupid). Germans tried to get access to oil fields of south of Russia and they failed. From that point the Nazis were doomed and the rest of the war was just finishing the inevitable.

Today I just want to say two things. First, I want to wish everyone that humanity stops fighting for resources. I understand that the war can happen when neighbors are trying to dispute some land, that happens all the time. But when a powerful country attacks someone to get its oil it’s outright disgusting. Are we not strong enough to just buy what we want? Why should we kill?

And second I want to celebrate the German soldier. It was so many flowers for the right side that I think we need to pay some respect to those who were sent to fight for the wrong side, and they were fighting like tigers. They were not criminals, they were just good soldiers.

Look at the casualties. I will list only those countries that were the most furious fighters, and I list only military deaths:

Axis side

  • Germany 5,533,000
  • Italy 301,400
  • Romania 300,000

Allies side

  • Soviet Union 10,700,000
  • Yugoslavia 446,000
  • USA 416,800
  • UK 382,600
  • France 212,000
  • Poland 160,000

It makes 5,930,000 for Axis and 12,316,000 for Allies. In other words, it took a life of two Allies soldiers to kill one German. I think the Germans were the real heroes! I’m paying my respect to both sides…

P.S. In the light of those numbers please recall the movie “Saving Private Ryan“. There a group of 15 American soldiers was fighting against the similar group of Germans and the fight was pretty much equal. Think a bit. You take American rookies who are at real war for the third day in their life against German commandos that were fighting non-stop for the previous 6 years and they can fight at equal foot! Total nonsense! In real life it would take 40 or 50 Americans to have an equal fight against 15 Germans. You can’t learn history on movies like that…

Few days ago I’ve posted my little theory that the Feds are conducting the harsh and unusual drain of funds to protect the important psychological barrier of $100 for a barrel oil.

The drain killed the Christmas rally and brought the markets on the verge of the technical breakdown. Today Feds did one final drain and the market, in its eternal stupidity, finally got the massage by sharply dropping the oil below $95.

Now the Feds may finally relax and I expect the increase of funds tomorrow. Then we’ll have the Jan 14 Taffy broo-ha-ha and I think the markets can go up for at least two weeks, because when lunatics get money they buy stocks, recession be damned.

By the end of the month the weight of negative earning surprises will finally take over the market and the rally will be over, but for now the party is on!

And because the recession will be already evident by February – believe me or not – I think that last week we saw the $100 oil for the last time for the next 5 years. Down she goes from now :-)

Update: What I gave you was an optimistic scenario based on my believe into Fed consciousness. Darth Toll gave a very ominous scenario down in the comments. I hope he’s wrong but my hope is thin

Oh, what a year it will be, even compared with all the turbulences of 2007!

Before going into the forecast let me wish you from all my heart to be surrounded by love and friendship that will help you to go through the tough times, good luck to avoid what is not under your control and the brain to change what you can! If those wishes materialize – believe me – you will be fine :-)

Recession

I do not make any recession call for 2008, because we are already in the recession since December of 2007. But my forecast is that the recession won’t be over this year

Credit crunch

The important feature of credit crunch is that it happens fast. Remember, the over-hyped Blackstone (the flagship crazy loaner) IPO was a huge success at June 21st and the full-scale credit crunch happened at August 10.

In 2007 the credit crunch was all about subprime mortgages, while in fact it was just the first wheel that came off. We will have some more major credit problems to develop in 2008:

  • Mortgages in general, including prime loans. Option ARMs – mortgages made for people who didn’t plan to pay from the day one
  • Commercial real estate
  • Credit cards
  • Auto loans
  • Municipal bonds

Each of those problems will come out of blue sky and cause major losses and panic across the board

Real estate

Whatever metric you chose there is no bottom in 2008 and it’s too early to say when that will bottom. For the details go to Calculated Risk, he’s the RE boss :-)

Major bankruptcies

It takes time for a company to bankrupt and even then most corporations finally do survive and re-emerge back from the bankruptcy, like Delta Airlines did. I have a list of companies that will bankrupt by 2010, but some of them (2 or 3) will seek the chapter 11 protection as soon as in 2008:

  • Countrywide
  • Washington Mutual – when this happens, it will be blood on the streets
  • Bkuna
  • Downey Financial
  • Chrysler (restructuring through bk, nothing special)
  • Standard Pacific
  • Beazer Homes
  • Hovnanian
  • Major problems (but no bankruptcy) for Fannie and Freddie

Stock market

The only thing I can say for sure is that we will be in the bear market for the whole year, with the first leg down in February. I have no idea how far down it will go – 5%? 30%? Who knows…

There are couple of sectors that will bottom and start drifting up already this year. That will be:

  • Utilities
  • Consumer staples
  • Financials. Yes, I’m not kidding. It will be a horrible year for financials but that will be a bottom, at some point. Two more panics like we had in August and I’m buying the big-cap banks and broker dealers, but not the small regional banks, those will not recover for years. I think the best day to go long will be a day when Washington Mutual goes bankrupt
  • Maybe Transports, hard to say

There are some sectors that will enter (or stay in) a violent bear market and have no recovery in 2008:

  • Cyclicals, Industrials
  • Consumer discretionary
  • Materials
  • Commercial real estate, REITs
  • Mortgage lenders, homebuilders

I have no doubt that the market in general will not bottom this year, but I will have many long positions going into year end, as I have many longs right now

Emerging markets

I think the first cracks in the Chinese economy will happen as soon as this year. They have three related major problems, each of nightmarish scale:

  • Almost all of the Chinese economy is very cyclical, they have very little counter-cyclical exposure. It’s similar to the industrialization in US back in 1920s. Moreover, the majority of industrial production is operating at the tiny margin, even no, when there is a boom, many businesses are operating at loss and receive government help. In comparison, US economy in 1920s had much better profit margins
  • Hundreds of millions of peasants left the countryside to work in cities for $1-$3 per day. They have no savings, no property. When the factory they work on finally bankrupt they will run out of food within days. There is no proper infrastructure to feed them, the only solution to the problem they will have is to take some weapons and kill for food, and there will be many millions of people like that. There will be blood on the streets
  • The Chinese middle class is fully invested at margin into grossly overvalued stock market. When market will start tanking for real it will have no bids, the 80% decline top to bottom is pretty much my target. This again reminds US in 1920s.

China is heavily dependent on the exports into Western world, and when the downturn happens we will have the upper hand. We can live with less imported junk, they can’t scale back. When we sneeze they’ll get sick, when we get sick, they will be in coma

Energy

I think oil will stay in the trading range until Chinese Olympics, probably making a last run to $100. After that the downturn will be so obvious that we’ll see $85 this year and $60-$70 in 2009. At some point oil will kiss $50, but it will be years from now, unless some kind of war happens

I want to partially answer a very nice comment from Tech Guy here. The main concern here is that we probably passed the peak of oil output back in 2005 and it seems that we will never ever reach the same output as it was two years ago.

It seems like it’s true. But let me to point out at the supply-demand part of the equation. I think for this economic cycle the oil bull market is almost over. It will probably do the last hoorrah run to $110 and then we’ll go into the bear market and I think oil will go as low as $50. Consumption will be pretty low. Lets talk about the next cycle.

We have all kind of oil depending on its price. I think we have only few months left of $50 oil and few years of $60 oil. (All prices are in current dollars, inflation adjusted for the future).

We probably have another 10 years of $70 oil and 20 years of $90 oil. But when the price goes up the consumption period will extend. I think we have at least 50 years of $150 oil and maybe 200 years of $200 oil. That (250 years) should be enough to finally come with fusion power. Nice job for our grand-sons :-)

What $150 oil means to us? I think we don’t need to go far for examples. The whole Europe is effectively living in the $150 oil for the last 5-10 years. The $6-$8 price per gallon is pretty much what it means. As far as I (and you) can see Europe is doing just fine. And I think we’ll be doing fine, after the coming economic crisis will make all the necessary adjustments.

Of course the low and middle-class people will not commute 20+ miles anymore. The suburbia will be left to upper middle class and most people will just move close to work. Believe me, it’s absolutely nothing wrong in living in the apartment in the 20 story apartment building and using mass transit for a short 3-5 miles commute to work. A billion of people is living like that and our population will live like that as soon as in 20 years. The upper mid class will still occupy the suburbia, but they will move closer to work, maybe 10-15 miles, no more than that. The railroads and 40+ miles/gallon cars will provide perfect and affordable transportation. As another alternative a short 3-5 miles trip to the nearest park-and-ride facility will do the job. Of course the bear market in suburbia real estate will continue as long as I see from now and going forward. A lot of homes will have to be abandoned and owned by Chinese and Middle-East investors.

I’m not pessimistic at all, oil has to be expensive and it will be, we will adopt perfectly well, we will just live differently

We all know from the sector rotation theory that the energy sector is the last sector to grow in every economic expansion and the energy/staples ratio turns around to decline when economy starts contracting.

So far we can’t say yet that the XLE chart is topping, though it’s possible that it is. What we can say is that the attitude of big oil companies toward oil price changed dramatically. All the last few years any price increase in oil was automatically translated into profits.

Not anymore. When oil is at record $95 and gasoline in US is far from last year maximum the profit margin is squeezed. The reason is that the consumers are not willing to pay more, they reduce the driving instead. Look at the chart:

gas to oil

Don’t you agree that the gasoline/oil ration is in the bear market?

The conclusion is that the big oil corporations are not happy anymore about the high oil prices. And I think that they have enough of financial and political power to start driving those prices down. It can’t be fast, it will take months, but we’ll see much lower oil prices next year.

And once the XLE starts declining the bull market is over

Look at one of the junk bond indices:

junk october

It is forming some kind of triangle with a decision point set to tomorrow. Sometimes I wonder how beautiful the chart dances are. The chart is just pointing into Fed decision day and then we’ll see a breakout either up or down and this move will be significant. I recommend watching junk bonds tomorrow – HYG, AFBIX, SHIAX. Whatever they do stocks will follow later.

It is pretty much given that Feds will cut 25bp tomorrow. The action in oil was orchestrated to give Feds the excuse to cut without being accused to disregard the high earl prices. But even as we know what will happen it is absolutely impossible to predict what the market will do. The only thing I know is that tomorrow the smart money team will make a good damage to stupid money.

As I think the smart money are very well aware of what is happening with various SIVs in the lite of recent action in ABX and asset-based commercial papers they will probably play bear. If not then I’m likely to lose some money as I’m a bear

The Commercial Paper report is just out, the decline of outstanding paper is another $13 bln for the last week, but it’s better comparing with pre-cut decline of $48 bln. The total decline from end of July is 15% comparing with 22% decline during the 2000-2002 period. The speed of decline is astonishing.

The price to fix the credit markets is high:

  • Dollar is at all-time low right now. Not just 20-year low, 40-year low. It’s the lowest level on record
  • Oil is all-time high
  • Gold is 25-year high

I don’t think Bernanke has a room to cut in October, unless credit markets will be materially worse

Cheaper oil means more money for other things, i.e. stocks must go up, right?

Wrong.

The Gulf nations are selling 25% of their oil to U.S. and then they invest 50% of account surplus back into U.S. economy. That means, for every $1 we pay for oil we get $2 back in investments, mostly going to Treasuries and stocks. So, when oil drops the amount of money Saudi Sheiks are investing into our stock market drops even more. Figure out.

As I was worried a little about today surprising drop in crude inventories and was struggling to find the reason, I fell into very nice article titled “Stop Counting Crude Inventories“, which explains it all. I suppose we can put the crude story to rest.

Next Page »

Follow

Get every new post delivered to your Inbox.